By Richard Morey
January 3, 2024
A Look Back
The last two years have been a wild ride to nowhere for most investors. In 2022 the stock market dropped 18% before rising 26% in 2023 – ending in a wash for stocks for these two years. In 2022 the bond market dropped 13% before rising 6% in 2023. (Note: Our #1 bond fund, PIMCO Income, outperformed during a difficult time once again. It dropped 7.8% last year when bonds got bludgeoned, and then in 2023 it gained a total of 9.3%. This puts them 8.5% ahead of the broad bond market in two years.
There are many reasons why this is our largest income-producing bond fund, and its performance when risk hits the bond market is one of those reasons.
In contrast, what we previously called our Tactical Allocation Portfolio made only a few dollars during this two-year stretch, though at a much lower level of volatility or risk than either the stock or bond market saw. If you look carefully at our returns, you see they benefited at times from a negative correlation to stocks and bonds. This was profitable earlier in 2022 but was continuing to hurt our performance as 2023 progressed. In response, this year we cut the negative correlation to stocks down to a minimum and then established a positive correlation with bonds.
Since making significant changes to this portfolio on August 10, the accounts have risen slowly (as designed). In late summer/early fall our newly purchased bond funds (yielding 6.5%-7.7%) went down in price – but our remaining managed futures fund (Campbell) continued to rise to offset the bond price pullback. Then in the middle of the quarter, it flipped, and the bonds ended up rising 3.5% to 4.4% (PIMCO Mortgage & PIMCO Income respectively), as Campbell reversed courses and fell 4.3%. Since we owned 3x more in bonds than the managed futures, since August the portfolio has achieved our goals which were to maintain the principal while getting a 6%+ yield on the 75%-85% we have in bonds.
Once we were receiving all the income, our bonds have indeed been putting out the aforementioned 6.5% (PIMCO Income) and 7.7% (PIMCO Mortgage) in annual income.
While simply maintaining the principal and receiving income are worthy goals – and the only ones we could prudently attempt to achieve while the bubbles continued to inflate last year – these are not the only goals I have for those who originally signed up for the Tactical Allocation Portfolio. These goals are outlined below in Opportunities for 2024.
Before looking ahead and what we expect will be some unique investment opportunities this year, I should mention that our clients will be naturally sorting themselves into one of several different investment categories – based on each person’s needs and preferences. Right now, there are two main categories:
- People who like the idea of safely getting over 6% in income and don’t want to consider trying to take (additional) advantage of the opportunities described below.
- Those who like the idea of benefitting from carefully developed and tested plans to profit from a market meltdown or debt liquidation event.
An important caveat is that this attempt to profit from the downturn will be done using the finest, proven risk control measures. It begins with volatility targeting, and my target is 9. To put this into context, 9 is the volatility you’d find in a typical multi-asset bond fund. It’s also 10% less than Vanguard’s retirement fund consisting of 40% in stock indexes and 60% in bond indexes. In other words, the risk level will remain both low and tightly monitored and controlled.
By targeting the STD at 9, this means we cap the risk at a conservative level. (Of course, I picked 9 because my studies show I can accomplish all the goals without exceeding 9!) Right now, the STD is at 3, with the plan being to gradually increase it as the opportunities described below begin to pay off.
Investment Opportunities in 2024
Managed Futures
The first and most obvious opportunity is likely to be in the little-known category called managed futures. Right now, we have from 15%-25% in one managed futures fund – Campbell Systematic Macro. After having a phenomenal year in 2022 when it gained 31%, last year Campbell started strong but then faltered and ended up down 1.8% for the year. This was, however, 4.9% better than the managed futures index.
Managed futures funds are structured so they should all deliver large gains whenever risk hits markets. The more markets the risk hits, and the more severe the problems and volatility, the more the funds are designed to make. Correction: These funds are not just designed to make large profits when markets have large losses – they have actually delivered these results over and over when risk hit in the past.
Given managed futures’ modest, targeted volatility, with a STD of only 10, we could double our allocation to this asset class and the risk would only move halfway up to 10 from our current level of 3. In fact, I plan to do just this – in three stages.
To double our managed futures allocations, thereby putting it back to where it was in mid-2022, we will first raise Campbell Systematic Macro to 25% in all accounts. We will then add 15% into AQR Managed Futures and 10% into PIMCO Trends Managed Futures.
These managed futures purchases will begin when stocks have dropped 5%. The first 10% (plus anything to top off Campbell) will go into AQR at that time. When stocks have fallen a further 5%, we will then finish the 5% additional to AQR plus invest 10% of our entire portfolio in PIMCO Trends Managed Futures.
Money for these purchases will come first from our short-term bond holdings such as PIMCO Enhanced Short Maturity and the one-year Treasury we purchased last year. Any additional amounts needed will come from sales of PIMCO Mortgage and/or PIMCO Income.
Treasury Bonds
Based on the most likely economic and market outcomes described in these annual reports, I suspect long Treasury bonds will have a strong year. After dropping over 60% from January of 2022, the longest Treasury bonds are now up 20% in the last 3 months. They are, however, much more volatile than the bond funds we now own.
This is a difficult decision, and I’ve debated PIMCO reps on the pros and cons of longer Treasuries versus PIMCO Income. They admit I’m 100% correct – if the downturn I see coming transpires. Since I do expect to be correct, but don’t want to accept the STD of 25 for the longest Treasuries, I plan to put a total of 15% of our money into 15-Year Treasuries (PIMCO Long-Term US Government Fund) which has risen 13% in the last 3 months and has a STD of 15 versus the 25 for the longest bonds (PIMCO 25+ Year Treasury Strips).
These purchases will also be done in at least two tranches – with the money coming from PIMCO Mortgage each time. The starting date will likely coincide with the first incidence of a “flight to safety” phenomenon in the bond markets.
Gold & Silver
Gold actually had a good year in 2023, ending with a gain of 13% for the year and at an all-time high. Of course, it began this year by dropping along with stocks. While still the most unpredictable of markets, I do expect gold to follow the pattern of going down some – say 5-10% – as stocks suffer this year. Then the year after the economic crisis has actually passed, gold and silver will shoot way up. This is purely a psychological phenomenon. At the very bottom – which happens to be the day before growth resumes – people are the most negative about the future. They buy gold and silver at the very bleakest time, known as the bottom, and it roars the first year coming out of a crisis. But during the crisis itself gold tends to lose a modest amount in tandem with stock market losses.
In other words, at this time we don’t plan to add gold or silver volatility to our retirement accounts (unless a client always wishes to own some).
Distressed Debt
There are opportunities today in this category – even for the most conservative. PIMCO has two funds paying over 9% in annual dividends and interest investing in both general corporate debt and commercial real estate debt.
Both of these funds are buying into depressed markets and expect to generate 9% in annual income plus substantial price gains over the next 5 years.
Another opportunity in this area is Oaktree’s Specialty Credit Fund (OSCL). This is a fund specializing in identification of high yield opportunities from Howard Mark’s firm Oaktree. Howard Mark is widely recognized as one of the truly world-class investors.
For most clients I’m not in a hurry to establish positions in this category. If a particular client is focused primarily on income, then we typically have perhaps 5-10% in this category as the year began.
For most clients, however, I expect to have somewhere between a quarter and a third of our portfolios in these three funds before the year is out. This will occur once I’m sure their prices can withstand anything difficult that may be coming regarding the infrastructure of the US financial system. These funds have somewhat more risk than I would normally like, so I want to make sure to buy them at the bottom (or accept the 9% in annual income and ignore the price for the next year or so).
Fixed Income Annuities
The fixed annuity products have had a “renaissance” since interest rates increased dramatically. The best feature is that income payouts are very generous, so much so, we have products for people seeking additional guaranteed income now or in the future that are worth a strong look. Why?
Locking in guarantees (for life) with today’s rates is a significant improvement, but like everything it will cycle in the other direction at some point. Our favorite opportunity is with Nationwide. They are offering an attractive rate of return, with the income growth guaranteed for the 1st ten years of the contract (over 12% annually). If creating more guaranteed retirement income is a consideration for you, this is worth a look.
Summary
These are presently the only sufficiently safe investment opportunities we see as 2024 begins. Risk seems to be everywhere we turn, which means loading up on managed futures and government bonds. We’re combining those with our short to intermediate-term, high-quality PIMCO bonds funds giving us good yield and safety.
Other opportunities will surely arise as events unfold this year. The changes described in this report are sufficient to more than double our potential gains in a severe market downturn, yet they will only take our risk level halfway between our current level and the highest target level of volatility. For now, this should be sufficient to see our accounts safely propelled forward as risk intensifies in markets over the next few weeks and months.
At the very bottom, clients will then get to choose how much growth versus income they wish to focus on going forward. At that time, we expect to have all our money in-tact, plus our recent profits, and great opportunities in numerous income and growth areas of the markets from which to choose.