A Continued Focus On Process

December 30, 2021

A bad system will beat a good person every time.

—W. Edwards Deming

It’s that time of year for, “40 New Year’s Resolution Ideas to Start 2022 Right,” or, “22 New Year’s Resolutions You Can Actually Keep in 2022.” It is thought that we (humans) have been setting New Year’s Resolutions for nearly 4,000 years. Several studies indicate that roughly eight of 10 resolutions fail. That is a staggering number of bad processes over the last 40 centuries!

James Clear, the author of “Atomic Habits,” sums up the problem well: “New goals don’t deliver new results. New lifestyles do. And a lifestyle is not an outcome, it is a process. For this reason, all of your energy should go into building better habits, not chasing better results.”

We find this to be analogous to the investing and planning process. The client’s desire for a specific outcome is often the impediment for achieving that outcome. Instead, a focus on the process itself keeps clients aligned with the appropriate behaviors necessary to arrive at the determined destination, ultimately achieving their goals.

In this month’s Co-Founders’ Note we discuss the value of having a trend following investment process, especially during the time of year when predictions run rampant. Having a process empowers you to ignore willy-nilly predictions altogether and gives you the blueprint for how to react to various market conditions.

But first, here’s a summary of our take on what transpired in the markets in December.

Asset-Level Overview: Market Talking Points for Financial Advisors

Equities & Real Estate

A volatile month in U.S. equities is poised to end on a positive, with most major market indices closing out 2021 near all-time highs. After starting the month by continuing the decline from the last few days of November, stocks rallied to briefly make or challenge new highs before retreating once again at mid-month. This was followed by a furious Santa Claus rally, which pushed most indices to new highs. As expected, the result is that Blueprint Investment Partners will continue to be overweight U.S. equities, particularly large caps, as we enter the New Year.

As has become a theme in our updates, international stocks continued to lag their U.S. counterparts, despite also being positive for December. This outcome once again illustrates the risk mitigating aspect of trend following, which has sidestepped declines in emerging markets. It also highlights the opportunistic nature of our process, which redistributes allocations from weaker developed equities to surging U.S. stocks. The combination of these tactical shifts has led to significant outperformance versus comparable benchmarks in 2021.

Also contributing to the outperformance has been the persistently large allocation to real estate securities. The astounding 30%+ return in this asset class has produced considerable, positive attribution to Blueprint Investment Partners portfolios in 2021. As expected, this allocation remains at its maximum as we enter 2022.

Our Asset Allocations

Fixed Income & Alts

The storyline for fixed income in 2021 centered on weakness in the short and intermediate sections of the yield curve, with the long-end and inflation-protected securities holding up relatively better. For December this continued to be the case, as both aggregate U.S. bonds and international bonds are on pace for another negative month in a negative year for the asset class. Though still positive for the year, inflation-protected bonds are also down for the month. Blueprint Investment Partners portfolios reflect the current dynamics of this asset class by favoring inflation protection and longer or very short duration.

After declining from their peak in October, commodities, like stocks, have generally moved higher to close December. The notable exception has been precious metals, such as gold, which has failed to gain significant traction and continues to move sideways. For now, Blueprint Investment Partners portfolios have minimum allocations, allowing for greater exposure in stronger U.S. equities.

Our Asset Allocations

3 Potential Catalysts for Trend Changes: Giving Clients the Context

Growth Estimates: Rising COVID-19 infection rates, inflationary pressures, and labor shortages slowed the economic recovery in the U.S. this month. Surveys of purchasing managers released December 16 showed that in the early weeks of December U.S. business activity continued to expand but at the slowest pace in three months, despite strong demand from customers. However, U.S. economic output is set to expand by more than 7% annualized in the final three months of the year, according to early estimates from the Federal Reserve Bank of Atlanta. That compares with expected annualized growth of about 2% in the eurozone and 4% in China for the fourth quarter, according to JPMorgan Chase.

Inflation, Inflation, Inflation: U.S. inflation last month rose at the fastest pace since 1982. The Personal Consumption Expenditures (PCE) Price Index increased 5.7% from one year earlier in November. Excluding often-volatile food and energy prices, core inflation was up 4.7%, the sharpest annual increase since 1989. The PCE is the Federal Reserve’s preferred inflation gauge versus the often-quoted Consumer Price Index gauge. For context, the Fed historically targets 2% annual price increases.

No Baby Boom: America’s population grew 0.1% this year, the lowest rate on record, according to Census Bureau figures. The U.S. added just 393,000 people in the year that ended July 1 for a total population of 331.9 million. Population growth had averaged more than 2 million a year over the last decade, though it had been slowing even before the pandemic. Population growth is a key long-term driver of GDP growth.

Process Versus Outcome

The things best to know are first principles and causes, but these things are perhaps the most difficult for men to grasp, for they are farthest removed from the senses.

—Aristotle

As we wrap up 2021, let’s take inventory. First, here’s a high-level snapshot of performance for a few major asset classes.

S&P 500: +29.4%
ACWI: +19.0%
Agg Bond Index: -1.9%
Commodities: +40.4%
Source: Morningstar, as of December 29. S&P 500 = ETF:SPY, ACWI = ETF:ACWI, Agg Bond Index = ETF:AGG, Commodities = ETF:GSG.

The S&P 500 had what can only be described as an incredible year, rising 29.4% and making 70 new all-time highs (only 1995 has more). And all of that without a daily drawdown of greater than 5.1%. But, surveying the macrosphere, U.S. stocks now appear to be grossly overvalued:

The Buffett Indicator of market cap to GDP is at all-time highs
Shiller CAPE ratio near all-time highs (only tech bubble is higher)
S&P 500 price-to-sales ratio is at an all-time high

Like I said, overvalued…Or is it?

There are also many commentators, managers, and research analysts who say stocks are undervalued because of these factors:

The S&P 500 P/E to start was 22.5x, but the “earnings” in the P/E ratio are up 36% this year, prices are +26%, and the P/E is down to 20.8x (source: FactSet)
Historically strong S&P 500 revenue and operating earnings growth
Negative real interest rates

So, here’s the summary:

Stocks: all-time highs
S. home prices: all-time highs
S. wages: all-time highs
Job openings minus unemployed persons: all-time highs
Inflation: highest since 1982

With all the noise and contradictory data, how do you keep yourself and clients focused on what’s most important? The answer is process.

We talk often about our systematic process and how the “secret sauce” is not complex algorithms but elegant rules combined with disciplined execution. Thus, employing a comprehensive planning process to codify a client’s long-term financial goals is only part of the equation. We’ve found that while goals are integral for designing progress, systems and processes are essential for making progress.

As we enter 2022, instead of making resolutions, how about you instead conduct a thorough review of your critical processes? It’s certainly not as fun as thinking about the goal itself, but as the data shows, without these processes the likelihood of you or your clients accomplishing the desired result decreases dramatically. In our opinion, it is best to maximize our odds of reaching the goal by minimizing the chance of being wrong in a big way. That is what a robust process can do.

From a market perspective, Blueprint Investment Partners has just one goal in 2022, and that is to follow our process. We saw the benefit of this laser-focus in 2021. Who could’ve imagined that 2021 would result in such a positive year for U.S. stocks? Or that real estate would outperform equities despite rising interest rates? Our trend following process had no opinion about the future direction of asset classes and yet gave us the best chance of being positioned appropriately. Any second guessing, opinions, or supposed foresight would have cost us in 2021. We suspect the same will apply going forward, and therefore our focus will remain on executing our process.