Regime investing: Defense wins championships
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Article Type
Insights
Topic
Macro
Published
October 06, 2023
Read time
5 mins
Author
Frank Rybinski, CFA
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With autumn upon us, not only do the leaves start turning but it also means we are in the throes of American football season. Given the continued Fed regime of monetary tightening, we find the old football axiom defense wins championships quite apropos for strategic asset allocation.

 

Since the Fed signaled back in December 2021 its intention to finally begin tightening monetary policy, owning risk has been an uphill battle. As illustrated in the chart below, the ultra-short duration risk-free T-Bills have been the best-performing asset, even more so on a risk-adjusted basis.1

 

Exhibit 1: Asset Class Returns - 12/31/2021 - 9/29/2023

 

Exhibit 1: Asset Class Returns - 12/31/2021 - 9/29/2023

 

Source: Bloomberg

 

We believe this defensive tilt will likely continue to outperform until a genuine pivot to a rate-cutting regime is clearly signaled (note: a pause is not a pivot). Why? Cash rates north of 5% not only represent a steep hurdle rate both for risk assets and capital investment, but also sharply increase the cost of debt financing. This is not a big surprise as it is exactly what restrictive monetary policy sets out to accomplish and why it is so successful in slowing down the economy and taking the froth out of asset prices. Small-cap equities are one of the asset classes most affected by this policy and hence it is no surprise that it has been one of the biggest underperformers.

 

While defense has clearly been the bias in this regime, it doesnt mean you cant make money owning risk - just that your timing needs to be more precise since you are swimming upstream. This brings up an important differentiation: strategy versus tactics. While strategy is the over-arching construct or scaffolding used in identifying the optimal risk tilt and inter-market allocation for the current regime, tactics focus on the ability to maximize intra-market discrepancies and nuances. Case in point: While cash has been the best asset class in this regime, one could still make money by correctly reading the episodic sentiment shifts and technical tea leaves of specific markets and timing actions accordingly. Metaphorically, strategy is like a supertanker, while tactics more resemble a cigarette boat. Our cheeky metaphors aside, well close with a quote from Sun Tzus seminal treatise "The Art of War":

 

"Strategy without tactics is the slowest route to victory. Tactics without strategy is the noise before defeat."

 

1Risk-free refers to an asset (such as Treasurys) where the return of principal is, in theory, guaranteed. US Treasurys are often perceived as risk-free because they are backed by the full faith and credit of the US government. All investments contain risk and may lose value.

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Author

Frank Rybinski, CFA
Head of Macro Strategy

Frank Rybinski, CFA, is head of macro strategy responsible for guiding the firm’s global macroeconomic view as it pertains to tactical and strategic asset allocation.

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Regime investing: Defense wins championships
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Regime investing: Defense wins championships
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