Fed Week: 3 P’s of Portfolio Management a Better Focus

Trifecta

Portfolio Management efforts can focus on more controllable and proactive themes like Protect, Prune and Plant. Countdown to the FOMC’s September 17th target rate decision is beyond our control and demands the perfect trifecta of outguessing Action, Reactions & Duration of Said Reactions. Good Luck!

When will the Federal Open Market Committee (FOMC) raise the target Federal Funds Rate and move the U.S. out of the zero interest rate policy (ZIRP) environment? The last tightening came in 2006, and based on recent Fed Funds futures prices and trading activity, the probability for a hike on Thursday has dropped from 50% to 25%. The likelihood rises to 74% for March 2016. Interest rates are the price of money which reflect supply/demand balances as well as inflation, credit, and other risks. Demographics, technology, structural unemployment, and muddle-through global demand will continue to deliver counter-punches to expectations for higher rates and inflation.

Bottom Line for Me: Deflationary counter-forces are powerful and Mr. Market will ultimately prove more powerful than what you see in the below Effective Fed Funds graph.

Whether it is former Treasury secretary, Larry Summers or The New York Times, smart people take polar opposite sides of the interest rate debate that will impact benchmark rates all along the curve (10-Year Treasury shown below). Stock markets throughout the world, as well as global currencies and capital flows, will be heavily influenced by the FOMC’s every word or lack of words. Let’s pretend you know the decision to hike is a foregone conclusion. Will the “market” react favorably or unfavorably? Okay, let’s pretend you rightly picked a 25 basis point increase and the market roars up as an indication the economy is strong enough to withstand the marking of a new interest rate regime. So what happens Friday or next month as investors, traders, speculators, and sovereigns digest the implication on their books? Can you pick the FOMC Trifecta?!

Advice: Spend more mind-share on the portfolio(s) you manage.

Similar to outguessing a room full of brilliant economists, forecasting the weather that impacts our future lawn and garden is fairly difficult. Still, here in North Carolina, we take more controllable and proactive actions in the fall to reduce soil compaction, save water, and enhance root growth in order to rejuvenate a lawn full of summer stress. Global portfolios have experienced summer stress with large losses experienced in numerous asset classes, geographies, market caps, sectors, credit grades, and investment style boxes. Sixty-five percent of the companies in the domestic S&P 500 have negative year-to-date price returns in 2015, and international currency translation is brutal with the strong dollar surge.

PROTECT. PRUNE. PLANT.

There are numerous proactive methods and techniques to pursue portfolio management/asset allocation goals that include less compacted correlations and exposures, savings of taxes, and enhanced future reward-to-risk opportunities. Here is a small sample with no FOMC Trifecta required!

Protect:

Cash is “King, Queen, Prince, and Princess” when uncertainty reigns, volatility and correlations rise, and markets are downright mean. Lots of methods to choose source of funds; however, an example is to quantify and rank reward-to-risk ratios for every holding/exposure and remove a percentage of those with the least favorable margin of safety. With a Growth-at-a-Reasonable-Price (GARP) investment philosophy, I like to rank valuation metrics such as PEG ratios and a proprietary view of estimated Price-to-Sales versus Profit Margins. Dry Powder is never a bad thing and so-called “Cost of Opportunity” is a protection risk I am willing to absorb.

In-depth analysis will look beyond simple stock, bond, cash, and security-level allocation modeling. I focus heavily on portfolio character, risk budgeting, and overall posturing; therefore, protective decision-making can shape a 100% invested portfolio.

Prune & Plant:

When a tide of losses hits 65% of the S&P 500, it is a superb opportunity to proactively harvest tax losses by swapping dollar for dollar into securities with equal reward-to-risk opportunity sets: This captures the economic losses which may be used to offset current gains or banked into carry-loss forwards. Of course, you can modify the type of exposure you have at the same time, but in this case the same amount of dollars remains exposed.
Note: Avoid Wash Sale Rules. 

Isolate and cull through the non-market/price related characteristics of your holdings and prune securities that have failed to meet fundamental or quantitative expectations over your tolerance of time. Perhaps, the business model is shaky, currency risk is too high, dividends are subject to change, the fund manager left, earnings estimates dropped, debt coverage breached your preferred ratio, valuation is too high, or liquidity, spreads, relative strength have weakened. It is rare for a portfolio to be blemish or disappointment free–just the laws of probability and no reflection on your security selection skills 🙂 

There will be no escaping the media and market’s desire to correctly pick the FOMC Trifecta in September, December, March…

Every investor and portfolio is unique so take more controllable and proactive actions that reflect your unique circumstances–In my experience, taking action (no matter how minute) is often worth the behavioral reward when market and events are highly volatile and uncertain.

ABOUT THE AUTHOR:

Michael loves to empower investors with his expertise in securities and economic analysis, goals-based wealth management solutions, and FinTech smart decision-support tools. While directly managing over $5 billion in growth and retirement assets; his proactive advice and software innovations have influenced thousands of fiduciary advisors to better their practices and service to clients. He enjoys spending time with his wife and three boys, competing in USTA tennis, and mentoring others to succeed.

Email | Michael@empoweredportfolios.com

Twitter | @MichaelHakerem

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