MPG Core Tactical 60/40: September 2014 Performance Update

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Dear Mr. Market:

October is historically one of your stormier months and it looks like you began to rumble a month or so early this year. We’re headed into the last quarter of the year but in case you’ve missed why we’re running a series of articles around the topic of a “60/40 benchmark”, here’s a refresher:

Click here to revisit the first edition of the MPG Core Tactical 60/40 Portfolio.

Here’s the current summary of the MPG Core Tactical 60/40 portfolio mix, which is updated as of this writing (October 6, 2014).

Click here to compare our portfolio against the benchmark.

It’s finally happening. Yes…it appears the stock market is correcting. As a matter of fact for the second time this year alone the Small Cap asset class has endured a correction of -10% or more. What’s puzzling (and actually quite worrisome) is the divergence between what Large Caps and what Small Caps are doing. In a healthy and rising stock market, “as the tide rises so do all the boats”. We’ve had warnings before but the alarm bells are ringing louder since not all asset classes are moving in tandem as they once were. What we’re seeing now are perhaps the final signs of the rally peaking out.

What adjustments did we make?

The following moves were made during the month of September:

9/2/14:  Added to our position of DXMIX (Direxion Indexed Managed Futures) 280 shares @ $35.71 (~$10k total)

9/23/14:  Added to our position of GLD (SPDR Gold Trust) 200 shares @ $117.56 (~$23k total)

9/25/14:  Added to our position of VB (Vanguard Small Cap Index) 100 shares @ $111.35 (~$11k total)

If you read last months update the nugget we put on the table was the “alternative investment story”. In short…this market environment is one that deserves caution in both stocks and bonds. Where do you go? In our opinion every portfolio needs at least a 15% allocation towards alternative investments even in healthy or perhaps more predictable market environments. Over the last several years the Fed has printed funny money to “kick the can down the road” and prop up a less than stellar economy, stocks could get blasted at any minute. On the bond side, interest rates have only one way to go and anyone not living in a cave knows what that will do to bond prices once rates increase. We continue to add to positions like DXMIX and even gold…which has been a dismal investment as of late.

Our exposure to gold is limited but becoming more enticing now that you don’t hear radio and television advertisements pitching it every five minutes. Gold is down -8.3% over the past 12 months and could be a nice hedge for when the market fully corrects. As the dollar strengthens gold will feel pressure but it takes just one unexpected event to make our small bit of exposure worth the extra nibble.

The same goes for adding to DXMIX although in this regard we couldn’t be happier with the recent performance here. Over the past three months DXMIX has increased over 13% and we believe there is more to come; especially if the market takes a nosedive.

Lastly, we basically added into the worst performing equity asset class (small cap) in the event there is any near-term rebound that catches everyone off guard. When you manage money you need to expect the unexpected. In this case we are underweight small caps relative to our normal portfolio model so we actually have the luxury of dollar cost averaging into it while it dips.

As for the standard and passively managed 60/40 Benchmark we made the monthly and automated adjustment to the allocation. On the first trading day of the month we bought more equities with proceeds from bonds:

10/1/14:  Sold 77 shares of BND @ $81.93 (Vanguard Total Bond Index)

10/1/14:  Bought 82 shares of IVV @    $198.26 (S&P 500 Index)

When stocks go down what do you do? Most people sell and go look for what is holding up better. As you’ll note from the above transactions we’re doing the exact opposite; which is the what this whole exercise is all about. Stocks got a haircut and bonds edged up so we once again took our total balance and allocated exactly 60% to equities and 40% to bonds.

As of this writing the MPG Core Tactical Portfolio is still positive for the year at +3.14% YTD. The passively managed 60/40 Benchmark sold off some but is still at +7.23% YTD. Stocks continued to surprise people in August but the party ended, or at least is taking a breather, in September. The last couple weeks of September also brought us some volatility …which for the most part seems like a distant memory. This was accentuated on 9/25/14 when the Dow Jones dropped 264 points for a -1.4% day. There were actually seven triple-digit closing moves over the last couple weeks which of course stirred the pot more for any “Nervous Nellies” hanging on to stocks they probably shouldn’t be holding anyway.

The big story of the month, however, was how poorly Small Caps performed. The irony here is that many novice and emotional investors probably looked at 2013’s performance of +41% in Small Caps and wanted to park more money there. What goes up the strongest is typically what comes down first…and Small Caps did exactly that by getting whacked -6.2% for the month!

As of this writing the S&P 500 is up +7.55%. The Bond Index continues to stay in the black and is up +2.49% YTD. The international stock index that we track is down -1.75% YTD. Lastly, we haven’t talked about Real Estate (REIT’s) for a while but for anyone telling you that story is over…perhaps it’s not. They got hit hard in September with VNQ (Vanguard REIT ETF) declining over -7% but they’re still leading all asset classes for the year at over +12% YTD!

Where are we going from here?

Don’t listen to anyone who is pounding the table with fear tactics but on the other hand it’s not “business as usual” either. Economists have an almost perfect record of not being able to correctly predict a recession! Almost all economists that speak and write about recessions do so with dust and rubble surrounding them because none of them saw it coming until it crashed on their wise heads. With that being said, don’t give too much attention to the next report that spells gloom and doom. Conversely, the average span between recessions is four years and nine months so we’re clearly on borrowed time and fast approaching massive odds of one hitting in the next two years.

Here are two quick ideas which you may see us implement in the next few weeks. If you’re of the mindset that you just want to “hit singles” consider looking at some dividend yielding financial sector stocks. In future articles we will likely discuss some specific holdings we like and currently own but you of course can always pick up a diversified ETF such as XLF (SPDR Financial Select Sector Fund), VFH (Vanguard Financials Index Fund), or IYF (iShares Dow Jones US Financial Services Index Fund).

For those with a stomach for a bit more of a roller coaster ride and perhaps a contrarian and surprise play…take a look at EWZ (iShares MSCI Brazil ETF). Taking a position here is not for the timid as the investment is down -13% just over the past month. It’s also one that can rally in an instant. The Brazil ETF has seen 11 declines of -20% over the past 10 years but they’ve been negated by even more powerful rebounds. Nobody in their right mind would touch Brazil over the past decade but what do you think has performed better even amidst that crazy volatility; Brazil or the Dow Jones that’s cracked 17,000 points?

The Dow Jones has a cumulative return of 66.71% and the Brazil ETF is now at 140.74%! Don’t get a second mortgage on the house and put it all on Brazil…but don’t be surprised to see this pop 20% or more in the next couple of quarters. In summation our basic story is that we hope you’ve listened to our message of the “best time to fix a leaky roof is when it’s sunny”. Now we’ve gradually built up our positions to ready ourselves for when nothing goes as expected. Once that happens you will see things like alternative investments, gold, or perhaps even Brazil…be the saviors of your portfolio.

See you next month!

 

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