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A Prudent Portfolio For A Melt-Up Or A Meltdown Redux

Summary Uses a mix of trend-following, active, hedged, and passive management style funds. Selects a stalwart, plain-vanilla benchmark for performance going forward. Constructed in the context of an aging bull market for both equities and bonds. Many portfolios, especially from the DGI crowd, have the dynamic active benefit of additions, subtractions, and constant tweaking by their authors. We always know what they are considering buying, selling, etc., with every article. I also feel that tmy hypothetical “Prudent Portfolio for a Melt-Up or Meltdown,” discussed in 2014, is not a static experiment; it should benefit from some updating and tweaking as well. The main goal of this hypothetical portfolio was simplicity and balance using only five funds in the context of an aging bull market that could still participate if the bull market continues or could ride out some punches from a correction. Much has happened since the inception of this portfolio back in 2014. Old Portfolio and Lessons Learned: TNDQ , PHDG , AGG , GGN , and UUP The TNDQ ETN and all the other RBS ETNs have been discontinued by their sponsor. Gold has continued its downward chaffing spiral, taking = with it the GGN closed-end gold income fund. Too much portfolio weight was given to this falling knife. Tame VIX futures in contango has mercilessly beleaguered the PHDG holding with its partial volatility futures holdings. All was not dreary, as the dollar surged this year, and correspondingly, the UUP fund benefited. Bonds have been a bit of a roller coaster, but the modest net durations of the AGG ETF still provided some desirable ballast. The “Updated Melt-Up or Meltdown” Portfolio: PTNQ , VQTS , TOTL , CEF , and AMFQX Pacer Trendpilot 100 ETF (BATS: PTNQ ) This ETF replaces the recently defunct TNDQ ETN. It has a similar moving average timing strategy tracking the same alpha rich NASDAQ 100 index – but is tweaked with a “50/50” allocation before totally going to the safety of 3 month U.S. treasuries. The complete strategy is as follows: When the NASDAQ 100 index closes above its 200 day simple moving average for 5 consecutive days the fund will be 100% invested in the NASDAQ 100 index. When the NADAQ 100 index closes below its 200 day simple moving average for 5 consecutive days the fund will switch to 50% to the index and 50% to 3 month treasuries. When the NASDAQ 100 index 200 business day simple moving average closes lower than its value from five business days earlier, the exposure of the Index will be 100% to 3-Month US Treasury bills. Once this “T-Bill Indicator” has been triggered, the Index will not return to its 50/50 position until the index closes above the 200 day sma as described earlier, followed by the 50/50 Indicator being triggered as described above. In summary this fund gradually seeks to avoid a deep correction in a gradual manner using 5 business day windows for signals rather than popular end of month signals. The strategy essentially hedges in steps and attempts to limit affects of market “head fakes” of brief periods when falling below the 200 day sma. The fund already has assets of over 27 million and is less than 2 months old. The other two Pacer index based trend following ETFs are growing rapidly as well. This author is long PTNQ. See pictorial below of the hedging strategy from the folks at Paceretfs : ETRACS S&P 500 VEQTOR Switch Index ETN (NYSEARCA: VQTS ) This ETN essentially addresses the drawbacks of the strategy index that PHDG and VQT follows. It dynamically allocates between the S&P 500, VIX futures (either long or short depending on slope of the VIX futures curve), and cash. I wrote about it here as well as fellow SA contributor Vance Harwood’s nice write up here . This ETN seeks to exploit the main weakness of the regular VEQTOR index by “switching” and having a short position in VIX futures and gaining additional alpha from the negative VIX futures roll yield during periods of steep contango. It makes for an excellent replacement for PHDG from the previous portfolio. Assets are still rather on the light side at about 25 million, but this ETN is young and will likely grow to robust asset levels. Especially if there is a steep correction like we had in 2011. SPDR DoubleLine Total Return Tactical ETF (NYSEARCA: TOTL ) The iShares AGG aggregate total bond ETF’s “dumb index” has been replaced with the steadfast expertise of Jeffery Gundlach’s active management for the bond portion of the portfolio. Bonds in my opinion, especially now more than ever need some active management. With upcoming rate increases promised by the FED, a bond guru will be a welcome addition to help tame some bond angst and volatility. This ETF version of his flagship portfolio has outperformed the total bond index handily. The mild average durations of 4 years along with hands on active management should make for some nice ballast for the portfolio. This ETF has an expense ratio of 0.55% and a healthy AUM of over 850 million. More info about this fund available here . Central Fund of Canada Ltd. (NYSEMKT: CEF ) This closed-end fund replaces the beleaguered and volatile GGN fund. With gold down in the trash heap of most investors radar this well regarded CEF was chosen for the small precious metals portion of the portfolio. This fund holds marketable gold and silver bullion. The fund currently sports around a 9% discount to NAV. This popular fund has a long history and is cheaper with fees of only 0.32%. No one knows how low gold will go especially in this backdrop of a strengthening dollar and threats of higher rates, but one could catch the falling knife and could take comfort that with this fund you will at least take a position at a considerable discount to NAV. More about this fund available here . 361 Managed Futures Strategy Fund (MUTF: AMFQX ) As bonds become less desirable and correlations increasing throughout asset classes – an alternative type of fund may be beneficial to a portfolio. For this updated portfolio a managed futures strategy seemed like a logical fit for this balanced “melt up or meltdown” theme. This four star Morningstar rated 361 Managed Futures Strategy Fund uses a counter trend strategy designed to navigate choppy volatile markets. Managed futures by design have low correlations to core assets such as bonds and equities and can reduce overall risk and volatility to a portfolio. Fees run about 2%. The fund’s performance so far this year have been stellar with it being up around 10%. More about this fund available here . Weightings The weightings of the balanced Updated Prudent Portfolio for Melt-Up or Meltdown are as follows: 30% PTNQ 30% VQTS 20% TOTL 15% AMFQX 5% CEF This summarily is 60% U.S. equities (index based and systematically hedged), 20% bonds (actively managed), and 20% alternatives and precious metals (actively managed and partially passive). The Benchmark: Vanguard Balanced Index Fund (MUTF: VBINX ) This venerable stalwart is cheap, passive and effective over the long term. It’s U.S. centric and is a formidable benchmark for this upgraded portfolio. It consists simply of 60% the total U.S stock market and 40% the aggregate U.S. bond market. It’s fees are only 0.23% and that immediately gives this “Melt Up or Meltdown Portfolio” a hump that will have to be overcome with alpha and/or reduced drawdowns. It should be a fun exercise comparing this updated portfolio to the this popular passive mutual fund. Summary and Caveats The construction of this updated hypothetical portfolio was an interesting exercise. The bar is set high for the future – competing with the performance of the before mentioned Vanguard Balanced Index Fund. In the context of an aging bull market for both equities and bonds it seemed timely for portfolio mixes of smart beta, index hedged, managed futures, and active management funds to hopefully shine in some outperformance in the years to come. One could use Morningstar or portfoliovisualizer.com,etc. to track it. Always read prospectuses and other fund literature before investing. Always use limit orders for lightly traded funds. Disclosure: I am/we are long VQTS, PTNQ. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Patience And Liquidity

The continued drop in commodity prices raised fears in the financial markets that global growth was slowing to a crawl. The result? Bond prices rose while stock prices fell. It is clear that there is overproduction relative to demand in most commodities. This is highlighted by energy. Prices continued to decline last week. Each commodity has its own dynamic but in virtually all cases production is increasing year over year at a rate surpassing demand growth. The key takeaway is demand and production are increasing. Major producers are finally cutting back production to levels equal to or beneath demand growth so that inventory levels stabilize or actually decline, which is a prerequisite for pricing power moving forward. It will take time and patience. Unfortunately there is a lot of speculation in the commodity markets and continued weakness in prices initially led to margin calls and now outright liquidation. Markets typically move too far each way. Fear of a further collapse in the commodity markets has spilled over into other financial markets creating opportunities for investors who have been patient and maintained their liquidity. I have stated that lack of or no growth was my biggest fear. But let’s put all of this in perspective: the U.S. economy is improving led by the consumer; China reported 7.0% growth last quarter and its stock market has rebounded of late; Greece is settled, at least for now, lifting a big cloud over Europe which will lead to renewed growth; Japan is doing fine led by exports; India is continuing to accelerate and will grow over 7% this year however many third world countries are suffering. The world is growing over 3.0% this year which may be less than in the past. Global growth should improve in 2016, too. Don’t forget that the drop in oil prices recently from $60 dollars per barrel to around $48 per barrel will boost consumer disposable income around the world and lower inflationary expectations boosting bond prices from what they otherwise would be at this point in the economic cycle. Beside the consumer, the drop in energy and other commodity prices are good for corporate margins in the aggregate but of course not for the commodity producers themselves. By the way, we added to our energy shorts after it appeared that a deal would be reached with Iran, which we discussed in previous pieces. It was an easy call. Over 70% of companies reporting so far have exceeded their forecasts for the second quarter and maintained or raised numbers for the year. Not too bad. Rather than reviewing events by region as we have done in the past, I’d like to review my core beliefs and see if there are any changes that may influence my investment policy: Monetary policy remains easy virtually everywhere and the supply of funds is exceeding the demand for funds, which is favorable for financial assets. It is clear that the Fed is on hold until year-end or early 2016 at the earliest removing an immediate concern in the marketplace. The dollar has remained the currency of choice, which may impede U.S. economic growth but also lowers inflationary expectations. Positive capital flows from abroad continue to reduce our interest rates from what otherwise they would be. The yield curve will steepen but the degree may be less than initially thought due to the sharp drop in commodities, weakness overseas and strength in the dollar reducing inflationary expectations further. A new conservatism permeates governments, corporations and individuals is clearly true. Just look at new Fed rules for the banks and at corporate cash flow reported for the second quarter so far. Hillary Clinton’s tax proposals are not good for the economy, capital formation and investment but may improve the Republican’s chances in the next Presidential election. Profits will surprise on the upside clearly occurred with second quarter results reported so far. Financial leverage and capital ratios will continue to improve. Clearly this is the case as most corporations are capping capital spending at depreciation therefore generating a lot of free cash. Banks continue to raise capital ratios and reduce leverage and risk. M & A activity will remain strong. Just look in the newspapers every day to see deals of all sizes. Both the acquirer and the acquired company’s stocks rise, as most deals are anti-dilutive day one. Commodity prices continued to decline as producers remained slow to cut back production at levels to or beneath demand growth so inventories continued to rise and prices fell. But lower commodity prices are good for inflation, interest rates and profit margins. Not for commodity companies though. Corporate managements are acting as their own activists recognizing that change is a necessity to survive and thrive in a globally competitive landscape. A Greek default was contained although I doubt that Greece can live up to the terms of its new deal with the ECB. The can was kicked down the road. I still doubt that the Fed can begin raising rates until 2016 and overall policy will remain easy. Future rate hikes will be small and spread out unless there are major changes in the outlook for the U.S and global economies. The economic cycle will be extended with lower highs and higher lows. Still valid. There are few, if any, excesses. Speculation exists today in real estate, private equity and art. Still valid. My beliefs remain for the most part intact. I continue to be pleasantly surprised by how managements are adapting to this global competitive environment. Management is everything to me. There is a reason why Alcoa, Dow Chemical, GE, Honeywell, Nucor, JP Morgan Chase, Wells Fargo are best in class. Then take a look at Facebook, Google, Apple, Starbucks, Visa to name some more. I am long 25 of the best managements in the world who have winning long-term strategies regardless of the economic environment. And that is the key to be a successful investor. Be patient and maintain ample liquidity at all times to take advantage of market moves like last week. While change is in the air it does not happen overnight. Follow your beliefs and challenge them at all times. Invest in stocks, not markets. Invest accordingly! Share this article with a colleague

Frustrated Yet?

The last year has been a tough one for investors. There are a few places one could have booked a double-digit gain in the last 12 months but not many and certainly not in assets that are in the standard portfolio. Currency hedged ETFs for European and Japanese stocks produced big gains, but a lot of the gain was from nothing but currency movements. And most investors shouldn’t be trying to make their yearly return punting on currencies. Stocks for the most part have been disappointing with Nasdaq as a notable exception. Notable because a lot of the action there is reminiscent of the last time that index was leading the market back in 1999/2000. The recent big moves in Google (NASDAQ: GOOG ) (NASDAQ: GOOGL ), Netflix (NASDAQ: NFLX ) and Amazon (NASDAQ: AMZN ) – based on not much – provided a eerie sense of deja vu for anyone who lived through that giddy time. The S&P 500 over the last six months is barely positive, up about 2% (or it is as I write this Friday afternoon; but if things keep going in the current direction, that could be a lot closer to 0 by the close). The average doesn’t do justice to what is really going on though. Only about half the stocks in the S&P 500 are trading above their 200-day moving average right now. Even for an index like the Nasdaq that has performed pretty well this year, less than half the stocks in the index are still in uptrends, trading above their 200-day MA. These are capitalization weighted indexes and at least right now, size does seem to matter. A similar message is sent by the advance/decline stats which show the decliners winning by a pretty wide margin. New highs/new lows also looks less than healthy with new highs increasingly scarce. So the internals of the stock market are deteriorating notably, something that doesn’t generally bode well for the immediate future for stock prices. There are other signs of stress as well. Junk bonds essentially peaked almost a year ago in price and have been trading sideways with a downward bias which has recently accelerated. With Treasuries generally well bid all week, the spread between junk and Treasury yields widened on the week, continuing the longer-term trend that started last summer and reversing the shorter-term narrowing trend that started at the beginning of this year. Credit spreads are highly correlated with the stock market, so ignore the junk market at your portfolio’s peril. Other signs of stress have emerged over the last couple of weeks. Commodities have resumed their downtrend and unlike some other recent periods, it isn’t just a function of a rising dollar. The dollar has been fairly steady but was down last week even as gold and other commodities plumbed new lows for the move. Oil is breaking toward its lows and that is undoubtedly the source of at least some of the selling in the junk bond market. The fracking companies are still struggling and lower prices aren’t going to help them make their interest payments now that their hedges are expiring. The Treasury market also is pointing to some stress with inflation and growth expectations both falling a bit recently. The frustration of the diversified investor actually goes back quite a bit further than the last 6 months or last year. If you have been following an investment plan that includes international stocks and bonds, a smattering of commodities and/or anything else that isn’t US stocks, your personal pain is now running into more like two years and maybe a bit more. I track a long list of passive portfolios and many of the globally diversified ones are working on their third consecutive year of low-to-mid single-digit returns – assuming this year turns out to have a positive number. It isn’t just the US stock indexes that have been narrowing; it is the entire investment universe. This winnowing of the investment universe to a few winners, turning diversification into a risk factor, is just one more example of the negative consequences of the modern form of economics in which common sense has been relegated to quaint notion and nonsense elevated to learned discourse. It is an Orwellian discipline where borrowing and spending have replaced thrift and investment as the drivers of economic growth, prudence is punished, speculation celebrated and rewarded. Is it any wonder that our economy continues to struggle when we’ve spent decades urging the population to be irresponsible, to ignore the future so that our present can be more comfortable? Monetary policy is a cudgel, a blunt tool used for more than a mere nudge, to make investors feel obliged to chase returns, to take excessive risks to achieve even their mundane goals. If you can’t achieve those goals with safe investments – and economic policy has made that nigh on impossible – you move out on the risk scale until you can because the alternative – spending less, saving more – has been deemed un-American, economically unpatriotic. The unspoken agreement – unspoken by the Fed certainly but widely accepted and believed – is that the monetary powers that be will maintain risky assets at the high prices that have, according to the Fed, produced or at least enhanced whatever meager recovery we’ve had since 2009. A permanently high plateau , if you will. The problem is that this unspoken agreement, this economic wink and a nod, has produced moral hazard on an epic scale. People do stupid things when they think their rewards are deserved and any losses will be absorbed or prevented by others. If you doubt that, just take a few moments to remember the structure of the mortgage system that produced the last crisis. It was a system where government policy didn’t just implicitly relieve lenders of the risks of their loans, they did it explicitly by either guaranteeing the loans or buying them outright. Now we apply that lesson to all investors, the Fed equally concerned about the stock index and the price index. It has “worked” so far in that risky asset prices are high but the economic payoff is less clear. It may be that the US and global economy is better off today than it would have been without the exertions of the world’s central bankers, but you’d be hard pressed to prove it. Considering the moral lessons being taught by these policies one can’t help but wonder if the gains are worth the potential losses. Markets, individuals, will eventually see through the Fed’s illusion of control and mark assets to a real market. The list of winning investments – risky investments – has been pared down to just a few over the last two years and the list gets shorter every day. Most recently the junk bond market has been quietly deleted or at least partially erased from the winners list. With oil prices falling again, the fracking companies bankers are balking of course, but it isn’t just energy companies that are being denied financing. Several deals have been canceled recently that had nothing to do with fracking. And it isn’t just junk bonds that are getting marked down; the high grade corporate bond ETF (NYSEARCA: LQD ) has actually performed worse than its junk bond cousin over the last six months. You certainly can’t call it a credit crunch yet but the new normal economy may not need a full blown crunch to fall into recession. It is a frustrating time for investors and one that is fraught with danger. The risk isn’t from without, from some unknown black swan, but rather from within, from ourselves, the self-inflicted financial wound caused by greed and the very American desire to win, to do better than the next guy. It is tempting to discard the investment methods that have withstood the test of time in favor of the fad of the moment, the church of what’s working now. But in every investment cycle there comes a time when winning is accomplished by not losing, by ignoring the sirens of risk and lashing oneself to the mast of safety. Now would seem a good time to at least find the rope.