In early January this year, Seeking Alpha editors published the article, "My 2013 Investment Game Plan." The link to it is found here.
As I have done in years past, I am now writing you with a mid-year review of the general plan assumptions and a first-half look back. Then I will offer a general analysis of the specific plan investments. Included are my second-half portfolio adjustments, with the promise to write you again at year-end to summarize final 2013 results.
For clarity, I have blocked and italicized original segments from the January plan, then followed up with a short discussion after each section.
"My 2013 Investment Plan" Basic Assumptions: Review and Analysis
The January plan began with several overarching premises. Here's a recap and analysis of the major premises:
The global economy will show improvement. The economies of the United States, China, and Japan will all demonstrate positive growth. Emerging markets will hit-and-miss follow along. Europe has seen the worst of its recession, but ongoing deleveraging will continue to prevent any meaningful economic expansion.
Generally Correct. The largest world economies have shown improvement. The United States, Japan, China and Germany have all grown. However, none has demonstrated robust growth. The Chinese growth rate has been a disappointment; Japan is now showing some life after years of economic malaise. The U.S. continues to hobble along, though some new green shoots may have begun to emerge. I contend that the EU has finally found a bottom.
U. S. interest rates will remain low. Indeed, the Fed has stated their intent to keep rates down. Likewise inflation will remain subdued. The banks will continue to straighten themselves out, perhaps with even more vigor than 2012. Residential housing markets will exhibit meaningful recovery throughout most of the nation.
Correct. These premises have been on track. I'm giving myself the benefit of the doubt on the Fed's intentions versus the market's perceptions and reactions. Despite the recent bump, rates still remain near historic lows.
Gold will continue to rise, though moderately.
Incorrect. Gold is seeing one of its sharpest short-term declines in memory. I admit this prediction has turned out to be downright disgraceful.
U. S. equity markets will trend modestly higher; there is a greater chance of extra upside than major downside. I make no numerical predictions on the market averages. I do premise that 2013 will be a decent year for corporate earnings. However, the Washington-manufactured "fiscal cliff" crises will dog the averages, along with both the reality and threat of higher taxes. Cuts to various government programs will not help the situation, either.
Generally Correct. I have been surprised at how the market has shrugged off the sequester and pending higher taxes. However, corporate earnings have been acceptable and U.S. equity markets have trended higher. Indeed, the trend has been better than "modestly" higher, too.
"My 2013 Investment Plan" Asset Strategies: Review and Analysis
NOTE to READERS: I have authored Seeking Alpha articles on many of the stocks contained in my portfolio. Whereas S.A. editors have published a 2013 article of mine written about these stocks, I've included an embedded link for readers who wish to take a deeper dive into my analysis and ownership thesis.
Concentrate equity investments in global Industrial, Financial and Energy sectors. I also will retain moderate exposure to the Materials sector. My go-forward rationale is that 2013 will see a marked improvement in many global economies. Typically, business cycles last five to seven years. However, the monetary tinkering by several international agencies has muddled the picture.
I have maintained this stance for the first half of 2013, and remain comfortable with it for the second half of the year. My underlying assumption is that the United States economy will gain momentum. If so, these sectors historically outperform.
Caterpillar has been a 2013 laggard, down about 7 percent on the year. I bought more during the most recent quarter. Currently, CAT remains my favorite long-term Industrial stock. I believe the shares have been heavily discounted. Investor sentiment is awful. Yet the dividend was boosted 15 percent: the shares now yield nearly 3 percent. These are reasons to buy, not sell. I wrote about why I believe CAT has been chronically undervalued back in February. The article is found here.
Eaton was one of my heaviest positions coming into the year. The stock has not disappointed, up about 23 percent. I believe the shares are at fair value now. I plan to hold. Under the leadership of CEO Sandy Cutler, the company is digesting its major acquisition of Cooper Industries. As an investor with a longer view, I am willing to let the shares consolidate now with the expectation of another leg up. My dividend yield-on-basis is quite high, and my expectation is that Cutler and his management team have under-promised and will over-deliver on merger synergies and forward business opportunities. These thoughts are amplified in this May article found here.
Aligned with my conviction to overweight Industrial stocks, I started an additional position in Union Pacific Corporation (UNP). The best-of-breed company is the undisputed railroad kingpin of the western two-thirds of the U.S. Seeking Alpha editors just published an article outlining my detailed opinions about the company here. If the stock price comes in, I will add to the position in the second half of the year.
In January, my Financial stock holdings included Wells Fargo (WFC) and Aflac (AFL). The pair have performed well, registering gains sans dividends of 21% and 8%, respectively. I am heavy in both issues, with no intention of trimming.
Wells Fargo is my favorite banking stock. The company has executed flawlessly, reporting quarter after quarter of record earnings. WFC originates nearly two-thirds of all U.S. residential mortgages now. I like the old-line business model: take in customer deposits, and make Main Street loans. An eventual rise in interest rates will further augment earnings. The bank has been struggling with declining NIMs (net interest margins) for years. A January article detailing my ownership thesis for Wells is found here.
I submit that Aflac is one of the market's most undervalued and misunderstood stocks. This Dividend Aristocrat has an excellent balance sheet, strong management, and a niche insurance business model that is very well-executed. Yet the P/E multiple languishes around 9x. I believe investor mis-perceptions around the Japan / U.S. business structure and yen/dollar exchange conversion rates are factors. For readers who would like to know more about how the company is structured, and my views about why it's undervalued, a link to my February article is found here.
In conjunction with my Plan, I also added an additional Financial stock to the portfolio early in the first half: U.S. Bancorp (USB). I like this particular banking stock for nearly all the same reasons I like Wells Fargo. In April, Seeking Alpha editors published an article supporting this thesis and why I wanted to own shares of this fine financial institution: U.S. Bancorp Is A Chip Off The Wells Fargo Block.
Entering 2013, Energy stocks were an overweight sector. However, my three holdings are diverse within the group: Royal Dutch Shell (RDS.A) is an international, integrated Super Major; Halliburton (HAL) is a large, growing oil service company, and Energy Transfer Partners (ETP) is a downstream transportation MLP.
Shell's 2013 stock price performance has been a disappointment, falling nearly 7 percent. However, I suggest that corporate leadership has recognized the chronically weak price action and taken concrete steps to improve cash generation and link performance to shareholder dividend increases. Seeking Alpha published a May article I wrote about these specifics here. Between the 5.5 percent dividend and writing some put and call options, I was able to mitigate the near-term share price weakness.
On the other hand, Halliburton stock has seen nearly a 24 percent bump since January 1. I believe this global oil service giant has more room to run. A combination of outstanding overseas growth, good expense management, and (hopefully) a subdued end to the BP - Macondo incident overhang will lead to improved margins and a run towards my 2013 price target of $51. I increased my exposure to this service company via long call options. A detailed analysis of HAL is found in a May article I wrote here.
The story behind Energy Transfer Partners isn't the 19 percent YTD increase in the unit price. It's the potential of this oft-maligned, under-performing, but high-yielding MLP to finally hit stride. Despite a distribution yield above 7 percent, investors have been down on ETP due to stagnant distribution growth and lackluster quarterly results. No more. A series of large, integrated acquisitions have completely re-imagined the corporate landscape. Energy Transfer will spend most of this year and into 2014 digesting and spinning off non-core assets. The once Texas-centered natural gas transportation business has now expanded into a national, downstream energy company; the scope includes a huge, crude and oil products pipeline system; NGL fractionation facilities; and network of retail service stations. While I was disappointed the quarterly cash distribution wasn't raised in the first half of the year, it did not dim my optimism for the future of the company. I've covered ETP routinely via S.A. for some time now. My most recent article is found here.
Nucor is the best-of-breed American mini-mill steel manufacture. I believe it's still a bit early in the business cycle to increase my holdings of this Dividend Aristocrat. Nonetheless, I have a close watch on the shares. Company management has used to prolonged downturn in the steel business to invest heavily for the future. This includes new DRI (direct reduced iron) facilities, the acquisition of a steel fabricator / distribution company, and a JV partnership with Encana to develop gas wells that will help supply energy to Nucor facilities.
International Paper is currently absorbing a major acquisition. In February 2012, the company completed a deal with Temple-Inland to buy out the business, thereby consolidating the industry. Experienced CEO John Faraci has reported accelerated post-merger synergies. In addition, IP has been able to push through a containerboard price increase this year, further strengthening future earnings prospects.
Shares of International Paper have increase about 14 percent YTD; while Nucor has been roughly flat. Both companies pay very good dividends. These returns were acceptable, as my portfolio positions are but small, core positions.
Reduce holdings of selected Tech stocks. My two core investments in this area have been Apple (AAPL) and Intel (INTC). I've owned shares of both corporations for many years. I'd like to trim my exposure to both stocks, but I'll patiently wait for the right price. I plan to take some profits in AAPL if it breaks $600 again. I remain positive on Intel: notwithstanding its legions of naysayers. The balance sheet, cash flow, and yield are outstanding. However, I'm watching for a decent catalyst coming down the road. If not, I may lighten up if the shares firm up to $24 or so.
My story around these premises is a study in why individual investors have an advantage: we don't have to answer to anyone but ourselves.
Towards the end of the first quarter, I changed my mind on the aforementioned strategy. I did not reduce my exposure to Tech stocks and actually increased my exposure. I added to my Intel holdings via long call options, financed by selling short puts. Due to my changed view that a real U.S. economic recovery will include the Tech sector, I even added a new name to the portfolio.
Apple, Inc. has been an unmitigated disaster. My thoughts of lightening up a $600 became a pipe dream early after the New Year. Nevertheless, I have held the shares I owned for years; and due to my low basis, they still register a decent gain. However, this does not compensate my displeasure with the miserable price action. I now believe the shares are too low to sell. I plan to continue to hold and periodically sell vertical spread options to add additional income to the position. I outlined why I believe that Apple's P/E ratio is an anomoly in this S.A. article.
I thought I would lighten up on Intel if the shares busted $24, but instead took an alternate route. My view is that prospects for the chipmaker have improved dramatically with a new series of power-saving products aimed squarely at the handset and tablet crowd. I decided to remain patient; certainly, the generous dividend helped me keep the faith. Shares have bounced 15 percent so far this year, sans the dividend. I expect directors to bump the payout upon the next quarterly declaration. A month ago, I learned of an anomaly in the Intel options scene: I bought the Jan 2015 $25 calls by selling the Jan 2015 $20 puts and adding but 30 cents cash. It's nearly a free ride for a year-and-a-half with the caveat of having to buy Intel shares below $20 each. That would indicate a yield above 4.5 percent, and an associated 20 percent drop from the current share price. On the other hand, I control shares of the chip giant above $25 for peanuts. I took those odds. Intel has long been a core holding; my eye has been on margins. An April article outlining historic margins and what to look for going forward is found here.
Finally, the recent Fed actions triggered me to rethink my overall portfolio strategy. I believe the potential for the Fed to taper QE3 is real, with the contingency that the U.S. economy starts to pick up steam. If so, then stock sectors Industrial, Financial and Tech tend to do well. Tech, in particular, is not heavily influenced by modestly higher interest rates.
So I started a position in yet another old-line Tech company: Oracle Corporation (ORCL). The beaten-down software giant retains a strong balance sheet, morphing cloud prospects, and the venerable CEO Larry Ellison. I believe the stock has bottomed at $30 with the most recent quarterly earnings announcement, and like the fact that the directors just doubled the dividend. Corporate management stated it thought that Oracle hardware sales had likewise hit bottom and will improve by year-end. Indeed, upon a true economic recovery, the I.T. space is one of the first places businesses invest.
Get into Healthcare. I missed the boat on this sector in 2012. Nothing in the kitchen for the sector. Boy, does that bug me. I premise, politics aside, that ObamaCare will be a boon for select health care stocks. My problem will be to find value. I don't like the picture for many of the large Drug stocks. I've got my eye on Johnson & Johnson (JNJ), Abbott Labs (ABT), and a few smaller names. I want in, but won't chase.
The companies on my January radar screen saw their stock prices run away on what I considered investor yield-chasing and resulting in subsequent share overvaluation. I would not chase them.
Nonetheless, I fulfilled the pledge to myself to find some Healthcare exposure by purchasing long call options on Express Scripts (ESRX). This pharmacy benefits management company completed a merger with MedCo and now is the biggest PBM on the block. Revenues, earnings, and cash are expected to grow significantly. Worries over the impact of ObamaCare on the franchise provided what I believe was a stock price opportunity entry point. I offer additional details as to why I ended up investing in ESRX here.
Underweight Utilities and Telcom. During 2012, I accumulated positions in Vodafone PLC (VOD) and Excelon (EXC). I'm pleased with Vodafone despite it's lackluster underlying capital performance. It's an out-of-cycle, beaten-down global telecom that's concentrated in Europe......Since I assumed moderate economic growth in 2013, I see no need to bulk up on either of these sectors [Telecom or Utilities]. Indeed, whereas Utilities used to be considered safe, slow-growers, I am convinced this is no longer the case. De-regulation, government over-regulation, and energy conservation initiatives leave me no catalysts for jumping in now.
I continue to follow the prescription outlined above. I continue to have a position in Vodafone, but reduced it during its first half bounce. I dumped Excelon in January, took a loss, and swapped out this June for a new position in Consolidated Edison, a favorite electric utility.
During the first half, Vodafone's 45 percent ownership in Verizon Wireless was a prospective buy-out target of Verizon Corporation (VZ). The stock raced up on rumors, and I sold a chunk of the position. I still own remaining shares of Vodafone, and hold it for a dividend yield greater than 5 percent. Furthermore, the company's struggles in Europe (particularly Southern Europe) lead me to believe that now is not the time to bail out. I suggest that the EU economy is in a bottoming process, and the telecom giant will likewise start to find revenues stabilize in the second half of 2013.
Consolidated Edison (ED) is a true, old-line regulated utility serving the Greater New York metropolitan area. In order to retain modest exposure to the Utilities sector, I purchased shares on the recent market sell-off of dividend-paying stocks, with the expectation that this Dividend Aristocrat will stabilize, then simply continue to payout and raise its bountiful 4.25% dividend. Last month, Seeking Alpha editors published a detailed analysis I wrote about this utility stock here.
Look for bargains in Consumer Staples. Given my premise that we will see moderate economic growth in 2013, I suspect the Consumer Staples sector will lag the averages. Therefore, this will be precisely the time to look for some bargains. I currently hold a solid position in stalwart General Mills (GIS); I'm happy to add to the position if the stock gets oversold. I also have a small position in tobacco company Lorillard (LO).
Thus far into 2013, this has turned out to be a strategy under revision. The underlying premise was wrong: Consumer Staples has not lagged the averages. Consequently, I have not found any bargains in this sector. My lone current Consumer Staples stock is General Mills. I sold shares of Lorrilard near its YTD highs. However, the premise that 2013 would see moderate economic growth has been largely correct. Typically, this does portend that CS stocks will lag. We will see what the second half brings.
General Mills , despite the stock price getting a bit overheated, remains a core position in the portfolio. The company has a number of positives including: a viable, international growth plan; excellent dividend growth; and unquestionably strong management and corporate culture. I have no intention of divesting of "The General" in 2013. My opinion on why I'm sticking with this household stalwart is found here.
Hold my lone position in Consumer Discretionary. I carried over a solid stake in TRW Automotive (TRW), a global manufacturer of automobile safety systems and equipment. I like the stock, but it's approaching what I believe is full value. If I get my price, I would be very selective about another Consumer Discretionary stock. I do see some decent value in certain retailers, but I envision too many other stocks that trump them.
In accordance with my plan, I started lightening my TRW Automotive shares when they approached $60. I continued to offload shares as they continued to rise, and now hold only a stump of the original equity position. The stock has exceeded my fair value target, so I am writing covered calls against the few remaining round lots.
I have hesitated to quickly sell all shares before the second-quarter earnings conference call. The company has a number of key items to report. Management's overview of the economic situation in Europe (wher TRW does a little less than half its business), the resolution of an EU anti-trust case, and the potential for the first cash dividend are all on the docket.
Hold some bonds as a placeholder. Last year, I re-learned a valuable lesson: no matter how upbeat or bleak the situation for any class or sector, stay diversified. I thought bonds would go nowhere in 2012, but my holdings turned out to be a very pleasant surprise.
Even if a major asset class is down, I continue to maintain some exposure to it. I've been down on bonds for a couple of years now, but until recently these investments have held their own. However, with the recent Fed announcements, I do believe the winds are finally changing.
The only outright bond funds I own are the Pimco Total Return Fund (PTTRX), the Pimco High-Yield Bond Fund (PHYAX), and the Templeton Global Bond Fund (TGBAX).
I reduced holdings in the Total Return Fund as rates spiked in late June. I will sell more if the fund price rebounds. While I have confidence in Bill Gross, the fund's long-time manager, I just do not like straight U.S. bond funds in the current environment. I may end up with a small core position only.
While I've held onto shares of the Pimco High-Yield and Templeton Global Bond funds, I have a close watch on them. For the Pimco holding, if the spread between the 10-year constant maturity T-note and the Baa corporate falls below 2 percent, I will begin to head for the exits. I am more likely to permit the global bond exposure to ride.
Rounding out this asset class, I sold about a quarter of a sizable position in the Vanguard Convertible Securities Fund (VCVSX). The spread between the 10-year T-note and the Aaa-rated corporate bonds have blown out to greater than 2 percent. That's my benchmark. I will continue to sell down unless that spread narrows.
Just for diversification, I also have small core positions in a TIPS ETF. Of course, I will continue to collect interest on a few select corporate and municipal bonds I bought years ago when rates were much better. Several issues were called at par or at a premium during the course of the first half of the year.
Hold Gold and Increase Real Estate. I believe that the yellow metal should always be a part of my portfolio as a hedge. While I premise that gold will rise yet again in 2013, I am happy with a 5 percent allocation of the total portfolio via the iShares Gold Trust (GLD). On the other hand, I plan to increase my interest in income-producing real estate and the mREIT Annaly Capital (NLY).
Gold has been terrible; a clear drain on my overall portfolio. It would appear my expectation for a modest rise this year will prove wrong. The loss has been buffered somewhat, since I offloaded 25 percent of my GLD holdings before the collapse in price. I have let the rest ride, and have no plans to either buy or sell more in 2013. I maintain that there is a place for the yellow metal in the overall portfolio. My current allocation is now considerably less than 5 percent.
Conversely, I have bought into the sharp decline in mREIT Annaly Capital Management . This has been a calculated risk. I believe the mREIT sell-off has been overblown, perhaps bordering on panic. Furthermore, my opinion is that Annaly will ultimately end up just fine, though at this juncture I admit the situation isn't for the weak. Often, the markets don't behave as they should, or as we think they should; that's part of the game. I've written a S.A. article about my thought process behind NLY stock ownership that was published in June. It's found here.
CASH is king. I tend to hold a fair percentage of cash in my portfolio; this year I may let the figure float to as high as 15 percent. I'm here to say that it doesn't bother me an iota to live with today's near-zero interest rates. Holding some cash permits me to sleep easy at night. I simply ladder some one-year CDs, even if the interest rates are barely above one percent.
Indeed, I have nothing to add to the foregoing. My strategy and tactics with respect to cash are unchanged. Cash holdings as a percentage of the total portfolio are now above 13 percent. I am perfectly content with that; that figure may rise if I continue to liquidate some fixed income investments.
On balance, I was satisfied with overall portfolio performance. The big losers were Apple, Annaly Capital, and gold via the GLD. This was somewhat offset by strong results in heavy-weight positions in Wells Fargo, Halliburton, Eaton Corporation, and TRW Automotive. During the second quarter, I bought into weakness in NLY, and into strength for HAL.
I am happy with my positioning heading into the second half of the year. While still emphasizing dividend stocks, my exposure is now most heavily concentrated in Industrial, Financial, Tech and Energy equities. All these sectors will benefit from a general economic improvement, even if interest rates rise moderately.
Fixed income (BOND) holdings are down, and I will continue to sell off bond funds into any bounce.
Real Estate and Gold were first-half portfolio drags, but I have no plans for any additional major moves. Gold is a hold, and Annaly was topped off upon recent share weakness.
And Cash is King.
Note to Readers: These views are my own. I am not trying to sell anything, nor providing specific investment advice to readers. Indeed, I simply enjoy sharing / exchanging views with fellow S.A. investors, based upon thirty years of practical experience.
Good luck on all your 2013 investments.
Additional disclosure: I am long mutual funds PTTRX,PHYIX,TGBAX,VCVSX