19 May January 2022 – Flipping the Calendar
Happy New Year! The end of one year and beginning of another provides the opportunity for many investors, economists, and prognosticators to provide their thoughts on the upcoming year, so I’ll jump in the mix and add my thoughts. Aggregate earnings for the S&P 500 are likely to grow in the 8% – 12% range this year. Indications from the Federal Reserve point to rate increases in 2022, which may mark the end of ultra-loose monetary conditions. Higher rates and tighter monetary conditions should decrease the multiple applied to earnings, leading to equity returns in the mid to high single-digit range. Consensus expectations generally settle around a similar framework, however it appears that the odds are against me and consensus. Over the last 94 years, the S&P 500 has gained between 5% and 10% only six times. During that period, the index has gone up approximately two out of three years with an average return of +18% during positive years. Conversely, the index has declined approximately one out of every three years with an average -14% return during the down years. An average return is fair to expect over a reasonable time horizon, but an average return is not common during any one calendar year.
The big risks on investors’ minds as we begin 2022 are inflation and Covid. The two are intertwined in that increasing spread of Covid decreases the availability of workers. The lack of available workers exacerbates supply chain issues and pushes up inflation. I found the following paragraph of a recent Wall Street Journal article interesting, “Every year the World Economic Forum asks business, political, and thought leaders to rank the biggest risks in the coming year or two. At the start of 2020, infectious disease didn’t make the list. Covid-19 became the most disruptive pandemic in a century. At the start of 2021, inflation didn’t make the list either. It is now the most vexing problem in the U.S. economy.” Inflation and Covid will undoubtedly have an impact on 2022, but some unexpected risk is also likely to surface.
So how do we manage portfolios when the return profile is likely volatile and unexpected risks will arise? We build portfolios of high-quality companies that we believe can navigate through a variety of economic backdrops and hold cash to allow us to invest opportunistically during difficult times.
Looking back to 2021, US equity markets provided a double-digit return for the third consecutive year, and 4th out of the last five years. Bonds were slightly negative on the year due to an increase in interest rates. We decided to start 2022 with a slight tweak to our typical newsletter format. Below you will find background information on activity in each of our portfolios last year. We hope you find this look under the hood interesting and informative.
The top performing stock in the Core Equity portfolio was Prologis, a real estate investment trust that leases distribution facilities. The position was originally purchased in November of 2020. Other top returning investments included Pfizer, Alphabet (Google), The Home Depot, Zebra Technologies, and Microsoft. Grocery Outlet was our worst performing holding. The stock traded down during the 2nd and 3rd quarters due to disappointing earnings guidance from the company. We added to the position during the 4th quarter, and the stock has rebounded since that time. Other laggards during the year were Disney and Comcast. We hold cash in the portfolio to allow us to be opportunistic during inevitable times of turbulence. The cash weighting varies over time based on the market backdrop and the prevalence (or lack thereof) of investment opportunities. There were a few bumps in the market during the year, but no pullback exceeded 5%. Since 1980 the average market intra-year pullback has been about 14%, and the severity of the pullback has been higher than last year’s 5% in 38 of those 41 years. The lack of volatility last year combined with stretched valuations resulted in an average cash balance of 10.2% throughout the year. Trading activity was lower than usual, with turnover being about half of the level of the average turnover for the previous five years.
Summary of trades in 2021:
- New positions: Fiserv, Columbus McKinnon, and Electronic Arts
- Increased size of position: Columbus McKinnon and Grocery Outlet
- Sold positions: Tyson Foods and Comcast
- Decreased size of position: Zebra Technologies, Target, Xylem, and Alphabet
Our Covered Call portfolio is designed to provide a higher level of income and a lower level of volatility than a typical equity portfolio. Income continued to be strong for the strategy with approximately 8.8% call premium plus approximately 2.0% dividends for an approximate 10.8% total income yield. This is the fourth consecutive year of income greater than 10%, and income has averaged 10.6% over the last six years. This strategy has higher turnover than our other portfolios, and typically averages five to six trades per month.
Top performers in our Diversified Income portfolio included Pfizer, Broadcom, Chevron, Cisco Systems, Prudential Financial, and Old Republic. Laggards during the year were AT&T, Unilever, and Verizon. The goal of the portfolio is to provide a sustainable income stream, and the portfolio provided an approximate income yield of 4.5% for the year.
Summary of trades during 2021:
- New positions: KeyCorp, US Bancorp, LyondellBasell, JPMorgan Series JJ preferred stock, and Wells Fargo Series CC preferred stock
- Increased size of position: Prudential Financial, Dominion Energy, Unilever, KeyCorp, and AbbVie
- Sold positions: GlaxoSmithKline, JPMorgan Series DD preferred stock, Bank of America Series KK preferred stock, Allstate Series H preferred stock
- Decreased size of position: Pfizer
Bonds were generally down slightly on the year as interest rates increased. The US 10-year treasury yield increased from 0.92% to 1.51%, and bond prices move inversely with interest rates. Our bond portfolio has a relatively short average time until maturity, which decreases interest rate risk. At current interest rate levels, bonds primarily serve as a reduction in volatility to an overall investment portfolio.
The Fidelity Real Estate ETF was the best performing security in our ETF portfolio, followed by iShares S&P 500 ETF, iShares S&P Small Cap ETF, and iShares S&P Midcap ETF. The iShares MSCI Emerging Markets ETF was the largest laggard in the portfolio.
Summary of trades during 2021:
- New positions: iShares US Home Construction ETF, Materials Sector SPDR, Financials Sector SPDR, and Industrials Sector SPDR
- Sold position: iShares High Dividend ETF
- Decreased size of position: iShares S&P 500 ETF and iShares S&P Midcap ETF
Best wishes for a prosperous 2022!
Tom Searson, CFA
The analysis and performance information contained herein reflects that of portfolios used by Providence Capital Advisors, LLC, a Securities and Exchange Commission Registered Investment Advisor. This information should not be relied upon for tax purposes and is based upon sources believed to be reliable. No guarantee is made to the completeness or accuracy of this information. Providence Capital Advisors, LLC shall not be responsible for any trading decisions, damages, or other losses resulting from, or related to, the information, data, analyses or opinions contained herein or their use, which do not constitute investment advice, are provided as of the date written, are provided solely for informational purposes, and therefore are not an offer to buy or sell a security. This information has not been tailored to suit any individual.
Providence Capital Advisors, LLC does not guarantee the results of its advice or recommendations, or that the objectives of a strategy will be achieved. Portfolios offered by Providence Capital Advisors, LLC may not have contained and/or may not currently contain the same underlying holdings and may have been and/or may currently be managed according to rules or restrictions established by Providence Capital Advisors, LLC. The income numbers for Covered Call and Diversified Income are based on one portfolio in the composite that serves as the model portfolio. Actual income returns may be different for other portfolios. Employees of Providence Capital Advisors, LLC may have holdings in the securities and/or utilize the same portfolio strategies as presented herein.
Benchmark returns are used for comparative purposes only and are not intended to directly parallel the risk or investment style of the accounts included in our investments. The volatility of the indices compared herein may be materially different from that of the compared Providence Capital Advisors, LLC strategy. There is no guarantee that the strategies will outperform, or even match, benchmark returns over the long term.
This commentary contains certain forward-looking statements. Forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason. Past performance is not indicative of future results. Therefore, no current or prospective client should assume that future performance of any specific investment or investment strategy (including the investments and/or investment strategies recommended or undertaken by Providence Capital Advisors, LLC) will be profitable or equal the corresponding indicated performance level(s). Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will either be suitable or profitable for a client or prospective client’s investment portfolio. Historical performance results for investment indices and/or categories generally do not reflect the deduction of transaction and/or custodial charges, the deduction of an investment management fee, nor the impact of taxes, the payment of which would have the effect of decreasing historical performance results.