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Buy in May

As we head into May the mantra we all know too well is echoing through the media. Every financial publication we read reminds us what and why to sell in May. But what could be bought in May?   

Let’s start with a conversation about regimes. Markets tend to find a median story in each cycle that grows to dominate the allocation context for three to seven years. These regimes are a porridge of sentiment, monetary policy, geopolitics, the economic cycle and demographics. Our belief is that we entered a new regime in early 2022 and that regime is still intact. The basic character of the regime is that inflation will be stickier than at any time in the last 20 years, high-growth equities will be de-rated more than any other asset class, the US dollar will find a lower base and de-globalization will impact all the above. That’s obviously a very different world than most financial decision makers have made decisions in.

In this unfamiliar regime it now makes sense to shift one’s perspective from Indices to Benchmarks. What’s the difference?  Indexes are helpful to understand deviations from exposure to an intended modality. Benchmarks are useful to measure one success or failure – pure reward and risk. Index investing can be an absolute failure but a relative success. Benchmarking appropriately should avoid this ambiguity. And when it comes to financial benchmarking there is one single critical goal. One must at least outperform inflation at home.

With those perspectives, the answer of what to Buy in May should be based on a view of what assets will incrementally give a portfolio an improving chance of outperforming inflation. That question was addressed by researchers from Allspring Global Investments who recently published insights and fresh views of base-rates and unconstrained asset allocation optimizations for various inflation regimes.1

With our view that we are fairly early in a new regime, defined largely by the inflation dynamics, this work resonated loudly. The following table from the paper demonstrates the historic risk premiums associated with asset class factor strategies in varying inflation regimes.  

Matching today’s cyclical inflation regime to the table nearby, we see that the High (above historic median) and Falling (year-over-year declines) periods are dominated by Commodity strategies.

Top Five Alternative Asset Class Factor Strategies by Inflation Regime (US)

    Inflation Regime    
Strategy Low-Falling Low-Rising High-Rising High-Falling
1 Commodities Carry All Stock Selection Defensive Commodities Momentum Commodities Momentum
Average Return During Period 14.20% 8.40% 14.30% 9.10%
2 US Stock Selection Defensive Equity Indexes Market Commodities Market Commodities Carry
Average Return During Period 9.10% 8.30% 13.90% 8.40%
3 Commodities Multistyle Intl Stock Selection Defensive All Stock Selection Defensive Commodities Multistyle
Average Return During Period 8.20% 7.70% 7.70% 7.40%
4 Intl Stock Selection Momentum Commodities Value US Stock Selection Defensive Equity Indexes Momentum
Average Return During Period 7.90% 6.30% 6.70% 5.30%
5 All Stock Selection Momentum US Stock Selection Defensive Equity Indexes Market Commodities Value
Average Return During Period 7.60% 6.00% 6.50% 5.10%

Source: AQR’s factor database at combined with Global Financial Data’s inflation data for the United States. See Important Disclosures & Definitions for description of Factor Exposure and Inflation Regimes. For illustrative purposes only. Past performance is no guarantee of future results.

This is a helpful base-rate of historical observation to measure our current fundamental views against. We won’t rehash our thesis here but we see structure opportunity in real assets, further it would not surprise us to see the Federal Reserve gradually move away from the 2.0% inflation doctrine. In that environment, points in time like today where global equities, domestic equities and bonds have all see some recovery, the answer to Buy in May is clear.

Important Disclosures & Definitions

1 Brian Jacobsen and Matthias Scheiber. “Inflation-Plus Investing: Real Returns for Real Investors.” The Journal of Portfolio Management, April 2023.

Factor Exposures:
- Value - The value factor is based on a belief that assets that are cheaper relative to some measure of fundamental value may outperform those that are more expensive.
- Momentum - The momentum factor refers to the tendency of outperforming assets continue to perform well in the near term.
- Carry – The carry factor is the tendency for higher-yielding assets to provide higher returns than lower-yielding assets.  A simplified description of carry is the return an investor receives (net of financing) if prices remain the same.
- Defensive – The defensive factor is the tendency for lower risk assets (defined as low-beta and low volatility) to outperform higher risk assets.

Inflation Regimes
- High inflation - average year-over-year inflation is above the historical median.
- Low Inflation - average year-over-year inflation is below the historical median.
- Rising inflation – expected one-year inflation is above trailing one-year inflation.
- Falling inflation - expected one-year inflation is below trailing one-year inflation.

Performance data quoted represents past performance. Past performance is no guarantee of future results; current performance may be higher or lower than performance quoted.

One may not invest directly in an index.

AAI000264 05/02/2024

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