The global economy and financial markets continue to be challenged by a multitude of crosscurrents. Persistently high inflation exacerbated by the energy price shocks from the Russia-Ukraine conflict, spurred the Federal Reserve to hike interest rates more aggressively than anticipated. High inflation and tighter financial conditions weighed on consumer and business confidence, and growth fears helped send stock prices into bear market territory. The question is how much of this is priced in? In fact, unemployment continues to be low at 3.6%, with an excess demand for labor. Given consumer spending constitutes 70% of the GDP, retail sales rose 1% reflecting a market that has perhaps priced in a shallow recession that may or may not come to be.

To monitor key trends in advisors' strategic allocations and rebalances, we have reviewed over 3,200 professionally managed investment portfolios in Q2 2022 through our proprietary portfolio construction capabilities. Our analysis uncovers key themes playing out within each asset class, that we believe will continue to be top of mind in 2022 and potentially beyond:

Q2 2022 portfolio analysis included:

56%

moderate/moderate-aggressive portfolios

18%

aggressive portfolios

26%

conservative/moderate-conservative portfolios

We observed the average portfolio has:

15

holdings

6

different asset managers

57

bps of underlying blended fees

5

Domestic

2

Sector

2

International

4

Fixed Income

1

Other (Alternatives & Commodities)

  • Domestic Equity
    The average equity sleeve in a portfolio was 66%. The equity sleeve is 78% allocated to U.S. equities, which is higher than the previous quarter (75%). Within U.S. equity, the average portfolio has 66% allocation to large caps, 22% to mid caps and 12% to small caps compared to 64% in large caps, 24% in mid caps and 12% in small caps in Q1. Consumer spending continues to pick up in pandemic-impacted areas but the economy is beginning to lose momentum. The S&P 500 forward P/E ratio is a couple clicks below its 25-year average of 16.9x, but the earnings denominator may have to be adjusted lower. With this drawdown, forward-looking returns are looking better with a lower starting point, but high interest rates will continue to cause pressure on valuations.

    Insights:

    Q2 saw advisors turning to more defensive sectors allocating 25% of their equity sleeve to them compared to 22% the previous quarter.
    While all major asset categories sold off during Q2, more defensive sectors performed relatively well, including consumer staples, utilities that outperformed other global categories.
    There was a decrease of 3% in Growth allocation from 39% in Q1 to 36% in Q2. This went into Core (40%) while Value allocation remained consistent (24%).
    Value has outperformed growth since late 2021 because of energy's outperformance and tech's underperformance leading to advisors moving away from their long-term growth bias.
    Many commodity prices finished Q2 near multiyear highs but a refocus on recession dampened the rally. It remains a rare bright spot with positive returns for year to date. However, only 10% of advisors have exposure to commodities with an average allocation of 5%.
    In Q2, 16% of advisors encountered had some exposure to liquid alternatives. Of those advisors, the average allocation was 9%. Some liquid alt categories have a lower correlation to equity and should be considered as an alternative to fixed income as a hedge to equity, especially during this period of high inflation.
  • International Equity
    The equity sleeve allocation showed 22% to be allocated to non-U.S. equities which is lower than the Q1 2022 allocation by 3%. This amount is steadily decreasing from a high of 28% in Q1 2021. Advisors have 82% of their international sleeve in Developed Markets and only 18% in Emerging Markets.

    Insights:

    With Europe facing near-term recession risk due to being impacted by high energy prices, overall uncertainty due to the Ukraine-Russia conflict, and general inflation pressures, advisors are reducing their international exposure.
    Forward earnings growth expectations for non-U.S. stocks ticked down but remain positive despite being below their long-term averages.
    China's zero-COVID policy and property markets leverage remain a risk along with structural imbalances that exist in that economy. However, policy easing to support manufacturing, property, and consumer spending has the potential to lift China out of extreme slow growth.
    Additionally, the U.S. dollar has strengthened versus most major developed-market currencies year-to-date.
  • Fixed Income
    The average fixed income sleeve in a portfolio was 28%. The average portfolio allocation to high yield within that is 25%—a drop of 4% compared to Q1 2021.

    Insights:

    In late cycle and recession, investment-grade bonds tend to do better than other asset classes. This has caused advisors to increase allocation from 71% in Q1 to 75% in Q2 towards investment-grade bonds.
    We are also seeing an increase in duration from 4.6 in Q1 to 5.7 in Q2.
    A silver lining to rising rates is that after several years of extremely low bond yields, fixed income assets now offer relatively better income with more attractive valuations.

After a strong 2021 for absolute and relative returns, performance in 2022 has been challenged as both stocks and bonds have struggled against the backdrop of 40-year-high inflation. We may have entered a higher inflation regime where additional asset classes besides stocks and bonds are needed to build a more diversified portfolio. Contact your Fidelity representative to find out how we can help you navigate these challenges to position your portfolios for years and decades to come.

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Contact your Fidelity representative today to discuss how to successfully navigate the markets in 2022.

Fidelity Portfolio Construction Solutions Team

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Paul Ma
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Kelly Gushue
Kelly Gushue
Director, Portfolio Solutions Consultant
Nils Bierkamp
Nils Bierkamp
Portfolio Strategist
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Craig Blackwell
Portfolio Strategist
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Taylor Hankins
Portfolio Strategist
Alex Harrington
Alex Harrington
Portfolio Strategist
Gavin Robinson
Gavin Robinson
Portfolio Strategist

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