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Risk Cuts Both Ways

Part of my job as a CIO for Astoria Portfolio Advisors is to

  • Identify market trends

  • Alert clients of these trends

  • Suggest ways to benefit, protect, or diversify one’s portfolio

If I identified a trend and suggested to clients to act on my premise only once, I do not think I would get much traction. Hence, I must constantly repeat myself. Well, ever since I was a young kid, I was told that I tend to repeat myself. I must have been destined to be a CIO since I was a kid!

Anyhow, back to the markets. The US 10-year touched the 1.75% level this week. That is an incredible move since March 2020. As I have repeated constantly, this has huge portfolio implications.

Astoria has been at the forefront of this move. Back in June 2020, I appeared on CNBC, arguing for the very rotation that we are seeing today. I will not include the June 2020 CNBC link anymore because even I am getting tired of hearing myself specifically mention this interview. Separately, I will be on CNBC this coming Monday – happy to send details!

The bottom line is the following:

  • I am quite concerned for portfolios as most are OW long duration assets, technology stocks, and US large-cap growth.

  • Most portfolios own low-cost market cap weighted ETFs, which have a huge technology bias.

  • Most portfolios are underweight cyclicals – the very area that is benefiting the most with this move higher in rates.

Risk cuts both ways. Those portfolios did well when technology stocks were going to the moon. Of course, nothing goes up forever. Now those portfolios are suffering.

At this point, owning a 10% sleeve in reflationary assets is not even a tactical position anymore. In my view, it is simply a prudent hedge against technology which, as mentioned, makes up 25% of that US large-cap market cap weighted ETF.

Astoria’s top ideas for that 10% sleeve:

  • Cyclicals

  • Inflation sensitive assets (we include physical commodities, commodity equities, cyclicals, and TIPS in our solution)

  • Small/mid-cap stocks

  • Emerging Markets (China, really though)

(Nick Cerbone has run countless simulations showing that the risk of a moderate risk-type portfolio does not change much with a 10% sleeve; contact us if you wish to see his research).

Check out the 5-year breakeven inflation chart below. Clearly, the stock and bond market are giving us a signal. The signal is:

  • Rates are trending higher

  • Inflation is (on the margin) increasing

Source: Federal Reserve Bank of St. Louis.

Also, if you believe there is potential for higher taxes in the next few years to help fund the ballooning federal deficit, then perhaps what makes sense is:

  • Taking gains today from a higher principal notional but lower capital gains level

  • Re-establishing the correct asset allocation strategy (tilt more towards value, international, small/mid-caps, commodities, and tilt away from large-cap technology)

I fear investors who are sitting on large-cap technology stocks are hamstrung on trimming their position because of incurring taxes. Well, seeing the principal erode does not make too much sense to me. Full disclosure: We are not accountants, so please speak with your tax professional before doing anything.

See our previous note on what a rising 10-year environment means for your portfolio (click here). I will try not to repeat myself in the future!


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