October 2023 Model Update Announcement

The ghost of Septembers past haunted markets once again in 2023.  This notoriously weak seasonal period, combined with rising rates, declining liquidity and geopolitical risks, saw stock and bond prices press lower in recent market movements.  As bonds continue to seek a dovish tone from the Fed, and markets continue to look for a top in rate action, markets continue to be volatile.  Although corporate earnings continue to surprise to the upside, and there is a case for economic growth going forward, markets are riddled with concerns that are rattling investors. These market concerns also create opportunities. The LSA committee will be implementing model updates to the mutual fund, ETF, and variable annuity models.  These changes will be rolling out over the next two weeks.  The committee continues to believe that the markets face potential recessionary risks and managing bond exposures remains important to help manage against the mounting wall of worry and potential equity volatility.   The committee finds it equally as important to remain thoughtful in finding equity opportunities in quality and cap size to continue to lean into valuation dislocations.  Below you will find a breakdown of the upcoming changes:

Posted Wednesday, October 25^th – ETF, ETF Tactical, Private Client Blended, PC IQ, Private Client L100k, – targeted model update – Wednesday, November 1^st.

Posted Thursday, October 26^th – Private Client Traditional, Private Client, Private Client Tax Efficient, PC Income Strat/Income Focus– targeted model update – Thursday, November 2nd.

Posted Friday, October 27^th – Bear Market Entry, Cautious Bear Plus, Impact Series, DFA, DFA Blended, American Funds, Fidelity, Vanguard – targeted model update – Friday, November 3^rd.

Posted Monday, October 30^th – Variable Annuities – targeted model update – Monday, November 6^th.

*The mutual fund model revisions impact the NTF models as well.

*As a reminder, the Revision Explanation Presentation/Video will be posted in the “Portfolio News” section on each of the platform home pages.

Investment Rationale:

As markets continue to climb a “Wall of Worry” they tend to exhibit a forward-looking nature and they often rally, even in the face of bad news. As all the negative news becomes known, markets start looking ahead to better times, and guarded optimism for the future.  Markets continue to be concerned about the possibility of interest rates remaining higher for a longer period than initially expected. The prospects of a government shutdown have also added to these concerns. Although a near-term shutdown has been avoided, political maneuvering in Congress is expected as they grapple with increasing interest rate expenses and their impact on discretionary spending and budget deficits.

Challenges on multiple fronts are contributing to market worries. These include a strengthening U.S. dollar, rising oil prices, the resumption of student loan payments, and inflation. These factors could potentially lead to a slowdown in the economy as consumers reduce their spending. Additionally, China’s economic growth has slowed, and there is the potential for more fights over government spending and shutdowns in the near future.  Despite these concerns, economic growth is still a prevailing trend. The Conference Board predicts growth in GDP in the fourth quarter. While Q3 year-over-year corporate earnings are expected to be flat, many analysts anticipate a return to corporate earnings growth in the fourth quarter of this year and in 2024. GDP projections for 2024 remain modestly positive, though there is a possibility of a mild recession next year.

Model portfolio adjustments are being made based on relative valuations in different asset classes and in an effort to continue to find good diversification and risk controls. The committee wants to continue to validate the inclusion of value stocks as quality has been underwhelming in 2023, and we are seeking an increase in small caps due to desirable valuations. Higher quality bonds and duration continue to provide better yield to worst profiles and potential longer term opportunities.  Although near term rate action has created a volatile bond market once again in 2023, we continue to believe well-diversified bond exposures will help influence overall bond performance.

In our view, market prices continue to struggle to properly reflect the risks associated with contracting economic conditions and the concern of recession. Therefore, we are repositioning portfolios to continue to be sensitive to potential equity volatility, while addressing longer-term opportunities.

Here are the core themes: 

1. Fixed Income – the committee is looking to continue to address the risks of rising rates by addressing diversity in bond selection and the role of active-share from the strategy level and overall model level.  Although the committee believes that the role of quality and duration continue to remain a long term staple for strategies, in moments of bond market volatility it is equally important to find good solutions that help mitigate interest rate sensitivity.  The committee will be addressing existing bond positions that have struggled to provide good protection during this unprecedented rate hiking cycle. It will also look to replace these positions with managers/positions that have demonstrated better skill in weathering recent bond volatility.
2. Valuations matter – over time it is important to understand that asset class and sector leaders are constantly changing.  Last year value and quality was rewarded as markets were adjusting to Fed normalizing pressures.  This year growth has been the beacon of opportunity as quality and value have lagged on a relative basis.  The ability to select the next categorical winner is challenging, which is why common sense tells us to be diversified.  The committee continues to believe this diversity is important as we consider the near term concerns the markets will need to address.  It is important to use these moments of uncertainty in markets to realign risk controls in models.  The committee will address exposures to value relative to growth and small cap versus large cap.  Recent valuations suggest that there is an opportunity to find an increase in overall small cap exposure and to make sure a balance is aligned in value exposures relative to growth exposures.
3. Manager Exposure – it is important to revisit all positions to make sure that we continue to have the appropriate player in place for the role they play in the models.  There are a number of investments available and we utilize these model updates as an opportunity to revisit all the underlying positions that make up a model and make sure that we continue to have a meaningful manager or position that is bringing skill and value to the strategy.

It is often in times of mounting market concerns that we see the resiliencies of companies take over.    Markets are constantly looking for clarity, and with all of the headwinds we addressed, the committee continues to believe that volatility could still be a factor throughout 2023.  However, clarity is often the antidote to improving market conditions. Addressing our bond exposures, and continuing to monitor equity opportunities, should help models stay competitive and balanced in 2023.  This is always a difficult balance, but a necessary focus as volatility can happen at any time.  As the fourth quarter continues we will hope for continued clarity, but plan for uncertainty. In the meantime, these model adjustments will continue to support the diverse approach we take with every strategy.