Truth or Dare: Do you really believe that trees grow to the heavens?That stock markets do best when everyone loves them and investors are fully invested? If so, don't waste your time reading this article. We believe this is the time to protect what you've gained, and here's how:
We do things differently. We make our money when we buy, and we grow progressively more cautious as the market becomes overheated. This is quite different from how most people invest. Most people wait to invest until the market is already well into its uptrend (and above the best buy point) and is being touted as the place to be. Worse, they are loath to sell, or even protect their gains, as long as the media, their stockbroker and the "experts" tell them the market has further to go.
Their approach seems to be, "I have to make all my money while the fish are running so when I lose in the downturn I'll still have something left!" Why "plan" on losing? Wouldn't it be more rational to buy when the sentiment, fundamental, and technical indicators indicate stocks are cheap based upon the historical deviation from the mean? And sell when they aren't?
Instead of looking to "beat the market" on the upside and then "hope" you don't lose it all on the downside, our strategy is to avoid losing money. By staying on the positive side of the trendline, we have shown conclusively that you don't have to find the elusive stock that will triple in a year or the one industry that has the biggest momentum.
Our portfolios did not decline from 2000-2003 because we had protected our gains with boring old bonds, cash, preferreds, etc., so when the market rebounded in 2003, we were able to buy with our portfolio value intact. In 2008-2009, we lost - but not as much as the market, allowing us to buy when others become distraught over their losses.
Right now, just like every time we reach an historic deviation from the market's long term trendline, most market participants see us as out of touch or, worse, trying to take away the punchbowl. Not true! If people want to get so sloppy drunk they are no longer able to focus on the signs of excess all around them, I say, "Play on!" After all, these are the people who will sell to those of us who decided to sober up before the market exacts its inevitable penalties.
So how is the "usual" way the average market participant invests working for them? By all accounts, not well. While the S&P 500 was returning 9.7% over the past 20 years, the average investor, trying to make their money after the bull market was well-established and selling after panic sets in, earned just 2%, barely at the rate of inflation. Everything they "made" they lost in purchasing power.
We believe that "beating the market" over any period measured in less than 7 years - allowing for both an up and a down cycle - is rather meaningless. High heresy, I know. I'm battling the dark forces of lazy reporters and hot-stock jockeys: I say that our job is to manage risk first, and only then decide what to buy; and when; and when to sell. No offense to the skeptics, but while our approach may not always exceed the S&P in any given year, over time, consistency always trounces volatility! Where does this approach lead us today?
Protecting Our Portfolio
We've been cautious for a long time. This means we've been leaning more toward bonds, preferreds, hedged ETFs and low-volatility funds as the market advanced into nosebleed territory. Specifically, we have been buying and still like:
Closed end bond fund PIMCO Dynamic Credit Income (NYSE:PCI): PCI took a hit Friday as Bill Gross resigned / was fired / exited his role as CEO of PIMCO and took over / landed on his feet / was rescued by Janus Funds. Whoopee. We don't buy our bond funds because one in-the-limelight individual leaves a firm. In fact, Mr. Gross is not one of the five team managers of this fund. Indeed, all his departure from PIMCO did Friday was increase the discount from NAV closer to 10% and increase the (monthly payout) annual dividend yield closer to 8.5%.
We are not overly concerned about this fund in a rising-rate environment. 49% of its holdings mature in 0 to 4 years, and 37% more in 5-9 years. On the downside, this is primarily a high-yield (sometimes called "junk") portfolio, with names like Virgin Media, McClatchy (NYSE:MNI) and Radio One (NASDAQ:ROIA) among its larger holdings. This may scare some investors away. However, the "junk" moniker means less in a recovering economy as more and more holdings designated as less than investment grade do well and pay their debt as it comes due at par.
PowerShares Emerging Markets Sovereign Debt ETF (NYSE:PCY): If you are concerned about rising rates in the USA, why not own bonds in nations that are as likely to lower rates or keep them the same. Here I am referring to the sovereign debt of emerging market nations. As I've written here before, many emerging markets have higher credit ratings than many developed nations and many more deserve to have higher ratings! it is only inertia and rating through the rear-view mirror that keeps this from happening. Would we rather own debt issued by developed nation France or developing South Korea? Spain or Poland? Greece or Latvia? Personally, I continue to prefer nations with a hard-working populace, recent experience with the "workers paradise" of socialism, and no albatross of welfarist public coddling. I'll take France, Spain and Greece for the weather and the Republic of Korea, Poland and Latvia for nations that will repay their debts honestly. PCY fits that bill.
Municipal bond ETFs and Closed-End Funds like Market Vectors High Yield Muni ETF (ARCA:HYD) and closed-end Invesco Municipal Trust (NYSE:VKQ) If you like the relative safety of good municipal bonds, don't obsess that they are not a good investment "unless you are in the highest federal tax bracket." Indeed, each investor should simply determine what their after-tax equivalent yield would be for a taxable bond and make their own determination. If it makes sense for you, please note that HYD yields 5.4% on an after-tax basis and VKQ yields about 6.4% and sells at near a 12% discount to NAV.
Income mutual funds that have proven their staying power. PIMCO Foreign Bond - US Dollar Hedged (MUTF:PFODX) and RiverPark Strategic Income (MUTF:RSIVX) are two we have bought as alternatives to stocks and are continuing to buy.
(For those who would like to maintain their long positions but still want a hedge, options like the iShares Russell 2000 Index (ARCA:IWM) January 2015 $115 puts seem like a fine in-the-money hedge. For those more interested in a more leveraged out-of-the-money play, the ProShares Short Russell2000 (NYSE:RWM) January 2015 $17 calls look attractive right now.)
And, finally, but not to be denigrated in times of turmoil, there is CASH. If indeed the market is desirous of taking a swan dive into the shallow end of the pool, CASH is always nice. No, it doesn't make a lick of sense as a long-term portfolio holding but, short-term, it provides a feeling of calm and repose as others are crashing into concrete.
The Fine Print: As Registered Investment Advisors, we believe it is our responsibility to advise that we do not know your personal financial situation, so the information contained in this communiqué represents the opinions of the staff of Stanford Wealth Management, and should not be construed as personalized investment advice.
Past performance is no guarantee of future results, rather an obvious statement but clearly too often unheeded judging by the number of investors who buy the current #1 mutual fund one year only to watch it plummet the following year.
We encourage you to do your own due diligence on issues we discuss to see if they might be of value in your own investing. We take our responsibility to offer intelligent commentary seriously, but it should not be assumed that investing in any securities we are investing in will always be profitable. We do our best to get it right, and we "eat our own cooking," but we could be wrong, hence our full disclosure as to whether we own or are buying the investments we write about.
Disclosure: The author is long PFODX, RSIVX, PCY, PCI, HYD, VKQ.