Portfolio Review: August 2023

Summary

• In August we added 2 hedges to our portfolio to insure against tail risks related to a continuation of the melt-up in the S&P 500 and of long-end interest rates breaking out.
• Our S&P 500 call option hedge initiated in the portfolio on 8/23 added considerably to our portfolio’s performance last month, leading it to beat its benchmarks.
• The TUR ETF (Turkish Stocks) added to the portfolio on 8/3 has risen 17%, proving its low correlation with the S&P 500. TUR contributed significantly to the portfolio’s outperformance in August.
• Our 30% precious metals position generated losses as the dollar strengthened. We’re considering trimming our allocation given our view that the dollar will rise in the near-term.
• We closed our small position on MCHI (Chinese Stocks) as our stop-loss was triggered. Stimulus policies announced recently have failed to convince investors that a turnaround is imminent.

Performance

Our Model Portfolio was down 0.3% in August, outperforming the S&P 500 by 1.6 pp., a 60/40 portfolio by 0.9 pp. and a global asset allocation fund 2.0 pp. [1]

For the year through July, our portfolio is up 8.0% compared to rises of 18.7%, 12.1% and 6.4% for the S&P 500, a 60/40 portfolio and a global asset allocation fund, respectively. [2]

The top drivers of the Model Portfolio’s performance in July were SPY Call (hedge), TUR (Turkish Stocks), GLD, SLV and GDX (Gold, Silver and Gold Miners) and TLT (20+ Treasury Bond).

Our S&P 500 hedge (SPY Call) added the most to the portfolio, close to 2 pp., as the market rebounded shortly after entering it. Our small position on Turkish Stocks (TUR) also added.

Our TLT position dragged the portfolio’s return as the term premium expanded. While we put in a hedge on 8/11 to insure against TLT downside, the ETF was already down 5% in the month by then.

Going forward, we expect our TLT put to hedge against tails risks related to term premium expansion driving long rates higher, while leaving plenty of upside to our recession thesis.

Our precious metals positions (GLD, SLV and GDX) added negatively to returns, as the dollar saw substantial strengthening. We’re considering trimming our precious metals allocation.

Since inception on 9/27/2022, our portfolio is up 7.5%. It’s underperformed the S&P 500 by 18.0 pp., a 60/40 portfolio by 9.5 pp. and global asset allocation fund by 5.6 pp.

As the focus turns to a recession by the first-half of ‘24, we expect our sizeable allocation to long-duration bonds (TLT) and cash (BIL) to provide significant outperformance relative to the S&P 500.

Changes to the Portfolio

We made 4 changes to the Model Portfolio in August, as shown below:

• Initiated 5% TUR (Turkish Stocks) long position around the beginning of August. TUR offers significant upside at low valuations, catalyzed by a return to orthodox economic policies.
• Initiated 1% $85 Strike 2/16/2024 long put position on TLT. The aim is to hedge against new tails risks emerging for U.S. long duration Treasury bonds related to a rising term premium.
• Closed MCHI (Chinese Stocks) long position. Price hit our stop-loss after recent stimulus announcements failed to convince investors of a turning point in the economic malaise.
• Initiated 4% $475 Strike 1/19/2024 long call position on SPY. The rationale is to hedge against a continuation in the melt-up in equities seen this year given we have zero equities’ exposure.

Portfolio Positioning and Outlook

Since adding TUR to the portfolio on 8/3, the ETF is up close to 17%. In the month of August, it contributed 60 bp. of portfolio performance.  It remains 17% away from our target of $46.

The appeal of TUR stems from it trading at very low valuations, reflecting a lot of pessimism. TUR is also uncorrelated with the S&P 500, whose risk-reward looks poor.

We’re looking to increase the number of uncorrelated ideas in the portfolio in coming months.

TUR’s move higher came with no change in the Turkish lira, following the country’s recent overhaul in economic leadership. That means that the appreciation was driven by local currency returns.

The high inflation regime in Turkey is benefiting corporate profit margins. Turkish investors see the domestic stock market as a hedge against declining purchasing power.

While inflation has helped corporates boost pricing power, high inflation will eventually undercut demand. Ultimately, we need the lira to strengthen, reflecting economic stabilization.

A big drag in Model Portfolio’s performance this year has been our lack of long equity exposure and our allocation to long-duration bonds (TLT), amidst a decline in recession odds .

To address our outsized exposure to a recession, in August we deployed 2 hedges in our portfolio:

1. As documented in the prior section, we went long an OTM TLT put to hedge against tail risks related to a rising term premium.

2. We also went long an OTM SPY call to hedge against the risk of a continuation of this year’s equity market’s melt-up.

Both hedges were bought at reasonable prices. We expect them to cut off downside risks from the potential of rates and stocks moving higher, while allowing for significant upside in a recession.

Another risk facing our portfolio relates to our 30% allocation to precious metals through GLD, SLV and GDX. The recent strengthening in the greenback creates downside risks to our portfolio.

We’re considering trimming our allocation to precious metals on the back of a dollar that’s seen momentum flipped positive. We believe the DXY could strengthen by around 3% in coming weeks.

While the dollar could see an appreciation in the near-term, we expect gains to be capped by an eventual U.S. recession. Those outcomes have generally been a negative for the dollar.

The updated GOT Model Portfolio is shown below.

Footnotes

[1] Returns are computed on a total return basis (i.e., including dividends and distributions).

[2] The 60/40 portfolio is based on a weighted-average of total returns of the S&P 500 (60%) and the S&P U.S. Aggregate Bond Index (40%). The global asset allocation fund is based on the total return of the BlackRock Global Allocation Fund.