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1st Quarter 2023 Update & The Bond Market

After a year in which the S&P 500 Index dropped 18.32% and the bond market's broadest index, the Barclays U.S. Aggregate Bond Index, dropped 13.02% (as reported by the iShares ETF of a similar name referenced below), it was nice to see the markets turn the page on the New Year with gains. As shown in the graphic above, most of our positions experienced increases in the 1st quarter of 2023, led by the iShares Russell Top 200 Growth ETF, up 15.27%. The markets started the year off with a bang in January in response to declining inflation readings and expectations that the Federal Reserve would end their rate increases, with the S&P 500 gaining 6.29%. February was fraught with concern that inflation was not cool enough, and the S&P 500 declined 2.13%, as a result. In March, we saw the emergence of a potential banking crisis, and a Fed that is committed to further rate hikes, and still the market increased by 3.31%

Overall, we can't be disappointed in the results over the first 90 days of the year. But going forward, the U.S. economy faces many challenges, including ongoing stubbornly high inflation and the likely prospect for a recession. As a result, we are making a fundamental change in our investment models that we believe is beneficial to our clients.

In reviewing our investment models, we have been following the performance of the bond market with particularly keen interest. Last year, we replaced our model position in the iShares iBoxx $ Investment Grade ETF (LQD) for the iShares Core Aggregate Bond ETF (AGG), under the belief that the higher quality bonds being held in the AGG ETF would cause it to outperform LQD. Remarkably, the price action in the two funds performed in near lockstep over the last 12 months.

Recently, we made an investment in the Schwab Value Advantage Money Fund to better invest larger cash positions our clients hold. The current 7-day yield is 4.9%, as of this writing on May 17, 2023. In contrast, the 30-day SEC yield on the AGG and LQD are 3.85% and 3.63%. As a result, given that Federal Reserve interest rate policy will remain constant for a period of time, at least until they see real signs of a recession in the economy, we are trading out of our position in AGG in favor of investing the bond portion of client portfolios in the far higher yielding Schwab money market. In addition to a higher yield, clients will expect to see constant price performance ($1 per share) versus the up and down price movement of bond market investments. The chart below shows the relationship between Federal Reserve interest rate hikes and money market yields.

We anticipate that, at some point in the future, we will trade out of the Schwab money market fund in favor of bond market investments. However, that decision will be made when we have the analysis and economic conditions that warrant it. We don't always communicate changes in our discretionary risk-managed models, but this development was noteworthy enough to warrant sharing in light of client interest in money market yields and the uncertainty in the economy.

All market data provided by YCharts.