Initiating a New ETF Position for a Performance Edge

After you receive this Alert we will take the following action:

-- Initiate a new position in the SPDR Portfolio S&P 600 Small Cap ETF (SPSM) , with a "Two" rating, with the purchase of 150 shares at or close to $44.05. This will start this position off with a weighting of 2.4%.

The thought here is to build this position up to a weighting in between 5% and 6%, or about half of the portfolio's exposure to the iShares Russell 2000 ETF (IWM) . A priority must be placed on IWM as that fund does track the benchmark. Hopefully, a lesser, but significant exposure to SPSM will help the portfolio outperform the benchmark index in more months and years than it does not.

Broadening Small-Cap Exposure

The benchmark for this portfolio is the Russell 2000 index, even though the rules of the game for our portfolio don't match up perfectly with the rules of what kind of public firms are considered to be "small-caps" by Wall Street. A small-cap stock is normally defined by Wall Street as a public company with a market capitalization of between $300M to $2B. Mid-caps take it from there. On the way down, in terms of cap size, firms valued between $50M and $300M are considered to be micro-caps, and any public company worth less than $50M is considered to be a nano-cap.

Since the day I got here, the portfolio has held a large position (currently a 12% weighting) in the iShares Russell 2000 ETF, even though that fund runs about $216 per share. The problem with that is we are already at a disadvantage to the benchmark index, as a great percentage of individual stocks already in and eligible for inclusion in the that index are not eligible for the Stocks Under $10 portfolio by virtue of their greater than $10 market price per share. I have also noticed that over almost any time frame that the S&P Small-Cap 600 has outperformed the Russell 2000.

For example, over the past month, the S&P 600 is up 2.2%, while the Russell 2000 is up 0.7%. Over three months, the S&P 600 is up 1.6%, while the Russell 2000 is down 2.7%. Over the past one year, the S&P 600 is up 13.2%, while the Russell 2000 is up 2.2%. Going back over three years, which includes an excellent run for small-caps, the S&P 600 is up 52.6%, while the Russell 2000 is up 50.1%.

So, I got to considering, being we are trying to match or beat the most highly focused upon small-cap index available, it does make sense to expose the portfolio to an ETF that tracks the index as we have long ago done. However, being that we know that on average, there is another small-cap index that regularly beats that index, maybe we should add some exposure to an ETF tracking that index as well, since it really is still in our wheelhouse.

I have chosen the SPDR Portfolio Small Cap ETF as that fund has compared to the IWM fund in terms of performance much the same way that the S&P 600 compares to the Russell 2000. Oh, and another thing, the portfolio's cash position is in fact, way too large, especially in an inflationary environment, as it returns less than zero in real terms.

The Chair

Just to recap.

Fed Chair Jerome Powell was just vague enough and sounded just confident enough to allow Treasury security yields to put a halt to their meteoric rise of last week. This allowed U.S. dollar valuations to come in throughout the Tuesday session, also allowing risk assets to recapture some lost ground.

On the Fed's dual mandate, Powell said, "To get the very strong labor market we want with high participation, it is going to take a long expansion. To get a long expansion, we are going to need price stability." Powell added, "High inflation is a severe threat to achieving maximum employment and to achieve the long expansion that could give us that." The Fed Chair went on, mentioning that the era of pandemic-induced stimulus was indeed over, and that the Fed would set itself on the "long road" toward more normal monetary policy this year. One must ask, though: What is normal at this point? We haven't seen anything close to normal since at least prior to the "Great Financial Crisis" and in fact, really since the 1990s.

In my opinion, he is the best Fed Chair since then, if only because he does seem to learn from mistakes and adjust policy accordingly. Powell added: "I would expect this year, 2022, will be a year where we take steps towards normalization." On the balance-sheet run-off, that the mere mention of in last Wednesday's FOMC Minutes put the Nasdaq Composite, albeit briefly, into correction territory, Powell said that this would happen "sooner and faster" than the last time it did so, beginning in 2017.

Basically, rate hikes are going to come in groups, and later on, but still this year, the Fed will start removing this excess liquidity from the monetary base. Markets did not mind this on Tuesday, but we have to expect that at some point they will. I expect us to exist in a regime of volatility that will persist either until the central bank accomplishes the mission at hand (not as likely), or breaks something and backs off (based on experience, more likely).

Inflation

Seven percent consumer-level inflation. Been almost 40 years. In fact, the last time inflation ran this hot, I was standing upon the yellow footprints at Parris Island. Inflation wasn't on my mind.

Back to the present.

With December CPI printing at headline growth of 7%, and the core print at 5.5%, and with last Friday's print for wage growth at "just" 4.7%, one has to wonder: What does negative real wage growth do to demand overall? Would like to ex-out food, up 6.3% over last year, but folks need food. Would like to ex-out energy, but folks need energy. Gasoline prices are now up 49.6% year over year, and that's after contracting in December. They are no longer contraction by my neck of the woods.

Higher rates, and negative real wages don't usually end up as an all-that-hot environment for economic growth, which is why I don't think the Fed will end up getting as far it would probably like on the road toward normalization.

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