May 13, 2022 – From 2009 to 2021, central banks’ easy-money policies dominated the investor psyche.
Specifically, low inflation lulled central banks into complacency, permitting the monetary policy authorities to keep financial conditions too easy for too long.
These easy-money policies pushed investors into a false sense of security, believing that stock prices were never too high nor bond yields too low to invest.
The relentless money-printing and artificially low rates of central banks caused investors to justify this TINA investing – There Is No Alternative – by focusing their portfolios where stimulus money was priming the pump.
Specifically, the central banks’ stimulus pushed up stock and bond prices. Investors followed their lead, creating a positive feedback loop in which higher prices begot higher prices.
And it worked until it didn’t.
With inflation spiraling out of control, central banks are rapidly withdrawing stimulus, implementing quantitative tightening and raising interest rates. The Fed has finally removed the punch bowl.
The past dozen years’ easy-money policies are now reversing. Given these stimulative policies caused the rapid increase in stock and bond prices, a lengthy cycle of asset price declines only makes sense.
Clearly, the deflating of several asset bubbles has commenced. For example, in April, U.S. stocks were down -8.7%, Canadian stocks were down -4.9% and bonds were down -9.4%.
Now, with stocks and bonds both down significantly, investors are paying the price.
Nonetheless, the buy the dip mentality remains pervasive.
However, after years of speculative excess, a double-digit decline has not left stock prices cheap.
As seen below, the S&P 500 (white line) remains at an above-average valuation of 16x next year’s earnings, while the TSX (orange line) trades at a more-reasonable 12x forecast earnings.
Source: Bloomberg
In any event, those who have bought the dip have been punished, and the punishment will continue until valuations improve.
The inflation outlook is poor. The notion parrotted by central bankers that rapid consumer price increases were transitory in nature has been definitively discredited.
That being said, inflationary pressures cannot be left unchecked. Decisive action from central banks is necessary to tame the scourge of inflation.
Meanwhile, the acronym TINA never made sense – There Were Always Alternatives.
For example, during April’s market meltdown, the S&P 500 dropped nearly -9%, and Accelerate’s HDGE was up +7.5%. During the five latest equity market drawdowns, including the double-digit decline of March 2020, HDGE was up.
Source: Accelerate, Bloomberg
Alternative investments provide differentiated return streams that can be uncorrelated or even negatively correlated to traditional asset classes. Uncorrelated return streams represent the core principle of diversification. Adding more stocks to a stock portfolio does not constitute diversification.
While some investors may be late in discovering the power of diversification, it is never too late to spread an investor’s bets across asset classes to improve a portfolio’s risk-adjusted return.
Accelerate manages five alternative ETFs, each with a specific mandate:
- Accelerate Arbitrage Fund (TSX: ARB): SPAC and merger arbitrage
- Accelerate Absolute Return Hedge Fund (TSX: HDGE): Long-short equity
- Accelerate OneChoice Alternative Portfolio ETF (TSX; ONEC): Alternatives portfolio solution
- Accelerate Enhanced Canadian Benchmark Alternative Fund (TSX: ATSX): Buffered index
- Accelerate Carbon-Negative Bitcoin ETF (TSX: ABTC): Eco-friendly bitcoin
ARB was approximately flat in a month in which other asset classes experienced significant volatility, showcasing the strategy’s uncorrelated return stream and downside protection in turbulent markets.
SPAC arbitrage continues to be a calm place to hide to weather the equity and bond market storm. The principal-protected nature of SPACs, which effectively offer the ability to buy redeemable T-bills at approximately 97 cents on the dollar, gives investors confidence in their portfolios when it is most needed.
Nonetheless, we have seen an extensive widening of SPAC arbitrage and merger arbitrage spreads.
This arbitrage spread widening has two leading causes. First, rapidly rising interest rates caused arbitrageurs to demand higher returns. Risk premia, manifested through arbitrage spreads, are priced off the risk-free rate. Higher interest rates mean higher arbitrage yields.
Second, elevated market volatility raises risk premia. As volatility increases, the risk premium an arbitrageur requires goes up. The result is higher arbitrage yields.
On a positive note, arbitrage trades tend to be of low duration. In fact, the weighted average duration of the ARB portfolio is just 4.7 months.
In any event, ARB continues to hold up in a tough tape. Its benchmark, the S&P Merger Arbitrage Index Total Return, fell -1.1% in April and has sunk -3.6% year-to-date.
HDGE rose 7.5% in April, its monthly result buoyed by its short portfolio.Long-short factor portfolios knocked it out of the park last month. Long-short value, quality, price momentum and trend all notched double-digit returns.
The short exposures drove this dramatic outperformance of the long-short factor portfolios. Specifically, low-quality “junk” stocks were smoked last month.
These same junk stocks experienced explosive share price performance in 2020, after the Covid bear market. This unprecedented rally in junk stocks was indisputably caused by excessive central bank stimulus.
Now that the Fed has reversed its easy-money policies, junk stocks are crashing, as expected. We continue to believe this trend will take multiple years to play out, as it did through the tech bubble collapse 22 years ago.
HDGE remains long high-quality stocks with attractive valuations, good price momentum, solid operating momentum and a positive share price trend, while remaining short low-quality, overvalued glamour stocks with poor price momentum, bad operating momentum and a negative share price trend.
ONEC declined -1.7% in Apil.
Long-short equity was the stand-out performer with a 7.5% gain. Arbitrage hung in there with flat performance.
Leveraged loans, mortgages and infrastructure allocations declined less than -1%. Negative performance was driven mainly by risk parity, down -8.3%, and bitcoin, which fell -16.5%.
Nonetheless, ONEC’s diversified alternative asset allocation, consisting of 6 alternative asset classes and 10 alternative strategies, buoyed the performance of the traditional 60/40 portfolio during a challenging time for risk assets.
ATSX fell -2.3% in April, outperforming the TSX 60’s -4.9% drop by 260 bps.
Down markets are typically when ATSX outperforms its benchmark, given the defensive nature of its long-short overlay portfolio.
The Canadian multifactor long-short overlay portfolio generated gains from its longs and shorts. Massive divergences between growth and value, low-quality and high-quality, and negative momentum and positive momentum, have created one of the best environments for long-short equity.
ATSX has maintained a positive YTD performance as the majority of equity strategies have declined while maintaining a long-term, double-digit annualized return since inception. The Fund’s alpha + beta approach, whose beta exposure provides upside participation while its alpha overlay provides downside protection, has allowed investors to outperform the benchmark with lower volatility both year-to-date and since inception.
Have questions about Accelerate’s investment strategies? Click below to book a call with me:
-Julian
Disclaimer: This distribution does not constitute investment, legal or tax advice. Data provided in this distribution should not be viewed as a recommendation or solicitation of an offer to buy or sell any securities or investment strategies. The information in this distribution is based on current market conditions and may fluctuate and change in the future. No representation or warranty, expressed or implied, is made on behalf of Accelerate Financial Technologies Inc. (“Accelerate”) as to the accuracy or completeness of the information contained herein. Accelerate does not accept any liability for any direct, indirect or consequential loss or damage suffered by any person as a result of relying on all or any part of this research and any liability is expressly disclaimed. Past performance is not indicative of future results. Visit www.AccelerateShares.com for more information.
