Surf’s Up! Why We’re Paddling Into the Waves

 June 28, 2024

Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas.

—Paul Samuelson

We are frequently asked whether we are optimistic or pessimistic about the markets, the economy, the state of the U.S. in general, etc. These are reasonable questions, but they miss the essence of our approach. At Blueprint Financial Advisors, our investing process, which is predicated on trend following, doesn’t hinge on whether we view the market with optimism or pessimism. Instead, it is rooted in discipline and consistency.

In fact, we believe an emotional attachment to markets — whether via optimism, pessimism, predictions, or any other judgments — is counterproductive and can lead to subjective, ego-driven decisions. Trend following is not about making bold predictions or riding the waves of market sentiment. It’s about having a clear, adaptable plan that can be applied regardless of market conditions. This systematic approach allows us to manage both the highs and the lows without being swayed by emotional impulses.

In June, for example, we saw the persistence of certain outliers that could cause an investor to make rash decisions if they don’t follow a systematic plan: 

  • The S&P 500 and artificial intelligence stocks reached new highs
  • The Japanese Yen hit 30-year lows
  • Large cap versus small cap divergences were pronounced

Despite various forecasts and sentiments, by following price, a trend following approach inherently ignores the emotional charges of these movements.

Trend following is not about predicting outcomes but about maintaining a disciplined process. By adhering to a disciplined strategy, we can take decisive action without second-guessing ourselves or trying to parse someone else’s motivations or judgments. Yes, it can be boring, and we don’t always have a keep-you-on-the-edge-of-your-seats “story.” We’re focused far more on consistency and repeatability than narrative.

In this month’s Note, we discuss in greater detail the active outliers occurring in today’s market environment. We compare a traditional portfolio management approach to our systematic trend following strategy in terms of capturing these outliers. As part of our comparison, we talk about how, to catch the big waves, you sometimes have to paddle for the smaller ones that look promising but don’t always swell up.

But first, here’s a summary of the global asset classes utilized in our portfolios and their exposures for July.

Sourcing for this section: Reuters.com, “S&P 500, Nasdaq hit record closing highs ahead of data, Fed comments,” 6/17/2024; Barchart.com, “The Nasdaq Just Notched Another All-Time High, and Cathie Wood Thinks This Artificial Intelligence (AI) Stock Could Soar Another 1,300%,” 6/27/2024; and Finimize.com, “Yen Hits 38-Year Low, Japan Bond Yields Climb Higher,” 6/27/2024

Asset Allocation Update

July 2024 asset allocation changes grid for Blueprint Financial Advisors risk-managed global portfolios

Adjustments can vary across strategies depending on each strategy's objectives. What's illustrated above most closely reflects allocation adjustments for the Growth Strategy.

U.S. Equities

Exposure will decrease slightly and remain overweight. Trends over all timeframes are positive, and it remains the strongest equity asset class. The small allocation shift will result in returning exposure to real estate, which has strengthened.

International Equities

Exposure will not change and will stay at the baseline allocation. Trends are positive across all timeframes.

Real Estate

Exposure will increase marginally but continue to be underweight as the intermediate-term trend shifts to positive.

U.S. & International Treasuries

Exposure will increase slightly but remain underweight as trends improve.

Inflation-Protected Bonds

Exposure will not change and will remain at its minimum.

Alternatives

Exposure will continue to be expressed through a multi-asset alternative ETF. The current allocation is long equities, short fixed income, and slightly short commodities. Within currency markets, it is net short the U.S. Dollar, as well as long both the British Pound and Swiss Franc versus other global currencies.

Short-Term Fixed Income

Exposure will decrease slightly as some of the allocation is returned to modestly strengthening U.S. Treasuries.

Asset-Level Overview

Equities & Real Estate

By most objective measures, the S&P 500 Index (market-cap weighted) is enjoying a great year. As we hit the halfway point of 2024, this is where we stand with the benchmark index:

  • Up almost 15% year-to-date
  • Increasing in five of six months this year
  • Increasing in seven of last eight months overall

With that said, it doesn’t take a deep dive to notice some wide disparities within the index and across U.S. stocks more broadly:

  • Even among large-cap stock indexes, performance has varied wildly. For example, the Dow Jones Industrial Average is up only about 4% year to date (YTD).
  • Value and dividend stocks are faring better YTD but only providing roughly half the return of the S&P 500 Index. 
  • Mid- and small-cap performance YTD is underwhelming. The former is up around 5% and the latter has increased less than 3%.
  • While the market-cap weighted S&P 500 is up almost 15%, an equal-weighted measure of the same index changes the scenario to one that is up less than 5%.

Despite the variety, all segments noted above remain in uptrends. Consequently, our portfolios will remain overweight U.S. equities, particularly large- and mega-cap stocks.

Our portfolios will also remain steady for foreign developed and emerging markets. Emerging markets have now surpassed their developed market counterparts for the year, but both continue to perform more like value and income stocks in the U.S. than growth stocks.

Real estate securities continue to be among the weakest equity-like instruments, even after a slightly positive June. These assets remain depressed by higher interest rates and continue to be in the red for 2024 thus far. That said, the intermediate-term trend has turned positive and thus our portfolios will reflect a tiny increase in exposure. If this segment remains relatively weaker than other U.S. equity segments, any allocation increases will be capped.

Fixed Income & Alternatives

Like real estate, government bonds — particularly those in the U.S. — will see a slight uptick in exposure in our portfolios due to the return of an intermediate-term uptrend. The allocation increase will be relatively minor but sets the stage for more increases if trends continue to materialize. In our opinion, one of the biggest benefits to trend following is the ability to gain exposure early in an overlooked asset without taking material risk. We see July’s increased duration exposure as a potential example of that.

For the portfolio’s alternatives allocation, the most notable change in the current allocation is a switch in fixed income from long to short, which has allowed long equity to become the most significant allocation as we head into July. Overall, commodity exposure is slightly short, and longs in metals will be counterbalanced with a broad basket of short positions elsewhere. Global currency allocations will continue to be hedged, with meaningful shorts in the U.S. Dollar, Chinese Yuan, and Australian Dollar countered by longs in multiple currencies against the Japanese Yen.

Sourcing for this section: Barchart.com, S&P 500 Index ($SPX), 11/1/2023 to 6/27/2024; Barchart.com, Dow Jones Industrials Average ($DOWI), 1/1/2024 to 6/27/2024; Barchart.com, Value ETF Vanguard (VTV), 1/1/2024 to 6/27/2024; Barchart.com, High Dividend Yield Vanguard ETF (VYM), 1/1/2024 to 6/27/2024; Barchart.com, Midcap ETF Vanguard (VO), 1/1/2024 to 6/27/2024; Barchart.com, Smallcap ETF Vanguard (VB), 1/1/2024 to 6/27/2024; Barchart.com, “S&P 500 EW Invesco ETF (RSP), 1/1/2024 to 6/27/2024; Barchart.com, FTSE EM ETF Vanguard (VWO), 1/1/2024 to 6/27/2024; and Barchart.com, FTSE All-World Ex-US ETF Vanguard (VEU), 1/1/2024 to 6/27/2024

3 Potential Catalysts For Trend Changes

Record Highs: Home prices rose in May to another new high. The national median price for an existing home was $419,300, a record in data that goes back to 1999.

Rent Hikes: Apartment rents in several Northeast and Midwest cities, such as Kansas City, MO, and Washington, DC, are beginning to rise this year. Shelter inflation, which is mostly a measure of rents that lags market conditions by a few months, was high in May, with an annual rate of 5.4%.

Slowing Spending: American shoppers increased spending in May, but not as much as economists had forecast. Excluding autos, retail sales slipped 0.1% from the previous month, whereas economists had expected a 0.2% gain. Additionally, April’s report was revised lower to a 0.2% decrease, whereas the previous reading had said sales were unchanged from the prior month. Retail spending accounts for roughly two-thirds of GDP, so it is an important health indicator of the economy.

Sourcing for this section: The Wall Street Journal, “Home Prices Hit a Record High,” 6/21/2024; The Wall Street Journal, “Rent Hikes Loom, Posing Threat to Inflation Fight,” 6/18/2024; The Wall Street Journal, “U.S. Retail Sales Rise Less Than Expected in May,” 6/18/2024; and FRED Economic Data, “Shares of gross domestic product: Personal consumption expenditures,” Q1 2024

How We Know When to Catch a Wave, And When to Hop Off

There’s a model that I call “surfing” – when a surfer gets up and catches the wave and just stays there, he can go a long, long time.

—Charlie Munger

The close of spring in the U.S. and the onset of summer usually brings much talk about extreme weather events, from hurricanes to heat waves. The financial markets are another fertile ground for extreme behavior.

It doesn’t take much digging to uncover examples of markets or assets exhibiting movement outside of their accepted norms. Here are a few as we enter July:

  • The top five holdings in the S&P 500 now make up 27% of the index, the highest concentration going back to 1980.
  • The outperformance of U.S. large caps (S&P 500) over small caps (Russell 2000) is now at its most extreme level since November 24, 1999.
  • The outperformance of growth versus value is at its highest level since 2000 (Russell 1000 Growth versus Russell 1000 Value).

In these cases, most traditional methods of portfolio management have little opportunity to adapt to these realities because these events are inherently difficult to predict. Our brains tend to minimize the likelihood of outlier events, especially when using historical data as a guide. At best, a traditional management approach might approach these extremes by ignoring them, assuming that extremes will neither cause damage nor be worth the upside. At worst — and we believe this is the more typical reaction among the public — an investor might attempt to react on the fly without a tested process, resulting in emotional (i.e., irrational) decision-making.

We believe a strength of a trend following approach like the systematic investing process we use is the ability to adapt to extremes. By focusing only on price, our strategies seek to accomplish what Munger illustrated in the quote above: catch even extreme waves and surf them. We do not attempt to predict where a wave will occur. Rather, we try to put ourselves in a position to react quickly and enjoy it as long as it lasts. We may hold significant exposure for years and then ignore an asset, or we may enter and exit quickly. There is no emotional connection either way. We view all assets simply as the instruments to which we apply our rules, with our aim being to help investors reach their financial goals.

Evidence of this approach can be easily illustrated in our current and historical holdings. Our portfolios continue to overweight the top-weighted stocks in the S&P 500 while also overweighting U.S. equities generally and growth names in particular. Value, income, real estate, and fixed income instruments of any duration remain underweight.

Most of the clients we partner with tell us they value the way our strategies adapt to market movements. But occasionally we endure some criticism for taking certain positions or for holding too long. We acknowledge there can be small costs associated with our investing style, but the tradeoff is the ability of our strategies to take advantage of extreme events by leaning into exposure for outperforming assets.

In our opinion, the benefits of consistently capturing a greater percentage of outlier trends far outweigh the small cost of holding assets that have yet to sustain material trends. There is little cost to riding a wave that doesn’t materialize if you have a process for hopping off and catching the next one.

In fact, let us take it a step further and say we couldn’t do one (catch the extreme events) without the other (ride a few waves that don’t materialize). While other asset managers might tweak their trading rules in an attempt to weed out lower probability trends, we think that at some point a model can become overfit. In other words, to catch the big waves, you sometimes have to paddle for the smaller ones that look promising but don’t always swell up.

As we enter the height of vacation season in the U.S., we hope you and your families can enjoy some time outside in great weather with few extremes. We also hope you are able to surf some waves — whatever that looks like in the context of your life— while relaxing and having a memorable summer. The team at Blueprint Financial Advisors will continue to keep watch on your portfolios and diligently execute the strategies that help us catch and ride the market’s various movements.

Sourcing for this section: @charliebilello, “S&P 500: Weighting of Top 5 Holdings (1980 - 2024),” 6/23/2024; Bilello.blog, “US Large Cap Domination – Chart of the Day (6/20/24), 6/20/2024; and Bilello.blog, “The Week in Charts (6/23/24),” 6/23/2024

Let's Talk

If you have any questions about what transpired in the markets last month or portfolio positioning for the month ahead