What On My Radar Means as it Relates to Our Investment Strategies and Your Clients’ Portfolios
Stocks are likely to gain 2% to 4% over the coming 10 years. Bonds will gain just 1.5%. Both of those estimated returns are before inflation.
With 75% of investible capital in the hands of pre-retirees and retirees by 2020, I don’t believe that capital has the tolerance to weather the next -50% stock market correction. This time, bonds may not smooth the fall.
Recessions are a normal part of the business cycle. We tend to get one to two recessions per decade. The last recessions occurred in 2001 and 2008. The average stock market decline during a recession is approximately 40%.
Following are a few other market stats:
- Since 1950, the S&P 500 Index has experienced a decline of 10% or more once every two years, on average.
- Since 1928, we have seen at least 23 sell-offs of 20% or more, which is the official definition of a bear market.
- Those 23 bear markets over a span of 85 years work out to about one every 3½ years.
- Michael Batnick, CFA observed that “drawdowns of 20% or more have happened 23 times, or 26% of all years. On five of those 23 occasions, stocks still ended up positive on the year.”
Source: “What’s Going On?” Michael Batnick, CFA, The Irrelevant Investor (http://theirrelevantinvestor.com/2016/01/20/whats-going-on/).
Stand-Alone Bear Markets vs. Recession-Induced Bear Markets
Source: “Recessions and Stock Prices,” William Hester, CFA, Hussman Funds (September 2007).
A few additional points:
- Recession-induced bear markets tend to be longer, more drawn-out affairs. Stocks head lower over time as bad news continues to trickle out. The average length of recession-induced bear markets is 491 days, more than twice the duration of stand-alone bear markets. The 1990 decline was the only brief recession-induced bear market, lasting less than 100 days. (Source: “Recessions and Stock Prices,” William Hester, CFA, Hussman Funds (September 2007).)
- Not included in the chart above is the 2008/09 -50% S&P 500 Index recession drawdown.
Why is this important to understand?
I believe the most important lesson to learn in investing is to understand how compound interest works. Avoiding meaningful loss is more important than capturing the maximum gain. To that end, please read the educational piece I wrote, The Merciless Mathematics of Loss. Please share it with your clients.
Here is a quick summary: If a portfolio declines 20%, a subsequent return of 25% is required to get back to even. If it declines 50%, a 100% subsequent return is required. The 75% tech bubble correction? It took a 300% subsequent gain and 15 years to get back to even.
The pre-retiree and retiree do not have that amount of time. They are more likely, not less, to make poor, emotion-based decisions.
How does this relate to our strategies?
As an example, if you are invested in our CMG Opportunistic All Asset Strategy, you may find that we are invested in equity ETFs even though I’m bearish in my commentary on equity market returns for the next few years. This is because the strategy is a rules-based, tactical investment strategy that analyzes a global universe of exchange traded funds (ETFs) to determine an optimal portfolio allocation. With an unconstrained tactical mandate, the strategy seeks to generate positive returns over multiple market cycles. Its portfolio construction process utilizes a proprietary, relative strength ranking system to capitalize on opportunities across global equity, global fixed income, and commodity markets. It does not take into consideration any qualitative viewpoint.
If you are invested in our CMG Managed High Yield Bond Program, you’ll see that we are invested in high yield bond funds today. Yes, I am bearish on the outlook for high yield bonds, but “the trend is your friend”, as they say, and right now the trend is higher, so the model has us invested. Of course, we’re diligently watching the trend in the event it changes course.
These are just two examples of risks that can be included in a portfolio. They are flexible in nature; both look to generate growth, but with a disciplined approach to preserving principal. I believe portfolios should include a number of such return and risk drivers and they will do better over the next number of years. If you are part of the 75% pre-retirement or retirement capital, 60/40 stocks and bonds is in trouble — both the fixed income (ultra-low yields) and equity (high valuations) components.
The next correction will create much better return opportunities for equities (estimated returns in the 14% range when median P/E are lowest (best value)) unless, of course, one gets run over on the way to that opportunity. Thus, in expensively priced markets, I recommend that you underweight and/or hedge equity market exposure and overweight tactical investment strategies and liquid alternative strategies, such as managed futures and global macro.
With kind regards,
Steve
Stephen B. Blumenthal
Chairman & CEO
CMG Capital Management Group, Inc.
Philadelphia – King of Prussia, PA
steve@cmgwealth.com
610-989-9090 Phone
610-989-9092 Fax
Social Media Links:
CMG is committed to setting a high standard for ETF strategists. And we’re passionate about educating advisors and investors about tactical investing. We launched CMG AdvisorCentral a year ago to share our knowledge of tactical investing and managing a successful advisory practice.
You can sign up for weekly updates to AdvisorCentral here. If you’re looking for the CMG white paper, Understanding Tactical Investment Strategies, you can find that here.
AdvisorCentral is being updated with new educational resources we look forward to sharing with you. You can always connect with CMG on Twitter at @askcmg and follow our LinkedIn Showcase page devoted to tactical investing.
A Note on Investment Process:
From an investment management perspective, I’ve followed, managed and written about trend following and investor sentiment for many years. I find that reviewing various sentiment, trend and other historically valuable rules-based indicators each week helps me to stay balanced and disciplined in allocating to the various risk sets that are included within a broadly diversified total portfolio solution.
My objective is to position in-line with the equity and fixed income market’s primary trends. I believe risk management is paramount in a long-term investment process. When to hedge, when to become more aggressive, etc.
Trade Signals History: Trade Signals started after a colleague asked me if I could share my thoughts (Trade Signals) with him. A number of years ago, I found that putting pen to paper has really helped me in my investment management process and I hope that this research is of value to you in your investment process.
Provided are several links to learn more about the use of options:
For hedging, I favor a collared option approach (writing out-of-the-money covered calls and buying out-of-the-money put options) as a relatively inexpensive way to risk protect your long-term focused equity portfolio exposure. Also, consider buying deep out-of-the-money put options for risk protection.
Please note the comments at the bottom of this Trade Signals discussing a collared option strategy to hedge equity exposure using investor sentiment extremes is a guide to entry and exit. Go to www.CBOE.com to learn more. Hire an experienced advisor to help you. Never write naked option positions. We do not offer options strategies at CMG.
Several other links:
http://www.theoptionsguide.com/the-collar-strategy.aspx
https://www.trademonster.com/marketing/upcomingWebinarEvents.action?src=TRADA2&PC=TRADA2&gclid=CKna3Puu6rwCFTRo7AodRiQAlw
A Comment on Diversification – Client talking points:
A diversified investment portfolio is designed to meet pre-defined investment goals. It is often hard to stay the course when stress presents. That is when many investors make mistakes. Diversification means that not all investment risks perform at the same time. For example, managed futures and long/short funds have underperformed the last several years but are outperforming recently. We’d all like to be in the best performing areas all the time, but that is just not possible.
Major market events tend to present one or two times per decade. It is for this reason that a longer-term view can provide a useful perspective. We know that many investors incorrectly sold out of the markets during the tech bubble in 2000-2002 and again with record selling at the height of the 2008 great financial crisis. No one knows exactly how the current distress will play out.
For some time, I’ve been talking about the following: the issues in the high yield bond market, issues that can present post-QE and zero interest rate policy, issues with unmanageable debt in Europe, Japan and China and the issues a rising dollar may trigger as it relates to the $9 trillion in EM debt that was borrowed in dollars. As much as I’d like to think I do, I don’t know for sure which or how and when any of the above risks present and the degree to which they might play out.
What we can do is build portfolios that are diversified across a number of risk factors and market environments. We can identify periods in time to become more or less aggressively positioned (overweight when valuations are cheap and underweight when they are expensive). We can manage risk not only by the collections of ETFs and funds selected but also how we combine them together. Diversification brings meaningful improvement to portfolios designed to achieve a return objective over a long-term period of time.
I see the world of investing through a lens of risk and reward. Ultimately, it is far more important to minimize losses than to capture the best gains. Find me someone or some way to always capture the best gains – impossible, doesn’t exist. I’m friendly with some of the world’s greatest investors and none of them see themselves as perfect.
Over time, it’s really about understanding the power of compound interest. To this end, I wrote a paper entitled, The Merciless Math of Loss (here).
Thank you for your interest in this weekly post. It is appreciated! I hope you find it helpful in your investment and advisory work with your clients.
IMPORTANT DISCLOSURE INFORMATION
Past performance may not be indicative of future results. Different types of investments involve varying degrees of risk. Therefore, it should not be assumed that future performance of any specific investment or investment strategy (including the investments and/or investment strategies recommended and/or undertaken by CMG Capital Management Group, Inc. (or any of its related entities-together “CMG”) will be profitable, equal any historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. No portion of the content should be construed as an offer or solicitation for the purchase or sale of any security. References to specific securities, investment programs or funds are for illustrative purposes only and are not intended to be, and should not be interpreted as recommendations to purchase or sell such securities.
Certain portions of the content may contain a discussion of, and/or provide access to, opinions and/or recommendations of CMG (and those of other investment and non-investment professionals) as of a specific prior date. Due to various factors, including changing market conditions, such discussion may no longer be reflective of current recommendations or opinions. Derivatives and options strategies are not suitable for every investor, may involve a high degree of risk, and may be appropriate investments only for sophisticated investors who are capable of understanding and assuming the risks involved. Moreover, you should not assume that any discussion or information contained herein serves as the receipt of, or as a substitute for, personalized investment advice from CMG or the professional advisors of your choosing. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisors of his/her choosing. CMG is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice.
This presentation does not discuss, directly or indirectly, the amount of the profits or losses, realized or unrealized, by any CMG client from any specific funds or securities. Please note: In the event that CMG references performance results for an actual CMG portfolio, the results are reported net of advisory fees and inclusive of dividends. The performance referenced is that as determined and/or provided directly by the referenced funds and/or publishers, have not been independently verified, and do not reflect the performance of any specific CMG client. CMG clients may have experienced materially different performance based upon various factors during the corresponding time periods. Mutual Funds involve risk including possible loss of principal. An investor should consider the Fund’s investment objective, risks, charges, and expenses carefully before investing. This and other information about the CMG Tactical All Asset Strategy FundTM, CMG Global Equity FundTM, CMG Tactical Bond FundTM, CMG Global Macro Strategy FundTM and the CMG Long/Short FundTM is contained in each Fund’s prospectus, which can be obtained by calling 1-866-CMG-9456 (1-866-264-9456). Please read the prospectus carefully before investing. The CMG Tactical All Asset Strategy FundTM, CMG Global Equity FundTM, CMG Tactical Bond FundTM, CMG Global Macro Strategy FundTM and CMG Long/Short FundTM are distributed by Northern Lights Distributors, LLC, Member FINRA.
NOT FDIC INSURED. MAY LOSE VALUE. NO BANK GUARANTEE.
Hypothetical Presentations: To the extent that any portion of the content reflects hypothetical results that were achieved by means of the retroactive application of a back-tested model, such results have inherent limitations, including: (1) the model results do not reflect the results of actual trading using client assets, but were achieved by means of the retroactive application of the referenced models, certain aspects of which may have been designed with the benefit of hindsight; (2) back-tested performance may not reflect the impact that any material market or economic factors might have had on the adviser’s use of the model if the model had been used during the period to actually manage client assets; and, (3) CMG’s clients may have experienced investment results during the corresponding time periods that were materially different from those portrayed in the model. Please Also Note: Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that future performance will be profitable, or equal to any corresponding historical index (e.g., S&P 500 Total Return or Dow Jones Wilshire U.S. 5000 Total Market IndexSM) is also disclosed. For example, the S&P 500 Total Return Index (the “S&P”) is a market capitalization-weighted index of 500 widely held stocks often used as a proxy for the stock market. S&P Dow Jones chooses the member companies for the S&P based on market size, liquidity, and industry group representation. Included are the common stocks of industrial, financial, utility, and transportation companies. The historical performance results of the S&P (and those of or all indices) and the model results do not reflect the deduction of transaction and custodial charges, nor the deduction of an investment management fee, the incurrence of which would have the effect of decreasing indicated historical performance results. For example, the deduction combined annual advisory and transaction fees of 1.00% over a 10-year period would decrease a 10% gross return to an 8.9% net return. The S&P is not an index into which an investor can directly invest. The historical S&P performance results (and those of all other indices) are provided exclusively for comparison purposes only, so as to provide general comparative information to assist an individual in determining whether the performance of a specific portfolio or model meets, or continues to meet, his/her investment objective(s). A corresponding description of the other comparative indices, are available from CMG upon request. It should not be assumed that any CMG holdings will correspond directly to any such comparative index. The model and indices performance results do not reflect the impact of taxes. CMG portfolios may be more or less volatile than the reflective indices and/or models.
In the event that there has been a change in an individual’s investment objective or financial situation, he/she is encouraged to consult with his/her investment professionals.
Written Disclosure Statement. CMG is an SEC registered investment adviser principally located in King of Prussia, PA. Stephen B. Blumenthal is CMG’s founder and CEO. Please note: The above views are those of CMG and its CEO, Stephen Blumenthal, and do not reflect those of any sub-advisor that CMG may engage to manage any CMG strategy. A copy of CMG’s current written disclosure statement discussing advisory services and fees is available upon request or via CMG’s internet web site at http://www.cmgwealth.com/disclosures/advs.