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Retail investor, long/short equity, dividend investing, medium-term horizon
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Investment is a forward looking discipline. With that in mind, I developed an opinion on market conditions for 2014. Here's a chart of the S&P 500 ETF (NYSEARCA:SPY):

(click to enlarge)

In a five year view, the linear regression advances at a rate of 13.6% per year, loosely followed by SPY, which crisscrosses it from time to time and periodically bumps up against the upper Bollinger Band. Note the market ended 2013 well above trend.

After eyeballing this and doing some spreadsheet work, the most likely extension of past performance is that the S&P ends 2014 at 1,930, providing capital appreciation of 4%, to which one can add 2% for dividends, for a total return of 6%.

Very possibly SPY will cross under the linear regression at some point during the year. The resulting correction is unlikely to be much more than 5%, because the host of investors who missed the train pulling out of the station in 2009, and repetitiously since, are clamoring for a chance to climb on board.

The Usefulness of Generic Projections

Back in 2010, I did an article on projections, advocating a simplistic approach, and suggesting that investors should think carefully before embracing creativity in the projection process. As I put it at the time:

...the individual investor, if he is going to over-ride the indications of a generic projection, will be happier in retrospect if he has cogent reasons for doing so.

Under conditions that prevailed in 2010, I felt that a ratio of GDP to S&P 500 was useful, anchored to economic realities. Today the thought process of investors in the aggregate is the most relevant input to a market projection. It can be approximated by a linear regression and Bollinger Bands. The common sense assumption is that the market will just stay on track unless/until something throws it off.

I'm investing in ways that will be profitable under the scenario outlined above. That will involve staying long and selling covered calls. With such a tame outlook, I plan to devote some time looking for speculative or value situations, devoting a small part of investable assets to trying to pick up a few points here and there.

The extremely calm market conditions give me a sense of unreality, so I'm operating in a mode of suspended disbelief. In the past I've advocated the use of leverage, but under current conditions I'm resisting the urge. In my view, applying leverage to juice small returns is an invitation to disaster. I'd rather use it at low points when expected returns are generous if uncertain.

2013 by the Numbers

The discretionary returns were erratic, reflecting a none too smooth transition from an aggressive leveraged value approach to a more conservative approach focused on blue chips, maintaining generous levels of cash and avoiding excessive drawdowns.

A smoother transition would have provided better returns. I didn't anticipate the 30% rise in the market and sold a lot of covered calls, many of which were very profitable to those who bought them. I expect that the market will be a better fit for covered call strategies this year, and I will be continuing along those lines.

Articles/Calls I'm Proud Of

As a retail investor, I blog in order to expose my thought process to critical examination and comment from readers. I strive to improve my thinking by participating in the comment stream. When writing about stocks that are well-known and thoroughly covered by professional analysts, I'm looking to provide a fresh point of view that is not available elsewhere. Here are some that worked out well:

  • Looking at Norfolk Southern (NYSE:NSC) in January, I picked up on the importance of capex directed at the intermodal opportunity. With the stock in the $64 area, I offered an upside target: "Capitalizing the dividend at 5% and capex at 15%, the stock is worth $82." It currently trades around $91.
  • In August, with Raytheon (NYSE:RTN) at $75, I did a PE5 analysis and put up a target of $87: "My previous call, based on the same methodology, was good. However, I don't have much company on my $87 target price. FinViz reports a consensus of $68.08, well below current. Morningstar sees a fair value of $67." It's now trading in the $89 area.
  • In late October, before the news of Buffett's position came out, I looked at Exxon Mobil (NYSE:XOM) and saw strong project management driving high ROCE. "I'm investing on the basis that the stock is worth $100 today ($8 X 12.5 = $100)..." It went from $88 at the time of the article to over $100 on the news of Buffett's involvement, amid much learned discussion of what the Oracle saw that others didn't.

Not So Good

In February, while up 17.5% for the year to date, I took my discretionary portfolio to cash, offering the following rationale:

The more I think about it, the less I like the idea of being fully invested in the market, looking at best for 7% long term, when a (hopefully temporary) short term loss of 25% to 40% is logically possible.

Wall St. is not a nice neighborhood...etc.

It's a market of stocks. After taking a much needed vacation hiking the Appalachian Trail, I put a portion of my discretionary portfolio back in the market, tacitly acknowledging the mistake of pulling out. I'm positioned cautiously going forward, and still holding substantial cash.

Current Holdings in Synthetic Dividend Growth Portfolio

Here's a listing of shares controlled by means of options, together with common valuation metrics:

(click to enlarge)

The original plan was to hold companies that had at least five years of dividend increases, selected for a combination of quality, low beta, and higher dividend rates. I became concerned that it had too much Consumer Staples and other defensive names, and adjusted by dropping the beta requirement and adding consideration of the extent to which capex exceeded depreciation.

Larry Fink and others have asserted that US businesses have been reluctant to invest and hire, resulting in inadequate capex. As a theme for the year, I've been selecting companies that have been spending on capex over the past few years.

The Achilles' Heel of the Small Retail Investor

The little guy has some advantages. He can take sizable positions without moving the market. He answers to no one but himself, and is under no pressure to outperform on a short-term basis. He can take concentrated positions and change strategy at will.

However, his Achilles' heel is his vulnerability to market sell-offs. Often dependent on cashing in gains to meet his personal financial needs, he can wind up being forced to sell at market bottoms. If he carries an adequate amount of cash reserve (or hedge), he is unlikely to outperform an index fund which is fully invested by definition.

I've spent some time on this issue, and developed strategies that address the concerns. In retrospect, 2013, as uneven as it was, was relatively successful in that I managed a reasonable return on my discretionary account while holding and/or spending substantial amounts of cash.

Source: 2013 Review And Plan For 2014