Fed to Market: “Cool It.”

The investment team at Lyons Wealth Management discuss recent market events and what they’ve been doing in the wake of persistent volatility. To learn more about the strategy discussed below, please click here.

Fed to Market: “Cool It.”

The market keeps cooling on the Federal Reserve’s rate hike plans, even though the Fed and inflation aren’t cooling. Like the broken-hearted who with short memories keep returning to their heart breakers, markets are caught in a cycle of denial as to how far the Fed wants to move on and move up, instead discounting the Fed’s plan to jack up our discount rates. What follows, in near scripted fashion, is heartbreak meltdown when Fed officials reiterate they aren’t interested in how we feel. Despite the Fed telegraphing its next move, warning against a false sense of security, and its carefully curated words designed to let the market down gently, gently down it does not go. Lather, rinse, and repeat, before and after each recent FOMC meeting or Jerome Powell speech.

The market weakness in the first half of 2022 triggered the Lyons Tactical Allocation strategy to make a defensive tactical shift to U.S. Treasuries to start July, with an accompanying whipsaw hedge intended to participate in any potential market reversal against the allocation change. By using index options, we can establish the hedge with smaller position sizing, allowing for growing benefit if and when needed, or minimal drag if not. The market rallied fiercely in July as Fed pivot speculation (the cycle of denial) bubbled up. While our portfolio of 1-10 year Treasury securities was essentially flat for the month of July, gaining 0.33%, our whipsaw hedge quickly kicked into gear, contributing 289 basis points of the strategy’s 4.18% July gain. This compared with 5.36% for the benchmark and 3.56% for the Morningstar U.S. Tactical category of funds and ETFs.

Strength continued into August until midway through the month when affirmative Fed speak and a reversal in technical and positioning dynamics were harsh reminders that the market’s relationship with dovish policy is indeed over. Just before the mid month top, we rolled the hedge to take meaningful profits on a 259% gain. By rolling down our delta, we also avoided the delta bleed that would have rapidly devalued the hedge as the market declined. For the month of August, LTAP returned -2.30% compared to -3.25% for our benchmark and -2.60% for the Morningstar category.

Entering September, the strategy holds its defensive allocation with whipsaw hedge as markets remain weak in the face of persistent inflation and rising interest rates. While the economic impact of these dynamics have thus far been mixed, growing concern over the terminal rate and lagged effect on economic activity is likely to present an imbalanced risk/reward for stocks in the near term. LTAP remains positioned to capture a portion of potential equity market upside while concurrently minimizing exposure to significant downside, a capability that remains unique among the tactical space.

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DISCLOSURE

¹ This statement applies generally to initial purchases of a position. Additional shares of a particular stock purchased at subsequent quarterly rebalances may still remain in short-term holding status (owned for less than one year) at the time of this publication.

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Lyons Wealth Management (“LWM”) began formally tracking its strategy performance as of April 30th, 2012. Portfolio composite returns are preliminary and are presented on a time-weighted, size-weighted total return basis using monthly portfolio valuations. The composite returns for each LWM portfolio presented herein include all eligible LWM accounts. To be eligible for inclusion in the LWM composite, an account must be fee paying, fully discretionary, and not part of a broker wrap program. New portfolios that are managed to the Tactical Allocation Portfolio investment strategy and meet the composite definition will be added to the composite when fully invested. The composite is not representative of all accounts managed by LWM. All returns are expressed in U.S. Dollars and are presented net of all fees and expenses. The returns reflect the reinvestment of all dividends and interest. The return information presented herein has not been audited or otherwise verified by an independent accounting firm, and past performance of any LWM portfolio does not guarantee future results.

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