Systematic Investing Is a Flight to Safety

February 28, 2022

Adaptability is being able to adjust to any situation at any given time.

—John Wooden

Global markets continued to decline in February, as the downside volatility that began in early January continued to permeate nearly all major asset classes. From its high January 4 to the low February 24, the S&P 500 declined 14.4%, its largest drawdown since the Coronacrash in March 2020.

In our conversations with advisors and other professional money managers, one refrain stands out: “In February, there was nowhere to hide!” Whether considering stocks; real estate; crypto; or bonds of all durations, credit quality, and type, February was somewhat unique in that context. In fact, government bond prices, typically thought of as a “safe haven” when stocks decline, fell as 10-year rates rose nearly 14 basis points during the month.

Given the recent news around Russia, inflation, and rising rates, how does one go about designing a strategy to account for these economic and geopolitical risks? In our view, you don’t. Each environment is unique, with the speed, context, and timing being different for each. Our approach to designing systematic investing strategies is based on the one variable that is relevant in all market environments and for all asset classes: price.

In this month’s Co-Founders’ Note we discuss the necessary tradeoffs required to remain adaptable in all market environments. We discuss the idea that by acknowledging that the future is unknowable, one can still design a set of rules to deliver a repeatable and consistent process for making asset allocation decisions.

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

Asset-Level Overview: Market Talking Points for Financial Advisors

Equities & Real Estate

Continuing their behavior from January, equities declined in February. Growth stocks in general, and technology stocks specifically, lead the way downward. These two segments experienced year-to-date losses of over 12%.

U.S. large caps and real estate experienced significant weakness to begin the year, with year-to-date declines at approximately 8% and 10%, respectively. The historically more conservative value and dividend stocks also produced losses in February, as they near downtrends. At the asset class level, U.S. equity and real estate exposure will not change in Blueprint Investment Partners portfolios for March, as we await a long-term trend change.

International equities remained a relative bright spot but, like their U.S. counterparts, declined in February and remain in downtrends across all timeframes. Emerging markets nearly missed its first intermediate-term uptrend since last summer but ultimately declined, driven largely by the Russia-Ukraine conflict. As a result, Blueprint Investment Partners portfolios remain at minimum exposure to international equities.

To summarize, our equity exposure remains concentrated to the U.S., and our strategies that utilize individual equities continue to migrate from growth and technology to value and dividend-oriented stocks. Real estate exposure will not change but is nearing a possible decline for April, barring a sharp recovery within the next 31 days. Though relatively stronger in 2022, international stocks remain in downtrends and thus exposure will remain minimal, though poised to potentially increase soon.

Our Asset Allocations

Fixed Income & Alts

It may sound like a broken record at this point, but fixed income remained weak after declining once again in February. Uptrends remain far from sight, as almost all segments within this class experienced new lows since the declines began in the summer of 2020. The result is that Blueprint Investment Partners portfolios will continue to have minimum exposure to fixed income positions of any duration, favoring ultra-short-term bonds, which have the least interest rate sensitivity.

After a long period of consolidation, gold produced a positive return in February, as the conflict in Ukraine led to it being one of the few “flight to safety” assets. After increasing our exposure going into February, Blueprint Investment Partners portfolios will once again increase exposure to our maximum, pulling this exposure from ultra-short-term bonds.

Our Asset Allocations

3 Potential Catalysts for Trend Changes: Giving Clients the Context

Invasion: Russia’s invasion of Ukraine heaped additional risks on a global economy already struggling with inflation, supply-chain congestion, and a rocky recovery from the pandemic. The economic impact of the invasion will depend on the scale of the fighting and the effectiveness of the new sanctions the U.S. and its allies have enacted.

Oil Shock: A global oil benchmark surged above $100 a barrel for the first time since 2014. While Ukraine isn’t a big oil producer, Russia is one of the world’s largest and most influential crude-market players. Russia is also the single largest exporter of natural gas, and the country’s military push poses another threat to Europe’s already tenuous supply.

Consumer Confidence: Unlike the U.S.’s last big inflation bout in the 1970s and early 1980s, when price pressure built over a decade, this time a cost-of-living runup unfolded in months. It caught many by surprise, from President Joe Biden and Federal Reserve Chairman Jerome Powell to the ordinary grocery shopper. Polling shows the latest phase of the pandemic has further eroded faith in leaders and institutions, leading to feelings of frustration, aimlessness, and helplessness, even among some who are doing well in today’s economy.

Repeat After Me: The Future is Unknowable

People always want to believe that this time is different, that there’s something new under the sun, and that through their own ingenuity they can wish away risk.

—Seth Klarman

What’s paramount at Blueprint Investment Partners is having proper context of the markets and taking a long-term approach that matches the investment lifecycle of our partnering advisors and their clients. We often repeat the mantra that nothing in life or investing is free. As a result, there is a constant struggle between risk, returns, investor behavior, and other factors (like taxes). Prioritizing one or two of these always means demoting the others. Our goal is to constantly pursue the optimal tangent point among those variables.

Obtaining this level of perspective requires taking a few steps back and having strategies that eschew hourly, daily, or sometimes even weekly market moves in favor of a broader focus. We often refer to this as “having strategies that fit the market NOT like a glove, but rather like a mitten.” For those who have children, you likely agree that it’s much easier to put mittens on a 4-year-old than a glove.

This mitten versus glove comparison and how it plays out in the markets is clear now. After very few tactical shifts since the COVID-induced panic of Q1’20, Blueprint Investment Partners portfolios have recently undergone their first significant defensive shift in almost two years. Though material, the shifts taken so far have been by no means drastic. To some they may even seem overly measured and deliberate. But, this too is by design.

During an environment that appears risky – like a pandemic, rapid inflation, or the threat of war when global equity prices are rapidly declining – it is easy to assume that we should be more defensive. However, just as quickly as things went from rosy a few months ago to correction territory, the opposite can occur and markets can rapidly make new highs. If that occurs, then the inverse emotion rapidly sets in, and fear transforms to FOMO. Our blog on the 10 days myth highlights the benefits of reducing risk during these periods, despite missing large positive performance days.

The solution, in our view, is that we must constantly remind ourselves that we do not know what happens next.

All we know for certain is that right now, in this moment, markets have weakened to or below their longer-term averages. At Blueprint Investment Partners we have reacted the same way we always do, by following our time-tested systematic investing rules and reducing risk commensurate with what has happened (not what might happen). In hindsight the picture is ALWAYS clear. Yet that clarity NEVER does anything to improve our predictive abilities.

In our opinion, the beauty of a trend-based approach is its simplicity, consistency, and repeatability. Even if one believes that some declines are predictable, one must concede that not ALL are. All it takes is one significant mistake to interrupt compounding. However, ALL declines (and all increases) have a common characteristic: price. If one focuses on price and acts consistently, then the results will be vastly more reliable than varying approaches in varying situations.

The perfect pair of gloves feels better than mittens, but markets are neither perfect nor uniform, and an investor’s ability to navigate through them are far less than perfect. If one can attain the humility to realize they know they don’t know what will happen, then a simple yet sophisticated process implemented by a well-intentioned and well-prepared advisor is a dynamic combination to achieve investor goals.