The Dynamic MaximizersSM Portfolio has gotten off to a slow start this year. The Maxis Portfolio is down about 2.4% YTD. That still edges out the 2.7% loss in the Dow, but it is among the Maxis’ weaker quarterly returns.
Why is the Dynamic Maximizers Portfolio down YTD and what should you expect for the rest of the year?
Three months is hardly the kind of time-frame one should be thinking about when crafting an investment portfolio. There is lots of noise on a quarterly basis that can misdirect. And although nobody likes to see their portfolio fall in value, the Maxis have experienced losses of a similar magnitude on a semi-regular basis. Those short-term losses haven’t prevented the Maxis from achieving positive performance every year this century.
First Quarter Performance
Fixed income and consumer-staples stocks are the anchors of the Maxis portfolio. The combination of a quick rise in interest rates and truly ugly sentiment toward consumer-staples stocks has dragged down performance.
One of the unfortunate consequences of today’s low interest rate environment (among many others) is that bonds offer less in the way of interest income to cushion the blow of an increase in interest rates. One way to look at this is by comparing the yield on a bond to its duration. Yield is the projected annual return, and duration is a measure of a bond’s sensitivity to changes in interest rates. So, for example if you own a bond with a 5% yield to maturity and a duration of 5, a one percentage point increase in interest rates would result in a breakeven return over the course of the year.
During the decade before the financial crisis, the bond market provided 1.14 units of yield for each unit of duration. At the start of this year, that ratio was only .44.
Interest rates have increased about 40 basis points this year knocking down bond prices. Meanwhile, bonds have only generated three months’ worth of interest income to offset the falling bond prices. If interest rates end the year where they are today, one should expect a fund like the Vanguard Total Bond Market Index to finish the year flat. We would expect the fixed income component of the Maximizers to do better.
Consumer Staples stocks are suffering from what one might call the market’s Wimpy Syndrome. Everybody remembers Wimpy from the Popeye cartoons. Wimpy was obsessed with hamburgers. He would regularly try to con others into buying him hamburgers today in return for payment in the future. His most famous line is “I’ll gladly pay you Tuesday for a hamburger today.”
In today’s environment, many investors seem to be falling for the Wimpy con. They are gladly offering the Wimpies of the corporate world (think Netflix, Tesla, etc.) capital today in hopes of getting paid back in the future. The companies that pay investors today in the form of dividends and big streams of free cash flow are being shunned by investors.
Take General Mills for example. General Mills has its share of challenges, but over the last 12 months the company generated almost $2.3 billion in free cash flow. The market value of the company is $26.6 billion for a free cash flow yield of more than 8.5%. The dividend yield is 4.4% at today’s price. General Mills has been around since 1866 and owns some of the world’s most valuable brands. Compare that to Tesla. Tesla pays no dividend and burned over $3.4 billion in cash last year. Tesla operates in a fiercely competitive industry with established incumbents. Tesla has a market capitalization of $47 billion, or about 1.8X more than General Mills.
General Mills is but one example of what is a broader trend among consumer-staples stocks. Sentiment toward the sector is wretched, and the proliferation of factor-based investing and exchange traded funds hasn’t helped the issue.
We can’t forecast how long staples stocks will continue to remain out of favor, but as Ben Graham famously said, in the short-run the market is like a voting machine, but in the long-run it is more like a weighing machine. Over the long-run, count on a recovery.
The Maximizers are designed to provide mid-single digit returns and help you survive a stock market melt-down. Ignore the short-term noise and to stay the course.