Dear clients, friends and family:
Following is the 2015 third quarter net performance for CMG’s Tactical Investment Strategies along with our thoughts on each strategy over the past quarter. In addition, we have provided the net performance for the CMG Managed Blends and the CMG Classic Blends. We have also reflected the net performance for our tax-deferred variable annuity tactically managed programs. Market index performance is presented at the bottom of the chart.
Within the total portfolio construction process, we believe it is important to include a number of non-correlating risk diversifiers (equity, fixed income and tactical exposure), that performance evaluation should be considered over a three to five year period vs. months and quarters, and that one should compare equity performance against an equity benchmark, bond against a bond benchmark and tactical against a tactical benchmark. Asset classes are non-correlating for a reason and should be viewed from that perspective. Of course, past performance does not predict or guarantee future returns.
CMG Tactical Fixed Income Strategies
The CMG Managed High Yield Bond Program (“CMG HY”) returned -4.40% for the third quarter, net of fees. The same strategy managed inside the Jefferson National Tax-Deferred Variable Annuity returned -3.72% for the third quarter, net of fees.
The strategy began the quarter in a defensive position and not invested long in high yield bonds. As with equity markets, the high yield bond market was volatile during the quarter. As a result, the strategy traded more frequently than its historical average and had several whipsaw trades in July and September that contributed to negative performance. The strategy finished the quarter in a defensive cash position. The third quarter gave an indication of the challenges that are likely ahead for fixed income.
It’s been a bit of a wild ride for HY over the last several months. Prices dropped and yields rose to north of 8%. Although that is a pretty attractive yield, risk remains high. Here are a few thoughts Steve recently shared in On My Radar regarding high yields:
- First of all, HY is a great asset class and appropriate as a percentage allocation in most portfolios. The asset class, as with equities, struggles most during economic recessions.
- I’ve seen three major buying opportunities over my many years of trend following (trading in and out) HY. All came at recession lows. If you borrowed and you can’t pay it back, you default.
- A credit default cycle remains ahead of us. The next recession will flush out the weakest credits.
- The HY market has grown from $1 trillion to $2 trillion in total size in just five years. The Fed’s zero interest rate policy caused investors to chase into riskier asset classes like HY bond ETF/funds and the managers needed to put that money to work. A lot of bad lending has taken place.
- It is difficult to find new funding during recessions. A large number of bonds are set to mature over the next few years.
- Expect significant defaults in the next recession. My best guess is 2016 but it could be sooner or later.
High yields will struggle in the face of those headwinds and support the need for a risk managed approach as we face a different investing backdrop than the past several years. As tactical managers, we believe that actively managing risk and awaiting an opportunity to re-enter the market at lower bond prices and higher yields is prudent at this point in the interest rate cycle.
CMG Tactical Equity Strategies
The CMG Opportunistic All Asset Strategy (“CMG Opportunistic”), our broadly diversified mutual fund and ETF allocation strategy, returned -8.72% for the third quarter in the TCA (Trust Company of America) portfolio, -9.33% in the TDA portfolio and -7.16% in the ETF portfolio, net of fees. The Jefferson National Tax-Deferred Variable Annuity portfolio returned -8.88% for the third quarter, net of fees. The strategy began the third quarter in a moderate risk position with approximately 16% allocated to fixed income and 84% to diversified equity positions. As equity market volatility picked up and momentum in equities declined during the quarter, the portfolio shifted to more defensive positions. The strategy decreased allocations to large cap equities, real estate, regional banks and healthcare while increasing exposure to fixed income and cash. Additionally, the strategy avoided some poorest performing areas of the market, namely energy, emerging markets and commodities. Fixed income allocations shifted from inflation protected fixed income to convertibles, intermediate-term bonds and long government bonds. The strategy finished the quarter in more conservative risk position as reflected in the table below. The strategy held the following allocations (individual allocations may vary) to fixed income equities and cash at the end of July, August and September:
As volatility reached its highest level in three years (as measured by the VIX volatility index), the strategy reduced risk by increasing its allocation to fixed income and cash. While the strategy is designed to migrate to positions of strength and market leadership, it will not do so rapidly. Rather, this process typically takes several weeks or months rather than several days. The process is designed to capture intermediate trends in areas of market strength. The market environment in the past quarter during which there were quick, sharp declines in a matter of days is challenging for the strategy and most investors in general. Additionally, the portfolio was particularly impacted by an exogenous event as it relates to biotech and by extension to the healthcare sector.
Through the first half of the year, healthcare and biotech where in strong upward trends, returning approximately 10% and 20% respectively. Entering the quarter, the strategy had an approximate allocation of 18% to healthcare and 9% to biotech. Two non-market events impacted both sectors during the quarter: a massive price increase ($13.50 to $750) by Turing Pharma, run by former hedge fund manager Martin Shkreli and an announcement by Presidential candidate Hillary Clinton regarding reducing the exclusivity period for marketing new drugs from 12 to 7 years, sent biotech and drug stocks into a tailspin. Healthcare stocks, although typically lower beta and more defensive in market declines, were also impacted by the news. Healthcare and biotech finished the quarter down approximately 12% and 18% respectively. These allocations were the largest detractors to performance for the quarter. For a more detailed summary of current allocations for each specific portfolio and allocation changes over the past month, please visit our website at the following links to view the monthly update for each portfolio: TCA, TDA, ETF, and Jefferson National.
The Scotia Partners Dynamic Momentum Program (“Scotia Dynamic”) returned -7.89% for the third quarter, net of fees. Scotia Dynamic generated a modest loss in July and was overweight small caps, large caps, healthcare and biotechnology. Healthcare and biotech were the primary detractors of performance. The strategy performed well during the equity market decline in August with allocations to basic materials and precious metals contributed positively to performance. In September, the strategy overweighted basic materials, energy services, precious metals and large cap stocks while the primary detractors to performance were healthcare and biotechnology.
The CMG Tactical Rotation Strategy (“Tactical Rotation”) returned -1.41% for the third quarter, net of fees. Tactical Rotation began the quarter positioned 50% to international equities (EFA) and 50% to cash. Equity markets were modestly higher for the month of July with both domestic and international stocks posting positive returns. Bonds and REITS also trended higher for the month while commodities declined precipitously. The strategy rotated out of international equities and into domestic equities and was allocated 50% to domestic equities (SPY) and 50% to cash for August. August was the most volatile month for equity markets in over a year with international and domestic equities declining significantly. Commodities continued their decline and only bonds and REITS managed to post slightly positive returns. In September, the strategy was 100% invested in cash for the first time since 2010. None of the asset classes the strategy allocates to exhibited positive momentum and the strategy was able to sidestep another decline in equities. The strategy is allocated 50% to bonds (BND) for October with the remaining 50% of the portfolio allocated to cash.
CMG Tactical Long / Short Strategies
The Scotia Partners Growth S&P Plus Program (“Scotia”) returned -13.28% for the third quarter, net of fees. The strategy continued to struggle during the quarter as the model has not been able to generate returns in the volatile market environment. The majority of the decline for the quarter occurred in late August due to an oversold trade mean reversion trade followed by a short trade once the core model turned bearish. Equity markets declined significantly in the first half of the month but rallied at month end causing losses on the Scotia’s short trade. While we have been long-term investors in the strategy the hit rate for the quarter and for the year has been below the model’s historical average. We are continuing to monitor the strategy’s win rate, risk and return closely.
Starting in mid-August, equity markets declined significantly after testing all-time highs for most of the year. Fixed income markets were also volatile as the Fed has created greater uncertainty on the timing of an interest rate hike. The ongoing delay of a hike erodes the credibility of the Fed and markets will continue to be more volatile until a rate hike happens or clearer guidance is provided. In addition to the uncertainty regarding interest rates, China was the story of the quarter as growth continues to slow and Chinese equity markets continued their crash.
The current secular bull market and economic expansion that began at the depths of the financial crisis in 2009 is long in the tooth. The US has now gone six years without a recession, unemployment has declined significantly, and corporate profitability remains near all-time highs. We do not believe that these trends will continue and while all of them may not break down, it is likely that the one way equity and fixed income markets of the past six years are likely to get much more difficult. These are not fertile conditions for a bull market. Global growth is decelerating and central bank policy from the ECB, the Bank of Japan and the Fed is diverging as each economy is now operating at different speeds – the US is looking at a tightening cycle while the ECB and BOJ are still stimulating through quantitative easing. Clearly, global coordination of economic policy is going to be more difficult. Indeed, without saying it outright, the Fed is concerned about this divergence and the impact a rate hike would have on the dollar and the knock-on effect on commodities and dollar denominated debt in emerging markets. Although unemployment has declined to the Fed’s target levels, inflation has remained well below the Fed’s target, hence the indecision and uncertainty for investors. We don’t believe this picture is going to get much clearer in the near future and the Fed will be faced with reconciling its dual mandate.
The Chinese continued to crash during the quarter after a spectacular run up that started in 2014. In addition to several failed market interventions (bans on short selling, trading restrictions and potential criminalization of trading), China surprised markets with an unexpected currency devaluation. Xi Jinping, the Chinese President, is attempting a controlled economic liberalization that is meant to rebalance China’s economy. His government is now backpedaling and increasing liquidity after attempting to let some air out of the credit and real estate bubbles over the past year. As Chinese growth trends lower, emerging market countries that have depended on Chinese demand for commodities are at risk. Combined with reduced capital flows and dollar denominated debts to pay, the risk is high for emerging markets. Although balance sheets are stronger than in previous emerging market crises, some countries like Brazil and Turkey are more at risk than others and bear watching more closely.
In every investment cycle there comes a time when investors should shift their focus from maximizing risk and generating return to one where capital preservation and not losing is paramount. With global growth slowing, central bank policy diverging and corporate profits at all-time highs, we believe we are at the start of a change in market direction and behavior, one that requires investors to think differently than the past six years.
With kind regards,
IMPORTANT DISCLOSURE INFORMATION
Please remember that 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.
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Performance Disclosure: Performance results from inception to the present are net of the current advisor fee for the program, 2.50%, paid quarterly in arrears. Performance is not net of custodial fees. The performance results shown include the reinvestment of dividends and other earnings.
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 mange 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. (i.e. S&P 500 Total Return or Dow Jones Wilshire U.S. 5000 Total Market Index) is also disclosed. For example, the S&P 500 Composite 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. Standard & Poor’s 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.
CMG Global Equity FundTM, CMG Tactical Bond FundTM and the CMG Tactical Futures Strategy FundTM: 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 Global Equity FundTM, CMG Tactical Bond FundTM and the CMG Tactical Futures Strategy 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 Global Equity FundTM, CMG Tactical Bond FundTM and the CMG Tactical Futures Strategy FundTM are distributed by Northern Lights Distributors, LLC, Member FINRA.
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