Update to Our Portfolio Positioning


June 15, 2022

Dear Clients,

Over the coming days and weeks you will start to see our portfolio positioning shift slightly. Consistent with the article that we penned on 5/13/22, Are we There Yet, we have begun the gradual tilt to becoming slightly more aggressive as the S&P 500 has reached our targeted 3700 level. Our operating philosophy at Westshore Wealth has consistently been to compose our portfolios with plenty of “shock absorbers” and uncorrelated assets so as to minimize volatility. While we recognize that encountering a downdraft in your portfolio assets is always unsettling, this approach has worked. While the S&P 500 is down almost 22.5% from its peak in January, most of our portfolios have experienced losses that are less than half as large.

We will keep you appraised of our continuing quest to deliver compelling, yet stable, longer term returns as this cycle evolves
At this point, we think it is prudent to start the evolutionary shift back to a more offensive stance. As you may recall, our conservatism was borne over two main concerns. First, we thought that the Federal Reserve was underestimating inflation and that interest rates would need to adjust meaningfully higher. Second, we cautioned that valuations were at extremes, situated at the 99th percentile when the S&P 500 reached 4800. Fast forward to present, we have had a major readjustment in Federal Reserve policy. Interest rates have skyrocketed on the 10 Year US Treasury, from 1.15% less than a year ago, to 3.4% presently. The S&P 500 index has been crushed, falling over 20%. However, with that correction, the valuation premium has completely eroded. At the 3700 level on the S&P 500, the market now resides at its historical average P/E multiple of 16x. To be sure, this is a moving target. At the economy slows, earnings power will erode, but our sense is even in the event of recession, earnings could recover to present levels within a short amount of time. You may ask, why make this decision now considering the Federal Reserve is only embarking upon its third rate hike and the presumption is that there will be quite a few more? While the “Don’t Fight the Fed” adage is one that we follow closely, it is important to realize that the equity market has a strong tendency to start to rally after the third Federal Reserve rate hike. Why is that? Usually by the third hike, the nightly news has become overwhelmed with Fed watching. True to form, the word stagflation has become a part of the ordinary vernacular and the generally inconspicuous Federal Reserve Chairman, Jay Powell, has become a recognizable figure to many. When fear is this palpable and the risks are so well identified, typically, the stock market has already started to discount the negative outcome. We think we are rapidly approaching that point.

With all that said, we decided to begin Phase 1 of our portfolio re-orientation this week. The first shift that you will see is a move to sell down our holdings of JP Morgan Hedged Equity and replace that with the S&P 500 index ETF. The JP Morgan vehicle was very effective at limiting downside through its usage of put options (essentially insurance policies that protect portfolio values). That however, comes at a cost as it also limits upside participation. The S&P 500 index ETF, by contrast, will give us much more unencumbered upside. Before you worry that we are taking undue risk, please understand that we still have a fair amount of shock absorbers in the portfolio. The changes that we are making are evolutionary, not revolutionary. As we get more clarity on the market’s direction, you can expect to see us continue this measured, offensive drift. The other changes that you should expect to see in the coming weeks include the following. Given the market’s retrenchment, many of our positions now embed a capital loss. We intend to start recognizing losses on those securities where we can find a suitable proxy. Those tax losses can be used to reduce your tax burden in future periods. Finally, you can also expect some shifts in our capital preservation basket. Some of this will be done to capture capital losses as just mentioned, but we also will be making a fundamental shift as well. Given our aforementioned fear of Federal Reserve rate hikes, we had situated our fixed income assets in short dated maturities and floating rate securities. With the bond market selloff that we have experienced, many of the categories that we have purposely avoided, now appear attractive. Specifically, longer dated maturities in corporate and municipal bonds are now quite compelling.

We will keep you appraised of our continuing quest to deliver compelling, yet stable, longer term returns as this cycle evolves. If you wish to discuss any of these moves in greater detail, please don’t hesitate to reach out.