Re-balance Cycle Reminder All MyPlanIQ’s newsletters are archived here.

Regular AAC (Asset Allocation Composite), SAA and TAA portfolios are always rebalanced on the first trading day of a month. the next re-balance will be on Thursday December 1, 2022. 

As a reminder to expert users: advanced portfolios are still re-balanced based on their original re-balance schedules and they are not the same as those used in Strategic and Tactical Asset Allocation (SAA and TAA) portfolios of a plan.

Tactical Bond Fund Portfolios Consistently Outperform

This newsletter reviews the current fixed income market and then looks at the recent and past performance of our fixed income mutual fund and ETF portfolios. We then discuss market outlook.

Fixed income market update

2022 so far turns out to be the worst year for Treasury bonds (specifically 10 year Treasury bonds) since 1788, according to Bank of America:

The following table shows the latest returns for various bond segments (see 360° Market Overview for more details):

Fixed income bond sector returns (as of 11/04/2022)

Description Symbol 4 Weeks 52 Weeks Trend Score
Treasury Bills SHV 0.15% 0.89% 0.58%
Short Term Muni VWSUX 0.05% -0.95% -0.08%
Short Term Treasury SHY -0.26% -4.61% -1.63%
Short Term Credit IGSB -0.2% -6.76% -2.27%
Interm Term Muni VWIUX -0.7% -7.91% -2.68%
High Yield JNK 1.38% -9.23% -3.21%
Inflation Protected TIP -0.16% -8.05% -3.81%
Long Term Muni VWLUX -1.51% -12.49% -4.51%
High Yield Muni VWAHX -1.99% -12.57% -5.03%
International Inflation Protected WIP 4.97% -14.34% -5.31%
MBS Bond MBB -1.13% -13.99% -5.76%
US Total Bond BND -1.22% -14.99% -5.78%
Intermediate Term Credit IGIB -0.6% -15.99% -5.8%
Intermediate Treasury IEF -1.68% -16.76% -6.9%
Emerging Mkt Bonds PCY 3.17% -27.47% -7.41%
Long Term Credit LQD -0.97% -20.96% -7.5%
International Treasury BWX 1.2% -25.62% -9.17%
10-20Year Treasury TLH -4.19% -28.47% -12.14%
20+ Year Treasury TLT -6.47% -34.37% -15.33%

Virtually, other than Treasury bills (3 month Treasury bills, similar to cash), everything has had negative 52-week returns. It’s also very telling that long term Treasury bonds (TLH, TLT) have bigger loss than long term credit corporate bonds (LQD). Furthermore, high yield corporate bonds (JNK) has even smaller loss than Treasury bonds and credit bonds!

Remember that in bond investments, there are two major risks: interest rate risk and credit risk. So far, interest rate risk has totally dwarfed credit risk. Investors seem to be more scared of rising rates than corporate credit (debt quality). Unfortunately, this means that when further economic weakness hits (such as a recession materializes), corporate bonds will have more room to decline. Not a pretty picture by all means.

Misreading inflation and/or the Federal Reserve’s resolve

The secular bond bull market that has lasted since 1980s has apparently ended. Unfortunately, for many bond investment pros including excellent and famous managers, they are slow or reluctant to adapt to this new investment regime.This is reflected by dismal returns from the candidate total return bond funds for our fixed income portfolio:

Bond Portfolio and Bond Funds Performance Comparison (as of 11/4/2022):
Ticker/Portfolio Name YTD
1Yr AR 3Yr AR 5Yr AR 10Yr AR 15Yr AR
MPIQ ETF Fixed Income -6.7% -5.6% 2.2% 4.2%
Schwab Total Return Bond -1.2% -1.6% 4.2% 4.3% 4.7% 6.6%
PTTAX (PIMCO Total Return A) -16.5% -16.6% -3.7% -0.8% 0.6% 3.0%
DLTNX (DoubleLine Total Return Bond N) -14.1% -14.2% -3.8% -0.9% 1.0%
VBMFX (Vanguard Total Bond Market Index Inv) -15.2% -15.4% -3.6% -0.6% 0.7% 2.4%
LSBDX (Loomis Sayles Bond Instl) -13.0% -12.8% -2.3% -0.4% 1.0% 2.9%
TGMNX (TCW Total Return Bond N) -18.3% -18.4% -4.5% -1.3% 0.7% 3.3%
FTBFX (Fidelity Total Bond) -13.7% -13.6% -1.6% 0.7% 1.7% 3.9%
PONAX (PIMCO Income A) -11.2% -11.0% -1.0% 0.7% 3.6% 6.0%
PBDAX (PIMCO Investment Grade Corp Bd A) -17.6% -17.2% -4.0% -0.4% 1.9% 4.6%
BCOIX (Baird Core Plus Bond Inst) -14.4% -13.9% -2.2% 0.4% 1.7% 3.7%
MWTRX (Metropolitan West Total Return Bond M) -16.4% -16.6% -3.4% -0.4% 1.0% 3.5%
DODIX (Dodge & Cox Income) -14.4% -14.7% -2.2% 0.4% 1.8% 3.5%
BAGIX (Baird Aggregate Bond Inst) -15.1% -15.0% -2.8% -0.0% 1.4% 3.0%

All of the bond funds have incurred double digit loss this year. Though many of these funds have still outperformed the index fund VBMFX for the past 10 years, quite some have underperformed for the past 5 years. A noticeable one is DLTNX (DoubleLine Total Return Bond N) that’s managed by so called the new bond king Jeffrey Gundlach. The fund not only underperformed for 3 and 5 years, it also only did marginal better than VBMFX for the past 10 years (1% annual return vs. 0.7%).

We attribute the above lackluster performance to the misreading of the stickiness of inflation or high prices as well as slow reaction to this new rising rate paradigm. In fact, over this year, we have heard many who predicted that inflation has peaked. They also would claim that the Federal Reserve will soon pivot (i.e. stop raising interest rates or even start to lower the rates). Gundlach actually announced to buy Treasury bonds in early September, only to see that long term Treasury bond prices has further declined more than 10% (for example, TLT lost more than 13%) since then.

The main cause here is that many investors are so used to low interest rate and low inflation environment such that they pay too much attention to supply chain or manufacturing/goods side’s equation while underestimates how sticky higher prices can stay for a long period of time. The other main factors such as tight labor market (still ultra low unemployment rate (3.7%)), rising wages, price inertia in service sectors (slow price increase and decrease) and rents are all not that familiar to these investors. This result in their underestimate the severity of the current bond bear market.

At all, it does look like currently, the inflation situation is more like 1970s-1980s than that after the world war II. This would imply that we are likely to experience further higher prices for a while.

The consistent winning for more than a decade

The above table includes MyPlanIQ’s flagship fixed income portfolios Schwab Total Return Bond that’s a tactical portfolio designed to rotate no transaction fee and no load bond mutual funds for brokerage accounts in Schwab and, the ETF based MPIQ ETF Fixed Income. Both portfolios have done way much better than the excellent (some of the best) total return bond funds for more than a decade (for the Schwab portfolio) or for more than 5 years for the ETF portfolio.

We want to point out that our total return bond mutual fund based portfolios such as Schwab Total Return Bond  (see others listed on Income Investors page) have been live since 2010. We have openly tracked their daily returns since. These portfolios not only have done way much better than all of these mutual funds in terms of returns (such as 6.6% annual return vs. the best 6% of PIMCO Income (PONAX) or many others’ 3%-4% for the past 15 years), but they have incurred much smaller maximum drawdown (or maximum interim loss). We again encourage interested readers to look at these portfolios listed on Income Investors page and/or read more our past  newsletters on them.

Going forward, we believe our tactical bond portfolios will play an even more important role in one’s investment portfolios:

  1. Bonds will likely outperform stocks in the coming decade or so (see August 1, 2022: What We Can Learn From 1970s And 1980s for more details).
  2. As interest rates are elevated (or bond prices depressed), it’s actually a good period to take advantage of the low prices and high interest rates by utilizing a tactical active strategy like the one employed by our portfolios. This is because prices will likely rebound from their low levels. Furthermore, holding higher interest rate bonds will result in higher regular dividends.

Note, currently, it’s still not a good time to get exposure to anything other than ultra short (3 months) bonds. But the time will come when interest rates will stabilize and then start to fall. This hopefully (and probably) will not be far beyond. But again, we don’t rely on our subjective read or forecast. We’ll let our strategy guide us.

Market overview

As of last Friday, according Factset, with 85% of S&P 500 companies reporting actual results, the blended (actual and still expected) earnings growth for Q3 is 2.2%, lower than 2.7% expected on Sept 30, 2022. Even though analysts have started to reduce their earnings growth expectation for next quarter (to -1%), the expectations are still way too optimistic: in fact, they still expected a positive earnings growth for 2023 (again refer to the Factset report). 

On the other hand, the spread between 10 year and 3 month Treasury yields had become negative (or ‘inverted’) for more than a week:

This 10year 3month spread indicator has a 100% prediction accuracy for the past recessions: when it goes negative, the US economy will always go into a recession in the next 12 months. With the Federal reserve still being aggressive to raise interest rates and now mortgage interest rates has been highest since 2002, we believe that the economy will be very unlikely to have a soft landing without going to a recession in the next year.

Since the average S&P 500 earnings decline in a recession is more than 20%, the above earnings expectation seems way too optimistic. In a run-of-the-mill recession, if earnings declines 20%, even without price undershoot, S&P 500 index price will probably go down at least at a similar scale.

Again, we will let our strategies to guide us in this uncertain bear market. As always, we stay the course with our strategies and reiterate the following:

  • For strategic allocation (buy and hold) investors, ignore the current market behavior. Remember, as what we have emphasized numerous times, when you choose and commit to a strategic portfolio, you essentially know and commit that your investment horizon (or the time you need to utilize this capital) is 20 years or preferably much longer given the current high valuation. As we pointed out, if your investments are those diversified (index) funds such as an S&P 500 index fund (VFINX, for example), you know your money is in some solid ‘business’ that eventually (20 years later and preferably many more years later) will deliver some reasonable returns. As long as you are comfortable with this thesis, you should sit tight and forget about the current gyration.
  • For tactical investors, again, you have to ignore the current market noise. Furthermore, you should follow your strategy rigorously, especially in a time like this. Human emotion, both optimistic and pessimistic, and human desire, both greedy and fearful, are your worst enemies. This has been shown to be true time and time again.

Stock valuation has dropped and now valuation is becoming less hostile. However, it is still not cheap by historical standard. For the moment, we believe it’s prudent to be extra cautious. However how serious a correction might be, we have confidence in the US economy in the long term and thus in the stocks in aggregate. We just need to manage through interim losses carefully.

We again would like to emphasize that for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot.

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