This investment leader used bond market signals to ride the ‘almost anything’ rally

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Bond market moves informed a timely pivot from cash to equities, says James St. Aubin, chief investment officer of Sierra Mutual Funds
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A typically conservative mutual fund of funds recently shifted strategy and seized on the broader US stock market rally at the right time by shifting its allocation from 96.4% in cash at the end of June to 32.6% at the end of July. and is now fully invested in what he calls an “almost everything” rally.

As a result, the Sierra Tactical All Asset Fund (SIRRX) gained 10.5% this quarter, in part by increasing its investment in the S&P 500-focused SPDR S&P 500 ETF (SPY) from 0.50% as of June 30 to 10.1% as of July 31.

Sierra Tactical All Asset Fund June-YTD

Sierra Tactical All Asset Fund June-YTDSierra Tactical All Asset Fund June-YTD Source: Koyfin

“Before July, we were almost all cash and were able to be fully invested in four weeks,” Sierra Investment Management chief investment officer James St. Aubin said in an interview with Capital.com.

“We noticed that high yield (debt) credit spreads tightened (tightened against underlying benchmark interest rates) at the end of June and we started buying almost everything except raw material.”

Throughout 2022, Sierra had reduced its entire portfolio and increased its cash holdings from 31% as of January 31 to 96.4% as of June 30.

Currently, the Sierra Tactical All Asset Fund allocates 10.1% to US equities – the third-highest allocation – behind cash at 32.6% and tax-exempt municipal bonds at 20.2%.

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SPDR S&P 500 ETF (SPY) Price Chart

“Buy signals are hit evenly”

“While investor pessimism was pervasive for much of the first half of 2022, the second half of the year began on a significantly more optimistic note,” St. Aubin wrote in a report titled “Toro: Bulls Roar Back to Life”.

“From mid-June and through July, stocks and bonds rallied in unusual unison on the belief that inflation could be brought under control without serious economic collateral damage.”

While the S&P 500 (US500) is down 9.70% year-to-date, hitting a low on June 16 at 3,666, it has gained 13.7% so far in the third quarter , closing Thursday at 4,280. Over the next few weeks, “buy signals hit evenly,” across nearly every asset class, St. Aubin noted.

The exception was weakness in oil and gas – which itself is a buy indicator for most other asset classes.

Sierra Asset Allocations, June 2022

Sierra Asset Allocations, June 2022Sierra Asset Allocations, June 2022. Source: Sierra Mutual Funds

“When commodities worked, the energy sector worked,” St. Aubin said.

“What’s bad for energy is good for everything else.”

Sierra Asset Allocations, July 2022

Sierra Asset Allocations, July 2022Sierra Asset Allocations, July 2022. Source: Sierra Mutual Funds

In addition to commodity prices, St. Aubin tracks bond prices for signals that trigger allocation changes.

Notably, the 10-year US Treasury yield peaked in 2022 on June 14 and fell over the next six weeks to 2.57% on August 1.

10-year US Treasury yield, year-to-date

10-year US Treasury yield, year-to-date10-year US Treasury yield, year-to-date

“If you focus on that mid-June pivot point when 10-year Treasuries surged above 3.46%, you saw municipal bonds and then high-yield corporate bonds follow. Bond yields move inversely to prices, which means that when interest rates fall, bond prices rise.

“In July, the S&P 500 Index recorded its best monthly return since November 2020, as the yield on the 10-year Treasury note continued to decline after peaking at 3.49% on June 14, following the June FOMC meeting,” St Aubin wrote.

“Of course, bond prices also benefited from lower interest rates, which brought welcome relief to bond investors after a historically bad start to the year.”

Going forward, St. Aubin will monitor three economic indicators: GDP growth, Fed monetary policy and CPI inflation data. The most recent inflation data is trending lower, but if that reverses and pushes bond yields higher, it could trigger a sell signal.

“Trends have been positive so we’re going to stay for a long time,” added St Aubin. “If 10-year yields trend up significantly, it could be a signal that we are about to test new lows. [in US equities].”

“The bond market is just a little smarter than the stock market.”

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