Dear clients, friends and family:
Following is the 2016 fourth 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 +0.70% for the fourth quarter and finished the year +7.12%, net of fees. The strategy began the quarter in a long position before moving to a defensive cash position in early November, just before the U.S. Presidential Election. The strategy was in a defensive position for the entire month of November as fixed income assets declined significantly as interest rates rose. The strategy moved back to a long position in early December and remained fully invested for the rest of the quarter and into 2017. At the beginning of 2016, forecasts for high yield bond returns ranged from -3 to +6% based on an annual survey by LCD, a unit of S&P Capital IQ, with most forecasts from the major banks in the +4-6% range. Earlier in the year, high yields benefited from the stabilization in the energy market and the Fed’s backtrack on tightening. Energy was the wild card in this forecast and with oil prices having put in a bottom for the year, the risk of higher defaults in high yields abated. As a result, high yields outperformed most forecasts for the year. While the trend in high yields has been higher, it has not been a smooth path. Pockets of short-term volatility throughout the year triggered our model to trade more frequently than is historically the case, causing the strategy to be whipsawed on several trades leading to underperformance of the benchmark.
CMG Tactical Equity Strategies
The CMG Opportunistic All Asset Strategy (“CMG Opportunistic”), our broadly diversified mutual fund and ETF allocation strategy, returned -1.39% for the fourth quarter and finished the year +2.22%, net of fees. The Jefferson National Tax-Deferred Variable Annuity portfolio returned -1.54% for the fourth quarter and finished the year +0.79%, net of fees. The strategy began the quarter in a moderate to aggressive risk position as equity markets trended higher after the Brexit vote in the summer and then rallied into year end after the surprise U.S. election. In October, the strategy moved out of broad based emerging market positions into information technology and U.S. regional banks, increasing its equity exposure. In November, the strategy further increased its equity holdings by moving out of long duration bonds and into small caps, homebuilders and the leisure and entertainment sector. Equity markets rallied and fixed income markets crumbled after the election as interest rates rose, negatively impacting bonds while propelling financials higher. In December, the strategy increased equity exposure with allocations to utilities and telecommunications. The strategy’s positioning at year end was the most aggressive we have seen in over a year. At year end, the strategy held only one fixed income position (short duration bonds) in the portfolio. Additionally, the strategy had no commodity exposure during the quarter. Given the divergence between fixed income and equities during the quarter, we are pleased with the ability of the strategy to migrate from risk-off to risk-on positioning. The relative strength process has been adept at identifying opportunities but has rotated asset class exposure more than in recent years due to the choppy market environment, particularly in bonds. The strategy held the following allocations (individual portfolio allocations may vary) to fixed income, equities, commodities and cash at the end of October, November and December:
The Scotia Partners Dynamic Momentum Program (“Scotia Dynamic”) returned -3.49% for the fourth quarter and finished the year +16.07%, net of fees. Scotia Dynamic declined during the quarter despite strong performance for the year. In October, the strategy generated positive returns from positions in energy services and electronics with precious metals and basic materials detracting from performance. In November, the strategy incurred most of its losses for the quarter with allocations to precious metals, basic materials and biotech detracting from performance. After a slow start to the month, equities rallied after the election and quickly became overbought on a short-term basis. As a result, the strategy avoided several sectors that were overbought. The strategy attempts to reduce risk during overbought markets by limiting allocations to or avoiding allocations to overbought segments of the market. As a result, in early December, the strategy was heavily allocated to cash as most areas of the market had become overextended. Later in the month, the strategy was more fully allocated but positions in transportation and healthcare detracted from performance.
The CMG Tactical Rotation Strategy (“Tactical Rotation”) returned +0.20% for the fourth quarter and finished the year -3.87%, net of fees. Tactical Rotation began the quarter positioned 50% to domestic equities (SPY) and international equities (EFA). Both international and domestic equities declined during the month while commodities were the best performing asset class during the month. In November, the strategy was allocated 50% to cash and 50% to commodities (PDBC), identifying a positive trend in commodities that began in October. The balance of the strategy was in a defensive cash position as international equities, bonds and REITs all underperformed in November continuing their negative trend form the prior month. Domestic equities started the month slowly but moved sharply higher after the election. In December, the strategy stayed invested 50% in commodities (PDBC) and rotated back in U.S. equities (SPY) for the remaining 50% of the portfolio. Both commodities and equities performed well in December, finishing the year strong and contributing to positive performance for the strategy. After avoiding allocations to commodities for most of 2015 and early 2016, the strategy was able to correctly identify the positive trend in the fourth quarter. Additionally, the strategy, much like with commodities over the previous 18 months, avoided allocating to bonds, the worst performing asset class during the quarter. To start the new year, the strategy remained allocated 50% to commodities (PDBC) and domestic equities (SPY).
Market Commentary and Outlook
An unexpected result in the U.S. Presidential Election sparked a year-end market rally that now appears a bit long in the tooth. The election of Donald Trump and Republican control of Congress sparked optimism that fiscal stimulus and tax reform are on the way, thereby buoying bullish market sentiment. However, investor enthusiasm may have reached a point of overconfidence. The impact of any legislation on fiscal stimulus or tax reform will not be felt until 2018 as the legislative process is slow moving. Additionally, healthcare reform appears to be the priority at this point which would not necessarily be stimulative for the broader market. With equity valuations already at the high end of their historical range and a great deal of uncertainty surrounding what policy may actually look like in the new administration, investors risk being complacent to risks in the short term. We are by no means bearish on the current market as macroeconomic indicators, namely the most recent GDP, employment and wage statistics point to a strong U.S. economy in 2017. However, there are major risks that investors have chosen to overlook.
In 2017 we expect markets to trend higher. However, we see several challenges to work through for short-term momentum to continue.
Inflation and Fed Rate Tightening
In 2016 the Fed expressed extreme caution, weighing conflicting economic data en route to one rate hike in December, well below expectations from the start of the year. In 2017 they risk falling further behind as economic growth picks up. In particular, strong wage growth could force the Fed’s hand as inflation picks up faster than expected. Additionally, political pressure from the new administration could push the Fed to act more aggressively than investors anticipate.
There is a great deal of uncertainty regarding what domestic economic policies the new administration will pursue. Trade policy, tax reform, infrastructure spending, healthcare reform, immigration reform, the debt ceiling – these are just some of the issues that will have a dramatic impact on the economy. Despite having a majority in Congress, the Republican Party will have to reconcile competing views (i.e. increased spending vs. national debt) on several of these policies before they are implemented and at the very least reconcile campaign promises with political reality. The result is that we are not going to see the impact of these policies, particularly stimulative policy like tax reform or infrastructure spending until 2018 or 2019. Given the euphoric mood in the market at this time, the actual policies are likely to underwhelm and lead to a market correction that better aligns reality with expectations.
After a year of surprises that included Brexit, the U.S. Presidential Election and a failed referendum in Italy, the opportunities for surprise abound globally. Europe in particular is a hot spot as France, the Netherlands and Germany will have three of the most critical elections in recent times with several populist candidates polling well. The potential for their elections could mean very different policies for these countries, particularly with respect to immigration and the Euro. In Britain, uncertainty has increased with respect to the path for Brexit. The resignation on January 3 of Sir Ivan Rogers, Britain’s permanent representative to the EU since 2013, increased fears that Britain is unprepared for the difficult negotiations ahead. Theresa May had done nothing to clarify her plan for Brexit aside from her commitment to move forward in the first quarter of 2017. That changed on January 17, 2017 when Mrs. May made it clear that Britain intends to take a hard line – “Brexit means Brexit” being the rallying call.
China faces two key issues this year: managing its debt and facilitating an orderly party congress. This process will be Premier Xi’s opportunity to shape the leadership of China for the next four years and beyond. During the 19th Party Congress, he will push hard to pack the Central Committee, the Politburo and its Standing Committee and the army’s ruling council with allies. Additionally, Mr. Xi will push hard on the other two key issues at stake: amending the constitution to reflect his battle with corruption and massaging the state of the union speech to support his platform. His authority and ability to align members of the party will be impacted by Mr. Trump’s sabre rattling on Taiwan and the South China Sea islands. Mr. Xi may be forced to compromise more than he would otherwise, catering to hard liners, particularly in the military that see Mr. Trump’s comments as offensive to China’s stature in the world. Finally, while Russia is not likely to have a major impact on market risk due to its narrow role in the global economy as a commodity producer, it is a growing geopolitical risk. It is no secret that Putin seeks to expand Russia’s sphere of influence. It has been his stated goal since the “tragedy” that was the collapse of the Soviet Union. While it is unlikely that former glories will be regained, Putin will be further emboldened to challenge NATO in the Ukraine and the Baltic States. Additionally, Russia’s expansion in the Caucasus region will bring it further into conflict with an unstable Turkey.
Debt, Debt and More Debt
We believe unsustainable debt levels globally will continue to lower long-term growth potential for the global economy. The trend has been onward and upward for over a decade and the risk this year is that populist policies further exacerbate the world’s debt problem. In some cases, namely emerging market countries that have borrowed in U.S. dollars, this could be the tipping point into crisis. Populist policies are likely to increase debt (higher government spending), lower taxes (reduce government revenues) and set off a trade war (small tariffs set of a chain reaction). Increased ideological fervor adds fuel to the fire. Although infrastructure spending and tax reform could be economically stimulative, it will be harder to achieve both when the political middle ground has been decimated. Debt restructuring, or a “beautiful deleveraging” as Ray Dalio of Bridgewater describes it, in the current environment is not likely.
Long-Term Growth and Market Returns
Long-term growth projections typically rely on two key factors: demographics and productivity. Last quarter we discussed how based on these two factors, long-term growth expectations do not look good. The developed world is aging, creating an imbalance between retirees and workers while a lack of corporate investment and anti-globalization will undercut productivity as supply chains will be disrupted by protectionist trade policies. Additionally, missteps on immigration over the next several years could sow the seeds of anemic growth or stagflation in the future. Populist movements have one core aspect at their political heart: anti-immigration. The short-term trade off may be favorable for the current economy (a matter of opinion) but long term, an overzealous and restrictive immigration policy could lead to significant labor shortages by mid-century. That may seem like an eternity from now, but geopolitical cycles are long, typically forty to fifty years. Once protectionist policies are put in place, it is hard to stop their momentum. In the U.S., calls to limit illegal immigration have already morphed to restrictions on legal immigration. As Baby Boomers retire, the U.S. could face a labor shortage in the next 20-30 years, one that might be filled either through automation or, believe it or not, paying immigrants to come. Unfortunately, by that time, they may be happy to stay where they are.
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.
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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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