Tips on rebalancing your retirement portfolio

rebalance-moneyunder30

Many investors are in for a rude awakening when they open their year-end retirement plan statements. The bond portion will probably show negative returns. It could even wipeout a good portion of their positive returns from owning equities.

Now, the most common method used in rebalancing your established asset allocation mix would be to reduce the holdings that are up in value (sell stocks) and buy assets that have fallen in price (buy bonds). This practice may have worked very well in the past but interest rates are going up forcing bond prices down.

The chart below compares the S&P 500 with the IShares 20 plus year Treasury bond ETF

tlt

“The decades-long bull market in U.S. Treasuries has finally drawn to a close following Donald Trump’s surprise presidential election victory, according to mutual-fund manager Bill Miller.”

“Miller isn’t the first to call time on the bond bull market. Economist Henry Kaufman, the original “Dr. Doom” who is credited with calling the last bond bear market in the 1970s, told the Financial Times this week that the current bull run is at an end.”

In the past, when the Federal Reserve decided it was time to unwind its easy monetary policies, it would raise the federal funds rate fairly quickly. The Fed believes a neutral stance on monetary policy is reached somewhere above the 4% level. The current Federal Reserve is moving slower than normal. Based on an average of three rate hikes per year, it will take the Fed a little over 4 years to normalize interest rates.

Tip # 1

Short-term, reduce or eliminate investing in target date mutual funds since they automatically rebalance from equities to bonds. Plus they increase your bond exposure the closer you are to retirement.

Tip # 2

During a period of rising interest rates, the prudent strategy is to reduce the duration of your bond portfolio. That could mean using a short-term bond ETF or a ladder of GICs both of which would allow you to benefit from an increase in rates.

Tip # 3

If you’re comfortable with a little credit risk, use short-term investment-grade corporate bonds to get a little more yield.

Tip # 4

Cash is by far the safest asset class. Move some of your equity allocation and some of your fixed income allocation to cash. I have my doubts that President Elect Trump can get congress to pass all his stimulus agenda and even economists are unsure if these policies will actual increase economic growth.

Corrections in the bond market are not as uncommon as you think. Most have been short in duration. See the chart below:

lt-treas-losses

Keep in mind that in the past, rate hikes were implemented  at a much faster pace than what the current Fed has purposed. Losses in the bond market could continue for longer than expected.

Bull Call Spread: An Alternative to the Covered Call

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Most new option traders start with a covered call strategy. You buy 100 shares of company xyz and you sell one option that has a near month expiry date. One objective of this strategy is to earn extra income from the option premiums which hopefully expires worthless. Short term options decline in value very quickly if the stock price remains fairly flat or falls a little in value.

The covered call strategy is limited by the amount of capital you have to invest. Many popular stocks are trading over $100 like Apple ($114.90), Netflix ($123.75) and Facebook ($119.40) so buying 100 shares of these three companies would require about $35,805 of your capital.

An alternative to writing covered calls, one can enter a bull call spread for a similar profit potential but with significantly less capital requirement. Instead of buying the underlying stock in the covered call strategy, the bull call spread strategy requires the investor to buy deep-in-the-money call options instead.

To illustrate the difference, I am going to select 3 bull call spreads for the above three popular stocks. Disclaimer: These trades are for educational purposes only and are not recommendations.

Quotes as of 10:00 a.m. on Dec 13, 2016

Example #1

Buy 100 shares of Apple at $114.90 sell one call option Jan 20 at $115.00 for $2.60

Call spread: Buy 1 Jan 20 $105 call for $10.45 – sell one call Jan 20 at 115.00 for 2.60

Example #2

Buy 100 shares of Netflix for 123.75 – sell Jan 20 call at $130 for $4.50

Call spread: Buy one Jan $120 for $9.15 – sell Jan 20 call at $130 for $4.50

Example #3

Buy 100 shares of Facebook for$119.40 – sell Jan 20 call at $120 for $3.10

Call spread: Buy one Jan 20 $110 for $10.45 – sell Jan 20 call at $120 for $3.10

Now, the capital required to purchase 100 shares of each of these three stocks is $35,805 minus $1020.00 from selling the covered call options equals $34, 785. The bull call spreads requires a total outlay of $3,005 minus $1020.00 from selling the exact same covered calls equals $ $1985.00

Only time will time if these bull call spreads are good, bad or ugly. Stay tune for a follow-up post in the new year.

Another suckers rally in oil stocks?

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Over the past year there has been a lot of talk regarding the possibility of OPEC either freezing or cutting production. The Organization of the Petroleum Exporting Countries (OPEC) on Wednesday agreed to its first oil production limits in eight years, triggering an oil rally. The new norm for crude prices could be between $50 and $60 going forward.

OPEC has said it is seeking to secure 600,000 barrels per day of cuts from non-OPEC producers, and that Russia has committed to temporarily cut production by about 300,000 barrels per day in the first half of 2017. Russia and other non-OPEC producers are set to meet with OPEC on Dec. 9.

The key to all of this is whether these cuts will be implemented. Plus market watchers are also questioning whether the oil group will cheat. The sharp oil-price rally may well be short-lived, as oil production has been turning the corner in the U.S., with the rig count up 50 percent from lows in May.

Extracting oil from the Permian Basin, which spans west Texas and southeast New Mexico, is less expensive than it is in many major fields.

“Basically, $50 is good for Permian Basin stocks,” said Paul Sankey, senior oil and gas analyst at Wolfe Research. Pioneer Natural Resources and EOG Resources expanded their presence in the region in the last few months, and Sankey said the two companies would also benefit from $50 oil.”

In Conoco Phillips’ third-quarter conference call, management said the company was adding three rigs to its operations in the North Dakota Bakken oil fields for a total of four rigs in the region.

“The Trump Wild Card”

Cutting corporate income taxes will make U.S. shale producers more profitable and they could have extra cash to produce more oil. Less banking regulations could also allow more bank loans to the energy industry. Could Trump impose tariffs on imported oil? He is after all unpredictable!

The oil futures market has quotes for monthly contracts that are being offered at $53.00 for the first quarter of 2017 and $55 for the rest of the year. The trading volumes of contracts changing hands is very low which could be a bullish sign that oil producers believe that higher prices are coming.

Now over the last two years, I have avoided investing in oil stocks and posted many articles regarding the oversupply problem. I am currently doing research on some U.S. shale oil producers. Unfortunately, the fundamentals haven’t changed and most companies are still losing money at current oil prices.

What do you think?

Is this another suckers rally because hedge funds are rushing in to cover their short positions or is this the start of a bull market in the oil patch?