We have been telling you that stocks are overvalued for over two years. We have also been telling you to expect volatility to return to the market. Stocks may have been overvalued but "Mr. Market" does not seem to care and volatility has been absent without leave (AWOL)!
During 2016 and 2017 our best performing investment strategy has been Dividend Diamonds. This is because it is 100% invested in stocks and stocks just keep trending upward. Dividend Diamonds also benefits significantly from the rising dividend income produced by the 40 stocks in the portfolio. The dividend income has risen every year since we introduced the strategy at the end of 2009.
Owning Dividend Diamonds is still one of the best ways we know to get a "raise in pay" on a regular basis. The strategy has offered solid growth and rising income since we introduced it.
Back in 2010 and 2011 we were still reporting composite performance of all accounts we managed within a particular strategy. We were using Schwab Performance Technologies software to calculate those performance reports. According to our records, Dividend Diamonds total return for 2010 was 15.93%. In 2011 it was 4.44%. That was a year when many stock markets around the world were down double-digits for the year.
We have not reported composite performance since 2011. We now report performance to each account holder for their specific accounts using Orion Advisors Performance Report app. We use one account in the strategy as the "model account" and continuously rebalance all the other accounts to be as closely invested to the model as we can. Our Model Dividend Diamonds account has averaged 8.83% annual time weighted return from December 31, 2011 through July 14, 2017, net of all fees.
Our Mendocino strategy is now 19 years old. Our promise for this strategy has always been to "provide market like returns with significantly lower volatility than the S&P 500".
We feel like we have kept that promise, even though Mendocino significantly underperformed in 2015 and 2016. We kept the portfolio hedged and missed most of the upside in stocks during those year. We were hedged in anticipation of that volatility we were looking for.
The longer term performance for Mendocino is solid. For example, we have managed an account for one of our clients continuously from August 11, 1998 through July 14, 2017. The average annual time weighted return is 5.89% per annum, net of all management fees. The return for the S&P 500 is 6.50% per annum over those same 19 years (without any management fees).
One's first reaction might be to say, "I would have been better of investing in the S&P 500 index". That would be true if you had invested in a very low cost ETF and if you had the stomach to buy it and hold it through all the ups and downs; including multiple stock market crashes.
We are still looking for the investor who actually did that! We know many who tried, but got shaken out of the market by the violent moves up and down.
Mendocino's return was accomplished while rarely being more than 60% invested in stocks. It was accomplished with volatility that was far and away less than that of the overall stock market. We believe it has been a "sleep well at night" strategy.
This year-to-date that same managed account is up 6.75%, net of all management fees.
During 2017 we have taken a page out of the Dividend Diamonds playbook for Mendocino. That is, we are focusing more and more on stocks that offer rising dividends.
We have not moved entirely in that direction. We still want to own pure growth stocks in Mendocino. For example the #1 performer in the strategy since inception is Facebook (FB). Dividend Diamonds can't own Facebook because it doesn't pay a dividend.
We would like to achieve a balance of about 70% allocation to high yield and/or rising dividend stocks and 30% to pure growth stocks.
As of this writing we have about a 25% allocation to cash in the Mendocino strategy. We also have an allocation of about 9% to hedges that will protect on the downside if we do get a correction.
We are entering the season when they normally happen, if they are going to happen at all.
We think a correction might be approaching, bearing in mind that we have been wrong before. Frankly we hope it happens and will consider it to be a buying opportunity to get the rest of that cash to work and lift the hedges.
We are not bearish about stocks in any way at this time. We think that any correction of 5 to 7% will get bought in a hurry by managers and investors shopping for bargains. A correction of that magnitude will take most U.S. stock indexes back to their 200 day moving averages. They should be met there by a buying frenzy--if a correction happens at all.
As for "Sell in May and Go Away", Tom Bowley, of Stockcharts.com, wrote the following on his blog today:
I believe the true "go away" period is from the July 17 close to theSeptember 27 close. This period has been difficult and it begins at Monday's close. Over the past 67 years on the S&P 500, this much shorter two month and ten day period has risen 37 times. The average return during this 71 day period is -0.42%. The annualized return has been -2.18%. While that might not seem like much, it's actually more than 11 percentage points beneath the average annual return of approximately 9% that the S&P 500 has enjoyed since 1950.
Here is potentially the biggest problem. When we've seen big moves on the S&P 500 from July 17th to September 27th in the past, they've generally been downside moves. The S&P 500 has moved +/- 10% or more 11 times during this period since 1950 and 8 of those moves have been declines. Here are the eight awful summers:
So clearly this is the time of summer - and the year - when the stock market has the tendency to underperform. And from the above, you can see that the underperformance can be quite severe certain years. While I believe the long-term viability of the current bull market is sound, we did break out to an S&P 500 all-time high close on Friday with a negative divergence present on the weekly chart - a sign of slowing upside momentum:
The last time we saw momentum slowing like this on the weekly chart was in 2015. Shortly thereafter, the S&P 500 dropped from 2135 to 1870 in two months! Perhaps it's a coincidence, but note that the highs were established in July 2015 and the ensuing weakness occurred in August and September - two notoriously bearish summer months that we're now approaching.
Will we see a repeat? Stay tuned.....
If the correction happens Mendocino will be a buyer of the dip!
All the best,
5TQ CAPITAL, LLC
595 Coombs Street, Napa, Ca, 94559
(707) 224-1340 Main
Disclosure and Disclaimer - Updated November 20, 2016 by Paul Krsek, Govinda Quish and Jeffrey Roush:
ELLUMINATION is the proprietary newsletter written for clients, friends, and affiliates of 5TQ Capital, LLC. As of July 1, 2016, 5T Wealth Management, LLC has been renamed 5TQ Capital, LLC
SINCE 1998 Paul Krsek HAS BEEN the sole author of ELLUMINATION. While the views and representations found in the newsletter generally reflect the attitudes and opinions of the 5TQ Capital, LLC ("5TQ") members and staff, Paul Krsek wrote without editing was therefore solely responsible for the content and opinions contained in ELLUMINATION.
AS OF July 1st, 2016, ELLUMINATION IS NOW A COLLABORATIVE EFFORT OF THE INVESTMENT POLICY COMMITTEE OF 5TQ. THAT COMMITTEE IS CURRENTLY COMPRISED OF GOVINDA QUISH, PAUL KRSEK, AND JEFFREY ROUSH.
ELLUMINATION does not represent the opinions of Fidelity, Fidelity Institutional Brokerage Group, NFS or anyone employed by Fidelity in any capacity. Neither Fidelity, Fidelity Institutional Brokerage Group, nor NFS, nor anyone employed by Fidelity in any capacity has participated in the creation of ELLUMINATION and they are not responsible for the contents or distribution of ELLUMINATION.
ELLUMINATION is written to provide general information to clients, friends, and affiliates. The contents of ELLUMINATION are not to be taken as individual investment advice. No investment decisions should be made based on the opinions or information offered in ELLUMINATION.
5TQ does not represent that the information in ELLUMINATION is accurate or complete and it should not be relied upon as such. Opinions expressed herein are subject to change or modification without notice.
The investment portfolio models or management services mentioned in ELLUMINATION may or may not be available in some states, and they may not be suitable for all types of investors.
5TQ manages accounts with various histories and investment objectives. The third-party information and performance representations used in this document has been obtained from various published and unpublished sources considered to be reliable. However, 5TQ cannot guarantee its accuracy or completeness and thus does not accept liability for any direct or consequential losses arising from its use.
Investment returns may vary and are NOT guaranteed. Past performance may not be indicative of future performance.