FMP (SPY): I Love (Hate) You Just The Way You Are (NYSEARCA:SPY)

I couldn’t love you any better, I love you just the way you are, right – Billy Joel

So Far, So Good

There are currently only nine active positions in our Funds Macro Portfolio (“FMP”) versus 500 positions held by the SPDR® S&P 500® ETF Trust (NYSEARCA:SPY).

As of Dec. 20, 2022, these are the ETF‘s top 10 holdings:

Name		SPY Weight
Apple Inc. (AAPL)	6.18%	6.18%
Microsoft Corporation (MSFT)	5.63%	5.64%
Amazon.com Inc. (AMZN)	2.36%	2.36%
Berkshire Hathaway Inc. Class B (BRK.B)	1.70%	1.70%
Alphabet Inc. Class A (GOOG)	1.66%	1.66%
UnitedHealth Group Incorporated (UNH)	1.52%	1.52%
Alphabet Inc. Class C (GOOGL)	1.48%	1.48%
Johnson & Johnson (JNJ)	1.44%	1.44%
Exxon Mobil Corporation (XOM)	1.37%	1.37%
NVIDIA Corporation (NVDA)	1.25%	1.25%

Click to enlarge

While the ETF’s distribution yield is 1.66% (30 Day SEC Yield: 1.61%) and the S&P 500 Index’s (“SPX”) dividend yield is 1.75%, FMP’s average* annual yield is ~3.37%*, i.e. about twice as much as SPY.

*Based on 6.85% yield that has been generated since FMP’s inception date, nearly two years ago)

While the ETF’s total return YTD is down -18.55%, our FMP is up +6.76%, resulting in an outperformance of 25.31% for 2022 alone.

(Note that the below image contains data valid for the end of the previous trading week.)

Our FMP isn’t only outperforming SPY by 25.3% YTD, but it’s doing so while taking about 36% less risk (measured by the difference in the standard deviations: 0.99%/1.54% = 64% >>> FMP is 36% less volatile/risky).

More than the absolute return, it’s the relative return we focus on.

More than the relative return compared to the benchmark, it’s the relative return compared to the risk taken we’re proud of the most.

Because at the end of the day, you’re not (only) as good as the absolute return you’re delivering but (mostly) as responsible as the risk you’re taking.

Aiming for a phenomenal return while taking an even more phenomenal risk is an investment “strategy” that won’t last over time.

If age comes before beauty, risk (management) comes before (generating) return.

No Fed Pivot (This isn’t 2018)

Once again, the Fed’s James Bullard is doing the dirty job for Chair Jay Powell with some uber-hawkish remarks he came up with yesterday (Nov 29, 2022).

The Fed’s John Williams also came for help with his own (less hawkish, still far from being dovish) remarks:

• Unemployment rate is expected to rise to 4.5%-5% next year.
• 4.5% represents a more “benign scenario” but higher (unemployment rate) is possible.
• Recession is “clearly a risk.”

December 2018: CPI print was 2.5%Y/Y.

October 2022 (Most recent figure): CPI print is 7.7% Y/Y.

Given high inflation, the Fed is unlikely to “pivot” soon, surely not at the next FOMC (as some still hope).

Keeping It Simple

At the end of the day, things are fairly simple:

• New Lows > New Highs = Bear Market
• New Highs > New Lows = Bull Market

It isn’t (and doesn’t need to be) any more complicated than that.

Therefore, until we see more new highs climbing (=higher absolute number as well as relative to new lows) for more than just a random week or two, we have to:

1. Operate under the assumption we’re still very much in a bear market.
2. Remain skeptical and suspicious.
3. Refrain from thinking (perhaps convincing ourselves) that stocks have already bottomed.

The last several head fake (stock market) rallies were brief blips (including short-lived ‘New Highs > New Lows’ episodes).

The last bounce seems to be developing similar characteristics.

Stock Market Severely Overbought

The “new highs – new lows” indicator is at a level that has put an end to the past year’s various fake relief rallies.

SPX is approaching the 200-DMA level when the index already is extremely overbought. That’s not an encouraging combination.

A deteriorating economy, likely heading toward recession, surely doesn’t add too much optimism to the mix.

History Often Rhymes

It’s hard not to think that the next significant SPX move (>10%) will be down. If so, the SPX 2022 vs. 2008 analogy would be reinforced – and that’s not good news for stocks.

SPY(ware)

Be aware of SPY!

Remember: Analysts are still forecasting a 5% SPX EPS growth in 2023.

This means that a recession isn’t priced in, and (therefore) stocks can move down a lot more.

As already happened this past year.

What is the main risk of SPY? Sector allocation.

Out of SPY’s six largest sector allocations – Tech (XLK), Healthcare (XLV), Financials (XLF), Consumer Discretionary (XLY), Industrials (XLI), and Communications (XLC) – four are among the index’s worst five performing sectors for the year.

Out of SPY’s five smallest sector allocations – Consumer Staples (XLP), Energy (XLE), Utilities (XLU), Materials (XLB), and Real Estate (XLRE) – four are among the index’s top six performing sectors for the year.

Putting it differently, SPY has had large allocations to the worst (growth-oriented) pools, and small allocations to the best (value-oriented) pools.

That’s not only a risk (looking back at 2022) but also a challenge (looking into 2023), because most everybody – including yours truly – is expecting 2023 to be another year in which value is going to outperform growth.

FMP = Finding Mojo Patiently

Unlike the SPY, we were early (perhaps too early) to identify the value-growth trend.

The challenge isn’t to choose “value” and/or “growth,” but to assess the risks associated with each investing style (and relevant sectors) at the start of every year.

At the end of the day, risk management isn’t flipping a coin (at the start of the year) and acting based on the “head” (value) or tail (growth). Instead, it’s about modeling and analyzing both risks and (potential) rewards and (based on those) determining whether taking the risk is worth the potential reward.

No matter whether you’re a bull, a bear, a hawk, or a dove, one thing must be very clear to you:

[Hawkish comments] + [No Pivot in the foreseeable future] + [Overbought equities] + [Weak New Highs/New Lows Indicator] + [2008 Flashbacks] = Elevated Equity Risk = Lower Exposure to Stocks.

Exactly how the FMP is positioned.

Although there were brief, temporary, periods where we raised the level of risk (i.e. exposure) within the FMP, we’ve been predominantly defensive since mid 2021.

During the second half of 2021, this approach caused us to underperform the SPX, but then came 2022 and not only have we fully compensated for the 2021 lag, but we have built a nice buffer well and above the shortfall.

The below chart presents our current exposures on a net basis, i.e. without taking leverage effects into consideration. We’re now about 70% (!) in cash, but more importantly than that we’re only ~40% invested on a leveraged, net basis.

What does “leveraged, net basis” exactly mean?

If an instrument has a leveraged built into it (e.g. SOXL or TQQQ) there’s a cash exposure (=how much money exactly is invested into the instrument) and there’s the portfolio exposure (=how much value is at risk when we account for the leverage that is part of the instrument).

For example: If I put $100 into SOXL, the cash exposure is $100 (real money) but the portfolio exposure is $300 (due to the 3x-leverage effect).

Looking at the exposures on a leverage basis, we’re long ~63%, short ~23%, and that’s what brings us to a net exposure, including leverage, of ~40%.

Still, 40% is a very low exposure, even lower than the 50% we normally don’t get below.

The main risk for us right now is that we’re under-invested and so if the SPY runs higher – we’re likely to underperform, and perhaps significantly.

On the other hand, if the SPY keeps heading south, our hedge (stance) is our edge (performance), and we’re going to outperform SPY.

Since the FMP is aiming to outperform SPY on a risk-adjusted basis, this is both a risk and challenge.

The risk is that we may underperform by too much, and the challenge is to find the right (not perfect!) time to put more money to work, in order for the FMP to be closer in the long exposure to the SPY’s constant 100% long exposure.

Principally, we already know what we wish to do and where the FMP is heading to (in terms of exposures and allocations) in 2023.

Nevertheless, not all our investing preferences going into 2023 have been implemented as of yet within our FMP, and there’s a long way (for us) to go between what we want to do and how/when exactly we’re going to do that.

Going into 2023, we keep seeing a too high level of risk (versus a quite limited upside) that keeps us in our seats for now. As soon as this changes, and the risk/reward turns attractive (or, at least, balanced), rest assured we will act. Quickly and swiftly.

So 70% in cash is by far the highest percentage of “dry powder” the FMP has ever kept since its inception, and we’re ready to deploy when we feel the time is right.

And the time will be “right” not when we feel that we can make a “killing” (=exceptionally high and dangerous) return rather when we know that we’re not subject to a “killing” risk.

‘Cause you’re amazing Just the way you are – Bruno Mars