Gary Gordon Positions For 2019: Staying Seated For Market Turbulence

By Gary Gordon :

In today's market, investors may want to consider the age-old sports adage: The best offense is a great defense.

Gary Gordon, president of Pacific Park Financial Inc. (a Registered Investment Adviser with the SEC), continues to get "defensive" during volatile times, positioning clients not only into more conservative dividend-yielding stocks but also into vehicles like cash equivalents, high-quality corporate bonds and high-quality convertible bonds. The move is not only meant to lower risk, but to put portfolios in a place to take advantage of bargains when stock prices hit rock bottom.

Gordon's approach is presented in this 2019 Outlook installment.

(Q): You disagree with the notion that if the Fed backs off from rate hikes and balance sheet reduction, things will get better for the markets. Why should investors be wary of the Fed slowing rate hikes, or "going neutral?"

(( A )): If one believes that the Fed committee members are genuinely "data dependent," then slowing or stopping the pace of rate hikes and/or balance sheet reduction implies that the economy is weakening. Economic weakness in the 10th year of one of the longest expansions in history? That's not a good thing. Recession fears or actual contraction follow.

Even if one is more cynical about the Fed and believes that they simply bow to the whim of the financial markets themselves, history is quite clear on what happens when the Fed shifts to a neutral stance. In particular, you might get a bit more bullish behavior from risk assets for a short period of time, but why "play hero?" Stock bears and recessions are not that far off. (See the orange circles in the chart below.)

(Q): Back in October (Halloween, in fact), youdetailedreasons for reducing large-cap stock exposure. Is that still the strategy today?

(( A )): It's not just large caps, but most asset classes. The approach involves reducing one's exposure when the monthly closing price of an index falls below its 10-month moving average. To implement the approach, one needs to do little more than check in on the last trading session in a given month.

We have very little exposure to small caps, mid caps and foreign stocks due in part to this approach. (The macro global economy and micro corporate fundamentals also matter.) We've got a bit more in the way of REITs and dividend-yielding defensives. And a modest amount of large-cap exposure.

The tactical asset allocation mix will depend on the monthly close for several indices. So ask again at the end of each month.

The 10-month moving average component is far from perfect. Yet this is the exact methodology that helped me successfully minimize the bulk of the 2000-2002 dot-com blow-up and the 2008-09 financial crisis.

To be clear, my clients are primarily retirees and near-retirees. So risk management is crucial to maintaining their standards of living. They simply cannot afford to see 30%, 40%, or 50% losses in portfolio value, with little more than a hope of recovery over the next 10-plus years.

(Q): What asset classes are available for investment considerations?

(( A )): See above. I answered this in one of the paragraphs. But I could elaborate.

I also would add that I'm very fond of cash equivalents when they are yielding 2.3%-2.5%. Funds like JPMorgan Ultra Short income ( JPST ) and Invesco UltraShort Duration ( GSY ). Some folks can use a money market fund if it offers 2.3%-plus, but a lot do not.

I do not view cash as trash as the Fed pauses or slows rate hiking and eventually shifts neutral. That cash is fine for reducing portfolio volatility, picking up a bit of yield and preserving capital in the short term.

In the intermediate term, the cash is precisely what one needs to buy all sorts of stocks and risk assets at 25%, 35% or 45% discounts. You can't do that if you're always fully invested.

The other asset that I like for some retirement portfolios, at this stage in the Fed cycle, are the highest-quality individual corporate bonds. Ironically, lower quality investment grade corporates are a bad idea in my book, and could see their BBB ratings downshifted to junk status. But 7-10 year maturities on Apple ( AAPL )? You're going to get the 3.6%-3.8%.

(Q): Is it enough to get "defensive," investing in sectors like consumer staples, utilities, and healthcare, and asset classes like cash and extremely high-quality corporates?

(( A )): Sometimes the best offense is a great defense. A tactical decision to get "defensive" offers one the ability to become aggressive at bargain prices. If you're pedal-to-the-medal all of the time, you simply won't have the ability to scoop up bargains.

By the way, that doesn't mean I don't see a few bargains now. They just don't exist with the indexes.

For instance, when oil dropped more than 50% in 2016, and showed signs of recovery thereafter, I picked up some convertibles of Cheniere Energy 2045 (Coupon 4.25% Cusip 16411RAG4) at yields of approximately 6.1%-6.2%. With the oil rout that occurred here in 2018, I acquired some more for clients when the yield popped up near 6.1%-6.2% again.

We are talking about the largest exporter in the world of liquefied natural gas. As a developer and transporter of LNG, Cheniere also is the largest acquirer of natural gas. And on their traditional bonds, Cheniere has an investment grade rating. So I prefer this convertible to the junk bond space, which yields less on average.

The accreted value for Cheniere Energy 2045 (Coupon 4.25% Cusip 16411RAG4) in March of 2020 is 83. That's when it's callable. It could be called then, but that's unlikely. And even if it did, at a current price of 75, one would secure an approximate total return of 15% between now and then. Not too shabby for one year and three months.

It's far more likely that they do not call the bonds. In which case, the annual appreciation over time is approximately 1.2% with the 6.2% annual yield… so one might be looking at 7.4% annualized. I like that risk more than common stocks at this moment in the cycle.

Converting Cheniere Energy 2045 (Coupon 4.25% Cusip 16411RAG4) to common stock? I don't see Cheniere ( LNG ) common stock doubling into the $130s from $61 anytime soon.

(Q): I can see you're being selective. But what needs to happen for you to become more aggressive overall with index/ETF investing, in terms of investing in common stocks and general portfolio strategy?

(( A )): We would always add some risk to an asset type when its monthly close climbs above its 10-month moving average. But to be perfectly straightforward, we're talking about shifts between conservative/protection to moderate participation.

There's very little chance of becoming aggressive at this point in the longest bull market in history, let alone one of the longest expansions in history. We've peaked.

It follows that I will be waiting (hopefully not for Guffman or Godot) for bearish price depreciation on the main indices. That will likely be the trigger for the Fed to go back to quantitative easing and zero rates and possibly, if not probably, negative interest rates.

In much the same way that I became very aggressive with equity allocations in 2002 and 2009, I anticipate doing so again.

(Q): To finish up, your key themes for 2019?

(( A )): 1. Understand that a Fed that shifts from tightening to neutral is not a long-term positive for risk taking. It may produce risk-on trading opportunities, it may delay a reckoning. But the next step is usually recession that the Fed cannot stop from taking place. Stocks struggle prior to economic contraction.

2. Use cash equivalents with 2.3% or better yields to reduce portfolio volatility in the near term and to buy great bargains in the long term.

3. To the extent one takes risk in the year ahead, you will probably need to be quite selective. In general, I prefer ETF indexing in uptrends. But when uptrends get longer in the tooth, one should vet individual and highly selective risk-reward opportunities.

Disclosure : Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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