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The Importance of Diversified Portfolios

There is an investment adage, “If everything in your portfolio is working well at the same time, you have a problem.” The insinuation is that a portfolio with everything moving in the same direction is too highly correlated, and thus does not benefit from the positive attributes of portfolio diversification.

Never has this been truer than over the past several months, where rising commodity prices have stoked concerns over the inflation outlook for the U.S. economy, leading to a repricing in some of the frothier parts of the equity markets, such as SPACs and momentum strategies. Investors who found themselves overly exposed to particular sectors or strategies took significant losses (the IPOX SPAC Index is down 24% from the February high as of 5/11), while investors who were properly diversified across equity sectors, geographies, and market caps did pretty well.

The same is true across asset classes, as the weakness in bonds since the start of the year has been offset by the resilience in equities, particularly more value-oriented sectors. The source of the inflation worries stems largely from the massive increase in money supply we have seen since the start of Covid-19. Outside of the wartime experiences of WWI and WWII, this amount of monetary expansion is without precedent, as shown graphically below. As one would expect, there is a general relationship between money supply and inflation over time, but we would caution that correlation does not always imply causation, as there are other factors that contribute to inflationary environments as well, such as labor market strength, energy prices, etc.

At a high level, the prices for many consumer goods, such as food, gasoline, housing, and other goods have been rising over the past six months, that much is clear. The question is whether this increase in inflation will be transitory, and abate over time, or whether it will be sticky, and potentially increase in the future. In our view, if labor market conditions continue to tighten and energy prices continue to rise, inflation could prove to be stickier than some expect, so we will be watching both of these datapoints closely in the months ahead. From a portfolio perspective, we continue to recommend a focus on quality within equity allocations (foregoing the frothiest parts of the market), along with high-grade fixed income exposure of intermediate duration or less, to minimize the impact from inflation if it does move higher as we enter the summer months.

The commentary is limited to the dissemination of general information pertaining to Frontier Wealth Management, LLC’s (“Frontier”) investment advisory services. This information should not be used or construed as an offer to sell, a solicitation of an offer to buy or a recommendation for any security, market sector or investment strategy. There is no guarantee that the information supplied is accurate or complete. Frontier is not responsible for any errors or omissions, and provides no warranties with regards to the results obtained from the use of the information. Nothing in this document is intended to provide any legal, accounting or tax advice and Frontier does not provide such advice. This information is subject to change without notice and should not be construed as a recommendation or investment advice. You should consult an attorney, accountant or tax professional regarding your specific legal or tax situation.