Markets extended what is turning out to be a solid summer for performance with both equities and fixed income doing well.
Trade wars continue to be an overhang on the markets but that nervousness appears to be easing.
The yield curve flattening paused during the month as long rates moved higher faster than short rates.
While the Core Portfolio underperformed the S&P 500, it continued to move higher in its steady eddy fashion.
We discuss in "It's Getting Late" how the time is right to make preparations for a down market and how to participate in equities with less risk.
“Cash combined with courage in a time of crisis is priceless.”
- Warren Buffett
Our marketplace service is now in its third year and continues to grow well. The need remains for investors who are in or are approaching retirement to find safer income. The market continues to produce its ups and downs, but for the most part, our strategy is to keep clipping coupons and should produce a total return in 2018 in the 7% area. We'll take it given the risks and valuations.
The summer has been relatively calm with the VIX falling under 12. The equity market has slowly grinded higher as the trade "wars", emerging markets issues, and rising dollar fade into the background. We have followed the yield curve closely and would warn members to be cautious about pundits who say this time is different. This was stated many times in 2007 when the curve inverted.
Whether a recession is coming in 2019 or 2020 or beyond, it is coming. We are watching recession indicators closely and we are in the clear for now. But the environment can change very quickly. Risk controls are imperative as the music will eventually stop. We remain risk takers, overall, but also have one hand on the rip cord "just in case." That includes positions in a safe bucket as well as Core positions that are very high quality.
Our goal remains to protect your nest egg and retirement income. We have been discussing financial planning and how the Core fits with all the pieces of a complete retirement picture. The first step to developing a solid plan is understanding what you own (have been sold) and what are your options.
In our monthly newsletter titled, "Its Getting Late But There's Still Time", we discuss what we are watching in terms of indicators that would tell us its time to shift our strategy. While the bull market is the second longest in history, that in itself doesn't cause a recession. We wrote:
Late cycle investing in fixed income can be dicey but also have significant opportunities. At this point in the cycle, interest rates are rising and equity volatility has increased. Tighter monetary policy and those higher interest rates- along with a healthy dose of FOMO- causes investors to shun debt and overweight equity, often at just the wrong time.
We highlighted areas of the bond market that we think are attractive and how to play it. That includes the investment grade bond sector which is again back to a tightening trend.
We believe that while security selection remains important, portfolio construction is key at this point in the cycle. In a bull market, you really can own any and all risk assets and benefit mightily from the rising tide. But in late cycles, positioning matters as does planning for the eventual downturn. A nugget of what was written:
This is the first generation of the retirement era (the concept of retirement is only about 100-125 years old) that will not have a pension. That lack of pension and the exponential increase in longevity, is increasing the risk of retirement. We believe there will indeed be a retirement crisis in the next decade as state pensions fall short and retirement savings lacking.
Today, the financial advisory business is shifting quickly. The days of focusing solely on the asset management without consideration for planning or insurance will be over soon. Investors are starting to care more about outcomes over performance numbers. We hear this all the time from advisors as all clients want to know today is if their assets will last, not if they beat some benchmark.
Without the safety net of a pension, planning becomes exceedingly more important. What, if anything, should be set aside in a cash or safe bucket? How many years of income should be excluded from our risk assets? Is an annuity or some other type of income stream right for me? The income plan for paycheck replacement is going to become integral to financial planning in the near future.
The financial advisory business is morphing from a big focus on security selection (the asset management) to a planning focus. Michael Kitces has a Hierarchy of Advisor Value showing where advisors are providing their client the most value:
Want Equity Upside With Lower Risk?
In the next section, we described how members can participate in the market while limiting their downside risk. FOMO (the fear of missing out) is alive and well. The need for equity exposure remains but investors need to recognize sequence of returns risk. The next bear market in equities is coming so planning ahead of time is crucial. But investors need not shift to cash or other lower-return, safe investments.
Through the option market, investors can participate in the upside of individual stocks or an index like the S&P 500 while minimizing downside risk. We walk our members through how this can be accomplished while risking just the premium paid.
Our steady approach (hitting singles and doubles) on this strategy remains intact. The portfolio should be up around 7% this year barring any unforeseen issues.
The Barclay's U.S. Aggregate Index (AGG) is now down on a rolling two-year basis. This is the first time that this has occurred since the early 1980s. This is a key development and one that bears watching. We do not expect this two year rolling number to fall much more from here.
We do believe that the media and the dearth of knowledge about bonds in general is causing investors to shift their asset allocation towards equities. The added risk being assumed is likely not known by the investor. In our report earlier this month titled, "Just What It Means To Be In A Bond Bear Market" we wrote:
Investors shouldn't fear rising rates and shun bonds. Most individual investors know very little about bonds but they do know that rising rates negatively effect the price of a traditional bond. What we are seeing is many investors shift their bond assets to cash (earning less than 1%) or to dividend paying stocks. The question is: what are your bonds there for?
If the bond portion of your assets is to provide 'ballast' to the portfolio from stock volatility, than moving to cash will continue to offer some ballast. However, many high quality bonds tend to increase in value during stock market swoons. Cash will not do that so the notion that your bonds "zig" when the market "zags" is not really there by the move.
If the bonds are there for income, than moving to dividend paying stocks will continue to generate income and add growth to that but you are taking substantially more risk. Using typical standard deviations, a high quality dividend stock has approximately 4x the level of volatility compared to a typical investment grade bond.
July turned out to be a fairly strong month for both the bond and stock markets. The S&P 500 is up nearly 4% alone while the bond index is flat. CEFs on the other hand have performed well. Only a couple of funds in the Core Portfolio had a negative total return.
Digging into the portfolio, the top performer was again PIMCO Dynamic Credit and Income (PCI) which boasted a 4%+ return in the period. YTD, that fund is now up an amazing about 14%. PIMCO Dynamic Income (PDI) was right behind it on the month returning 3.9% but beats it YTD, up nearly 15%.
Nuveen Real Assets (JRI) was the third best performer generating just under 3% of total return. We highlighted this fund in May as a potential add along by increasing its weight in the portfolio. We are now seeing the benefits of that add and think there is room to run here.
Blackrock Multi-Sector (BIT) was another strong performer up ~2.2%. This fund had lagged in the last six months but it appears to have turned a corner. The NAV trend appears strong turning higher and the discount has closed by nearly 2 points. We think there is still some juice left here and it remains one of our higher yielding funds.
We also highlighted a few new opportunities for members to add to their portfolios.
Opportunity #1: A closed-end fund that yields over 8% with a solid YTD performance and what we think is a great portfolio for the current interest rate environment. It is one of the few funds to raise their distribution this year. The current discount is very attractive and we think this is a great time to add the fund.
Opportunity #2: A CEF that has been pummeled in price in the last few weeks. The portfolio is a short duration, high yield strategy of mostly floating rate loans. The distribution was recently cut opening up the opportunity. The coverage is back to ~100% and there is the potential for a reversion to the mean trade as the discount appears too wide by at least 2 points.
Opportunity #3: A target term fund that will liquidate at NAV in the future. The discount has widened recently due to a small cut to the distribution a few months ago. The coverage though is now over 107% with a strongly positive UNII figure. A similar fund that is a target term for one year earlier trades at a premium. If this fund moves to a similar position, the total return will be close to double digits with relatively low risk.
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Yield Hunting is a marketplace concept that focuses on finding that best risk-return area of the market for income investors, especially those nearing or in retirement. We focus on a Core Portfolio that aims to provide enough income to support your lifestyle without taking on excessive risks. We provide members with model portfolios, a vibrant and educational chat room, and access to professionals who can help guide you in building a proper portfolio for your risk tolerance. We issue a monthly letter and weekly commentaries used by financial advisors for their clients. For a sample of a past newsletter, please message us on SA.
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Disclosure: I am/we are long PDI.
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.