Dear clients, friends and family:
Following is the 2016 third quarter performance for CMG’s Tactical Investment Strategies along with our thoughts on each strategy over the past quarter. 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.
* Please note all strategy returns are reported net of a 2.50% management fee.
CMG Tactical Fixed Income Strategies
The CMG Managed High Yield Bond Program (“CMG HY”) returned +3.36% for the third quarter, net of fees. The strategy began the quarter in a long position and held its long position for the entire quarter. After a volatile second quarter that culminated with a Brexit-led drawdown, high yields trended higher during the third quarter. After a difficult start to the year, high yields have been one of the better performing asset classes. Two headwinds at the start of the year in the form of a Fed rate hike and collapsing energy prices have abated. The rebound in energy prices in particular has lowered the risk of a default cycle. As a result, high yields are outperforming most forecasts from the start of the year. However, valuations are looking stretched as junk bond prices are at their highest level since mid-2014. Although the Fed has not hiked rates this year (yet), the risk of a blow out in spreads at these price levels combined with historical leverage levels raises concern, particularly for a banking sector that is already surviving on razor thin margins. To the extent there is a deterioration in the high yield market, as tactical managers, we would identify a reversal in trend and move to a defensive position and wait for the next opportunity to present itself for re-entry into the market.
CMG Tactical Equity Strategies
The CMG Opportunistic All Asset Strategy (“CMG Opportunistic”), our broadly diversified mutual fund and ETF allocation strategy, returned +0.64% for the third quarter, net of fees. The Jefferson National Tax-Deferred Variable Annuity portfolio returned +1.38% for the third quarter, net of fees. The strategy began the quarter in a moderate risk position with allocations to fixed income and equities and no exposure to commodities. In July the strategy shifted to a more defensive allocation, overweighting fixed income in the portfolio with trades into U.S. government bond funds. Equity positions in the portfolio were overweight technology and telecommunications during the month. The strategy shifted to an aggressive position, increasing equity exposure in the portfolio during the month of August. The strategy shifted out of corporate bonds and U.S. government bonds into international and emerging markets. Additionally, the strategy shifted to higher beta equity positions in biotechnology and financials. The strategy was down modestly before rebounding in September as equity markets turned higher, particularly technology and emerging markets. Equity exposure was reduced slightly during the month and in addition to international and technology exposure, the strategy also held positions in utilities and financials through the month. The allocation to fixed income was increased as the strategy moved into emerging market high yields. The strategy did not have any commodity or cash exposure during the quarter. We are pleased with how the strategy continues to navigate these range bound equity and fixed income markets. The relative strength process has been adept at identifying opportunities but has shifted asset class exposure more than in recent years due to the choppy market environment. The portfolio held the following allocations (individual portfolio allocations may vary) to fixed income, equities, commodities and cash at the end of July, August and September:
The Scotia Partners Dynamic Momentum Program (“Scotia Dynamic”) returned +4.28% for the third quarter, net of fees. Scotia Dynamic generated strong performance during the quarter while maintaining a lower than average cash balance. In July, the strategy generated positive returns from positions in healthcare, biotechnology, and precious metals. August was another positive month for the strategy with returns driven by electronics, energy services, small caps and precious metals. Transportation was one of the primary detractors from performance during the middle of the month. September proved to be a volatile month for the strategy. Transportation, small caps, biotech and electronics drove positive performance in the first half of the month. In the second half of September, the strategy generated positive returns from biotech, healthcare and electronics. In the last week of the month, biotech and electronics pulled back, detracting from performance and causing the strategy to finish slightly down for the month.
The CMG Tactical Rotation Strategy (“Tactical Rotation”) returned -4.25% for the third quarter, net of fees. Tactical Rotation began the quarter positioned 50% to commodities (PDBC) and REITS (VNQ). REITS contributed positively for the month while commodities declined sharply in July. In August, the strategy held its position in REITS but rotated out of commodities into domestic equities (SPY). August was a difficult month for all asset classes. REITS were down for the month while domestic equities were roughly flat. The strategy stayed invested in domestic equities (SPY) and REITS (VNQ) for the month of September. Equities finished the month slightly in positive territory while REITS declined as fear of an interest rate hike caused all fixed income related investments to decline. The strategy held its allocation to domestic equities (SPY) heading into October and reallocated its position in REITS (VNQ) into international equities (EFA).
Market Commentary and Outlook
Markets recovered in the third quarter as global equity and fixed income assets trended higher, shrugging off all manner of risks. Given the uncertainty regarding the U.S. election, Brexit, timing of Fed rate hikes, terrorist attacks and a coup in Turkey, it is remarkable that markets have been this resilient. Volatility, particularly downside market volatility, has subsided and is significantly lower than levels seen at the start of the year. Yet, the calmness on the surface hides serious risks and impediments to further appreciation in just about every asset class. Forward looking returns based on current price levels in equities and fixed income look anemic for the next five to ten years. Commodity prices, after having recovered from oversold levels, lack additional fuel to move higher. With global growth and demand subdued and barring an exogenous shock or event, commodity prices look range bound and capped to the upside.
In the short term (through the end of the year), we expect markets to trend higher. However, we see storm clouds in our intermediate outlook due to the following factors:
- Fed Rate Tightening: We might see one hike this year and two in the next year. That said, we believe this tightening cycle will be modest by historical measures and will likely end at a lower level due to major structural limitations on growth (debt and productivity).
- Domestic Politics: Monetary policy has reached its limits. Fiscal stimulus, either through tax cuts or increased spending would be welcomed. A trade deal seems unlikely given the tenor of the current election. Tax reform may be the best opportunity for both parties in the U.S. to find common ground. Nothing will be easy in the political arena for the foreseeable future.
- International Politics: An Italian referendum designed to reduce political instability risks toppling Matteo Renzi’s government (nothing is certain in a post-Brexit world) in December. France and Germany will have two of the most critical elections in recent times. Populist forces are leading polls in France behind Marine La Pen and Angela Merkel looks weak as she attempts to maintain a majority in the face of significant criticism of her refugee plan. Additionally, troubles at Deutsche Bank could test her principles regarding bailouts – the rest of Europe, particularly the Greeks, will be watching. Finally, the commitment by Theresa May to trigger Article 50 of the EU treaty by the end of March will start a two year countdown that would see Britain leave the EU in 2019. May will attempt to steer a difficult course, with a desire to secure favorable access to the EU’s single market being the key issue of negotiation. Continental Europeans have to this point signaled that they are not in a negotiating mood – Brexit means a hard exit. No compromises.
- Debt: Global debt levels may be the single largest headwind facing the global economy at this time. There is not much more growth that can be squeezed out of this debt cycle. Until a global de-leveraging occurs, growth will be limited.
- Demographics: The Western world (U.S. and Europe) is aging and facing major challenges with respect to social security, healthcare and defined pension liabilities. In Asia, Russia, Japan and China face some of the worst demographic trends in history. Immigration and a free movement of labor would help moderate poor demographics; however, in the current political climate, the world is likely to put up more walls than are taken down.
- Productivity: Long-term growth is typically driven by two factors: the size of your workforce (demographics) and the efficiency with which it works or productivity. While demographics trends look troubling, the concern regarding productivity is equally concerning. Global productivity growth over the last 10 years has dropped precipitously according to a new report by the OECD. Two main causes, a lack of technology investment and the impact of lower global trade on the development of efficient global supply chains, are not likely to get better in the intermediate term.
In the face of these headwinds, we believe that to take a long only investment approach over the next several years will prove challenging: lower expected returns combined with short sharp bouts of volatility will make it hard for clients and advisors to stay the course. The need for tactical and satellite (liquid alts, REITS, FX, etc.) strategies to balance risk and provide exposure to diversified risk factors that can drive return will be greater than at any point since the rebound from the financial crisis in 2009.
With kind regards,
IMPORTANT DISCLOSURE INFORMATION
Investing involves risk. Past performance does not guarantee or indicate 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 Tactical All Asset Strategy FundTM, CMG Global Equity FundTM, CMG Tactical Bond FundTM, CMG Global Macro Strategy FundTM and the CMG Long/Short 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 Tactical All Asset Strategy FundTM, CMG Global Equity FundTM, CMG Global Macro Strategy FundTM, CMG Tactical Bond 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 Global Macro Strategy FundTM, CMG Tactical Bond FundTM and the CMG Long/Short FundTM are distributed by Northern Lights Distributors, LLC, Member FINRA.
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