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Investment Strategy

Weekly market insights and possible impacts on investors from the Wells Fargo Investment Institute Global Investment Strategy team.

March 28, 2023

John LaForge, Head of Real Asset Strategy

Mason Mendez, Investment Strategy Analyst

Chao Ma, PhD, CFA, FRM, Global Portfolio and Investment Strategist

Brian Rehling, CFA, Head of Global Fixed Income Strategy

Real Assets Spotlight: Making sense of gold and digital assets

  • Gold and bitcoin outperformed in March.
  • How they behave from here may give clues to the direction of monetary policy.

Equities: Has the tide turned for China?

  • Geopolitical tensions and economic decoupling are becoming longer-term risks to the Chinese stock market.
  • Given China’s impact, we maintain our unfavorable rating on Emerging Market Equities until we see evidence that investors are getting comfortable with Chinese market risks.

Fixed Income: Preferred volatility

  • Given the higher volatility of the preferred sector, we favor exposure to this sector be diversified among a variety of issuers, sectors, and structures. We strongly advise that investors consider a professional manager to oversee their preferred allocations.
  • We currently have a neutral recommendation on the preferred security sector.

Alternatives: The importance of hedge fund manager selection

  • Hedge funds have tended to exhibit greater levels of return dispersion relative to traditional equity or fixed income funds, placing a greater level of importance on manager selection when building a diversified portfolio.
  • While the recent elevated market volatility may be an opportune time to consider investing in hedge fund strategies, we believe a disciplined research and due diligence process is essential in seeking to optimize returns and mitigate risks.

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Real Assets Spotlight

Making sense of gold and digital assets

How quickly markets can change. For most of the past year, the Federal Reserve (Fed) was laser-focused on fighting inflation through a combination of increasing interest rates and quantitative tightening. That focus shifted a few weeks back, however, after a string of bank failures. The Fed remains concerned about inflation, but its main short-term focus is containing financial contagion. To aid in this effort, the Fed recently partnered with the Treasury to create a new credit facility for troubled banks.

The new credit facility has been used, which has increased the Fed’s balance sheet. Or said another way, the Fed has loosened monetary policy some. Per the Fed, though, this loosening is temporary, and not the start of a new loosening cycle. We believe many investors agree, but not all assets — gold and digital assets, specifically, are acting as if loose monetary conditions may be here to stay a bit longer.

Why gold and digital assets are worth discussing is that they are two of the most sensitive assets to shifts in monetary policy. And most importantly in 2023 through March 21, they are two of the best performing assets, after woeful performances in 2022 (gold was down 2% and bitcoin was down 65% in 2022).1 So far this month, gold is the best performing commodity, up 6%, while bitcoin is up 20% as of March 21. Today, we will take a brief look into what the outperformance of the two real assets may be signaling to the rest of the market.

Why gold

Gold prices are swayed by many things. The most influential ones are typically related to the macro environment, such as currencies, and central-bank policies. The U.S. dollar, as an example, often has a strong negative influence. In 2022, the U.S. dollar was strong much of the year, which is why gold prices flatlined in a strong performance year for most commodities. Related to U.S. dollar strength, the other great influence on gold last year was the persistent global tightening of monetary conditions. If monetary conditions were on the precipice of shifting, gold outperforming would likely be one of the earliest signals. The reason this has often been the case is that gold supplies are persistently limited. When monetary conditions loosen, more fiat money has ended up chasing the limited amount of gold supplies, and prices rise.

Now, gold’s outperformance in March may simply be defensive postering by investors. Gold is known to attract investment flows during crisis events. No matter, gold’s price action will be worth watching from here. We will be particularly interested if gold breaks above its all-time high of $2080 per ounce, which is only $140 from today’s (March 24) price. If it does, it may very well be signaling loosening monetary conditions ahead. Chart 1 highlights the influence of loose monetary conditions on the price of gold. The gold line is the price of gold, while the dashed purple line is global money supply divided by global gold supply. Notice that the price of gold has performed best when global money supplies are growing faster than global gold supplies (rising dashed purple line).

Global money supply versus the global gold supplyThis chart plots the price of gold against a ratio of global money supply over global gold supply. Historically, the price of gold increased when the ratio of global money supply increased. Ever since gold prices bottomed in October 2022, prices are up 11% through the end of February 2023. This price increase also coincided with a 3% increase in the global money supply to global gold supply ratio.Sources: Bloomberg, U.S. Geological Survey (USGS), World Bank, Federal Reserve Economic Data (FRED), and Wells Fargo Investment Institute. *Global Money Supply estimated by combining M2 Measures for the U.S., U.K., China, Japan, Canada, and the eurozone. Ratio is the global money supply divided by the global gold supply. Monthly Data: January 31, 1987 – January 31, 2023. Annual data is used for gold supply and is from 1987 – 2022. Past performance is no guarantee of future results.

Why digital assets

The banking turmoil has forced many investors to turn defensive in March. They have flocked to traditional defensive areas, such as gold, bonds, and defensive S&P 500 sectors, such as Health Care and Utilities. The strong move into bitcoin specifically, however, has left many investors confused. Bitcoin is often considered risky by traditional investors as it can be quite volatile. Yet, bitcoin is up 20% so far in March — outperforming every major asset class.

How can volatile bitcoin be one of the strongest performers in a market spooked by banking turmoil? Our answer has two parts. The first part is related to the monetary shift we just described with gold. Bitcoin, like gold, has a very limited supply. Loose monetary conditions generally lead to more fiat money chasing the limited supplies of gold and bitcoin.

The second part is that bitcoin technology aims to improve the current financial system. One of these improvements is directly related to the current banking turmoil — possession of one’s assets. As some regional banks were shuttered earlier this month, accessing deposits was difficult for these regional bank customers, and there were lingering questions about the extent of insurance on customer deposits. While bitcoin does not solve the problem of lost or uninsured deposits, as it can be lost and stolen too, it can be owned, stored, and controlled by its owner, without the need for a third party. In this way, we believe bitcoin is a bit like gold as it is held outside the traditional system for a rainy day.



Has the tide turned for China?

Since March 2021, the zero-COVID policy and geopolitical tensions have been two dominant headwinds for the Chinese stock market. As shown in the chart below, the MSCI China Index declined by over 50% from March 31, 2021 to October 31, 2022. In comparison, the S&P 500 Index retreated less than 10% over the same period. Shortly after, the Chinese stock market experienced a strong reversal, catalyzed by a few events that eased geopolitical and policy risks. These included China’s National Congress, the Biden-Xi meeting, and China’s reopening. From November 2022 to January 2023, the Chinese market outperformed the U.S. market, the Chinese yuan strengthened relative to the U.S. dollar, and multinational companies outpaced U.S.-oriented companies.

However, since then geopolitical tensions between the U.S. and China re-intensified as shown in the balloon incident, and the trend of economic decoupling and supply-chain onshoring continued to unfold. We believe geopolitical and economic trends are becoming longer-term factors that uniquely impact the Chinese stock market.

China accounts for over 30% of the broader MSCI Emerging Markets (EM) Index, and given China’s influence, the two indexes had a strong and stable correlation in recent years. We believe China needs to demonstrate a path toward sustainable growth and stability for investors to become more comfortable with these developing risks. Until then, we maintain our cautious view and unfavorable rating for the broader emerging markets asset class.

Equity index level history since March 31, 2021The S&P 500 Index had relatively small changes over the charted period, compared to the MSCI Emerging Market (EM) and MSCI China indexes. The latter experienced significant drawdowns prior to November 2022, a strong reversal between November 2022 and January 2023 and a resumption to a longer-term downtrend more recently.Sources: Bloomberg and Wells Fargo Investment Institute. Data as of March 16, 2023. The index level is rebased to 100% on March 31, 2021. An index is unmanaged and not available for direct investment. Past performance is no guarantee of future results.

Fixed Income

Preferred volatility

While many different types of businesses may utilize preferred securities in their capital structure, the sector is dominated by securities of financial institutions. As bank solvency concerns roiled markets in recent weeks, we have seen a significant pullback in the market price of preferred securities. As of March 20, 2023, the S&P U.S. Preferred Stock Index is down over 9% since the beginning of the month. We maintain a neutral rating on the preferred security sector, and selective opportunities exist given the market pullback, but investors should understand the market dynamics and risks of investing in preferred securities.

There are a number of features that investors may embrace when adding higher-yielding securities to their portfolio. These can include longer maturities, lower credit quality, less liquidity, and a loss of structural protections. Preferred securities contain most, if not all, of these qualities. These qualities can enhance the volatility of this sector during times of market stress as we have seen recently.

Preferred securities often are subordinate to other creditors. When a financial institution comes under stress, it is possible that a preferred security may stop paying coupon payments or in a default situation be completely wiped out. For this reason, we believe it is critical that an investor fully understands both the structure and credit risk of a preferred security they are evaluating.

Given the market pullback, the yield potential in the preferred industry is attractive in our opinion, however, this yield opportunity brings with it meaningful risks to investors. Given our expectation for deteriorating economic conditions, we prefer only the strongest credits during this period of uncertainty. Even in strong credits investors must be prepared for additional price volatility. We advise that investors strongly consider a professional manager to oversee their preferred allocations.



The importance of hedge fund manager selection

Hedge fund returns may vary widely from the top to the bottom performers. While industry benchmarks typically use equal or asset-weighted averages, the large dispersion in returns within each category can lead to an investor experience that may differ significantly from the averages. This return differential may be a result of many factors, including the greater flexibility in investment styles and approaches. Hedge fund managers often have the latitude to express their views using a variety of techniques, including the ability to construct concentrated portfolios, invest across a wide range of securities (stocks, bonds, and derivatives), and use greater amounts of leverage.

As shown in the chart below, the average dispersion between top quartile and bottom quartile hedge funds registered 5.1% versus a differential of 1.9% for global equities and 1.4% for global bonds on a trailing 10-year annualized basis. The larger return dispersion in the hedge fund industry highlights the importance of selecting managers that perform above-average relative to their peer group. The ability to identify managers that achieve top quartile performance can lead to a dramatic performance advantage relative to an average return for the category.

The current economic slowdown and increased market volatility may provide an opportune time to consider adding hedge fund strategies to a diversified portfolio of traditional stocks and bonds. We believe a disciplined research and due diligence process to identify managers should not only reduce risk but also prove to be an effective tool to enhance long-term return potential.

Annualized quartile and median fund returns over the past 10 years The bar chart shows the annualized return on a 10-year trailing basis from January 1, 2013 to December 31, 2022 across several categories of funds, including global equity, global fixed income, Equity Hedge, Event Driven, Global Macro, and Relative Value strategies. The data show that hedge fund category returns vary 5.1% on average versus 1.9% for global equity and 1.4% for global fixed income funds. The higher level of return dispersion in the hedge fund industry (versus traditional long only mandates) highlights the importance manager selection can provide in achieving attractive long-term returns.Sources: Morningstar, HFR, and Wells Fargo Investment Institute. Data covers the period from January 1, 2013 to December 31, 2022. Global equity funds and global bond funds are based on Morningstar categories. In the chart, the top of each red bar shows top quartile fund returns and the bottom of each red bar shows the bottom quartile fund returns. The triangles show the median fund returns. An index is unmanaged and not available for direct investment. Past performance is no guarantee of future results.

Alternative investments, such as hedge funds, private equity, private debt, and private real estate funds are not appropriate for all investors and are only open to “accredited” or “qualified” investors within the meaning of U.S. securities laws.

1 The performance of gold is measured by Bloomberg ticker “XAU curncy’ and bitcoin is measured by the Bloomberg Galaxy Bitcoin Index.

Risk Considerations

Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Stock markets, especially foreign markets, are volatile. Stock values may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. Foreign investing has additional risks including those associated with currency fluctuation, political and economic instability, and different accounting standards. These risks are heightened in emerging markets. Small- and mid-cap stocks are generally more volatile, subject to greater risks and are less liquid than large company stocks. Bonds are subject to market, interest rate, price, credit/default, liquidity, inflation and other risks. Prices tend to be inversely affected by changes in interest rates. High yield (junk) bonds have lower credit ratings and are subject to greater risk of default and greater principal risk. Preferred securities have special risks associated with investing. Preferred securities are subject to interest rate and credit risks. Preferred securities are generally subordinated to bonds or other debt instruments in an issuer's capital structure, subjecting them to a greater risk of non-payment than more senior securities. In addition, the issue may be callable which may negatively impact the return of the security. The commodities markets are considered speculative, carry substantial risks, and have experienced periods of extreme volatility. Investing in a volatile and uncertain commodities market may cause a portfolio to rapidly increase or decrease in value which may result in greater share price volatility. Investing in gold or other precious metals involves special risk considerations such as severe price fluctuations and adverse economic and regulatory developments affecting the sector or industry. Real estate has special risks including the possible illiquidity of underlying properties, credit risk, interest rate fluctuations and the impact of varied economic conditions.

Virtual or cryptocurrency is not a physical currency, nor is it legal tender. Bitcoin and other cryptocurrencies are a very speculative investment and involves a high degree of risk. Investors must have the financial ability, sophistication/experience and willingness to bear the risks of an investment, and a potential total loss of their investment. An investor could lose all or a substantial portion of his/her investment. Cryptocurrency has limited operating history or performance. Fees and expenses associated with a cryptocurrency investment may be substantial. Cryptocurrencies are sometimes exchanged for U.S. dollars or other currencies around the world, but they are not backed or supported by any government or central bank. Their value is completely derived by market forces of supply and demand, and they are more volatile than traditional fiat currencies.

Alternative investments, such as hedge funds, private equity/private debt and private real estate funds, are speculative and involve a high degree of risk that is appropriate only for those investors who have the financial sophistication and expertise to evaluate the merits and risks of an investment in a fund and for which the fund does not represent a complete investment program. They entail significant risks that can include losses due to leveraging or other speculative investment practices, lack of liquidity, volatility of returns, restrictions on transferring interests in a fund, potential lack of diversification, absence and/or delay of information regarding valuations and pricing, complex tax structures and delays in tax reporting, less regulation and higher fees than mutual funds. Hedge fund, private equity, private debt and private real estate fund investing involves other material risks including capital loss and the loss of the entire amount invested. A fund's offering documents should be carefully reviewed prior to investing.

Hedge fund strategies, such as Equity Hedge, Event Driven, Macro and Relative Value, may expose investors to the risks associated with the use of short selling, leverage, derivatives and arbitrage methodologies. Short sales involve leverage and theoretically unlimited loss potential since the market price of securities sold short may continuously increase. The use of leverage in a portfolio varies by strategy. Leverage can significantly increase return potential but create greater risk of loss. Derivatives generally have implied leverage which can magnify volatility and may entail other risks such as market, interest rate, credit, counterparty and management risks. Arbitrage strategies expose a fund to the risk that the anticipated arbitrage opportunities will not develop as anticipated, resulting in potentially reduced returns or losses to the fund.


Bloomberg Galaxy Crypto Index (BGCI) is a benchmark designed to measure the performance of the largest cryptocurrencies traded in USD.

HFRI Event Driven Index: Investment Managers who maintain positions in companies currently or prospectively involved in corporate transactions of a wide variety including but not limited to mergers, restructurings, financial distress, tender offers, shareholder buybacks, debt exchanges, security issuance or other capital structure adjustments. Security types can range from most senior in the capital structure to most junior or subordinated, and frequently involve additional derivative securities. Event Driven exposure includes a combination of sensitivities to equity markets, credit markets and idiosyncratic, company specific developments. Investment theses are typically predicated on fundamental characteristics (as opposed to quantitative), with the realization of the thesis predicated on a specific development exogenous to the existing capital structure.

HFRI Equity Hedge Index: Investment Managers who maintain positions both long and short in primarily equity and equity derivative securities. A wide variety of investment processes can be employed to arrive at an investment decision, including both quantitative and fundamental techniques; strategies can be broadly diversified or narrowly focused on specific sectors and can range broadly in terms of levels of net exposure, leverage employed, holding period, concentrations of market capitalizations and valuation ranges of typical portfolios. EH managers would typically maintain at least 50% exposure to, and may in some cases be entirely invested in, equities, both long and short. The HFRI Equity Hedge Index is a composite of the hedge funds that employ the alternative strategies and who report their performance figure to HFRI. The number of hedge funds reporting may vary between each reporting period.

HFRI Macro Index: Investment Managers which trade a broad range of strategies in which the investment process is predicated on movements in underlying economic variables and the impact these have on equity, fixed income, hard currency and commodity markets. Managers employ a variety of techniques, both discretionary and systematic analysis, combinations of top down and bottom up theses, quantitative and fundamental approaches and long and short term holding periods. Although some strategies employ RV techniques, Macro strategies are distinct from RV strategies in that the primary investment thesis is predicated on predicted or future movements in the underlying instruments, rather than realization of a valuation discrepancy between securities. In a similar way, while both Macro and equity hedge managers may hold equity securities, the overriding investment thesis is predicated on the impact movements in underlying macroeconomic variables may have on security prices, as opposes to EH, in which the fundamental characteristics on the company are the most significant are integral to investment thesis.

HFRI Relative Value Index maintains positions in which the investment thesis is predicated on realization of a valuation discrepancy in the relationship between multiple securities. Managers employ a variety of fundamental and quantitative techniques to establish investment theses, and security types range broadly across equity, fixed income, derivative or other security types. Fixed income strategies are typically quantitatively driven to measure the existing relationship between instruments and, in some cases, identify attractive positions in which the risk adjusted spread between these instruments represents an attractive opportunity for the investment manager. RV position may be involved in corporate transactions also, but as opposed to ED exposures, the investment thesis is predicated on realization of a pricing discrepancy between related securities, as opposed to the outcome of the corporate transaction.

Note: HFRI Indices have limitations (some of which are typical of other widely used indices). These limitations include survivorship bias (the returns of the indices may not be representative of all the hedge funds in the universe because of the tendency of lower performing funds to leave the index); heterogeneity (not all hedge funds are alike or comparable to one another, and the index may not accurately reflect the performance of a described style); and limited data (many hedge funds do not report to indices, and, therefore, the index may omit funds, the inclusion of which might significantly affect the performance shown. The HFRI Indices are based on information self‐reported by hedge fund managers that decide on their own, at any time, whether or not they want to provide, or continue to provide, information to HFR Asset Management, L.L.C. Results for funds that go out of business are included in the index until the date that they cease operations. Therefore, these indices may not be complete or accurate representations of the hedge fund universe, and may be biased in several ways. Returns of the underlying hedge funds are net of fees and are denominated in USD.

MSCI China Index captures large and mid-cap representation across China H shares, B shares, Red Chips and P Chips. With 140 constituents, the index covers about 85% of the China equity universe.

MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets.

Note: MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed, or produced by MSCI.

S&P 500 Index is a market capitalization-weighted index composed of 500 widely held common stocks that is generally considered representative of the U.S. stock market.

S&P U.S. Preferred Stock Index is designed to serve the investment community's need for an investable benchmark representing the U.S. preferred stock market.

An index is unmanaged and not available for direct investment.

General Disclosures

Global Investment Strategy (GIS) is a division of Wells Fargo Investment Institute, Inc. (WFII). WFII is a registered investment adviser and wholly owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.

The information in this report was prepared by Global Investment Strategy. Opinions represent GIS’ opinion as of the date of this report and are for general information purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report.

The information contained herein constitutes general information and is not directed to, designed for, or individually tailored to, any particular investor or potential investor. This report is not intended to be a client-specific suitability or best interest analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. The material contained herein has been prepared from sources and data we believe to be reliable but we make no guarantee to its accuracy or completeness.

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