The Optimism Invasion And Your Portfolio

by: David Nelson, CFA

With the fate of the euro hanging in the balance and rumors of potential bank failures in Europe a coordinated attack by central banks around the world delivered a stunning blow to bears on the last trading day of November. The move was mammoth in scale, with many market pundits using comparisons to the invasion of Normandy and D Day to describe the day’s action.

So What Happened?

Well before our markets opened Wednesday, China reduced the reserve requirements for banks for the first time since 2008. Effectively this adds about $55 Billion U.S. into the system. Slowing growth in China has been a growing concern as commodity and energy purchases in main land China was one leg of the stool for the risk on trade.

With the S&P futures already up strongly before the open, the Fed, along with 5 other major central banks (including the ECB and the Bank of England) announced a coordinated plan to “ease strains in financial markets, and thereby mitigate the effects of such strains on the supply of credit.”

With already a strong open in the cards good economic data hit the tape for the next few hours with each announcement adding fuel to the fire. At 8:15 a.m. the ADP employment numbers came in at 206,000, nearly 100,000 higher than the estimate. Then at 9:45, when we got a Chicago PMI well above the 56 estimate at 62.6, we marched higher still. When the dust settled on the battlefield, the Dow was up nearly 500 points, bringing us close to a flat line for the month.

Is it Safe?

Essentially the European Central bank can now borrow U.S. dollars at a cheaper cost, and then, if needed, loan that money out to European institutions. While the Fed doesn’t take on the credit or currency risk of the individual institutions, it is still exposed to the ECB. In addition, its balance sheet expands further. This will be the subject of many debates as we head into an election year.

Unfortunately none of the moves today get to the heart of Europe’s problem (Read: United States of Europe) but this coordinated effort buys time. The world is deleveraging and the central banks are trying to control the speed. The desired effect is to force investors into risky assets hence today’s risk on trade.

While Europe is going through their Lehman moment here in the states the picture is a little brighter. I have penned continuously all summer and fall that we are not in a recession and that our economy is in better shape than stock prices suggest.

Jim O’Neil, the chairman of Goldman Sachs Asset Management, pointed out the same today with his quote on CNBC: "The U.S. economy is nowhere near as weak as so many people seem to be worrying about.”

Our Alpha Select Portfolio Sector Breakdown

Our biggest overweight is in Technology at 24%, with the Benchmark at 14%. Our biggest underweight is still Financials at 8%, well below the benchmark at 17%. This is, of course, by design. Three regional banks US Bancorp (NYSE:USB), East West Bancorp (NASDAQ:EWBC) and Fifth Third Bancorp (NASDAQ:FITB), along with debit and credit card processor MasterCard (NYSE:MA), make up our financial exposure. We are still avoiding the Money Center banks, as well as brokers.

The Wall Street model is broken, and we expect brokerage firms to lose many of their biggest producers. Brokers are starting to realize that they don’t need the security of the big name and are gravitating to smaller individual RIAs or, in fact, starting their own firms.

Best and Worst

Positions in our Alpha Select Portfolios that provided the most Alpha were Noble Energy (NYSE:NBL), Oil States (NYSE:OIS) and Boeing (NYSE:BA). Marathon (NYSE:MPC), eBay (NASDAQ:EBAY) and Aloca (NYSE:AA) all underperformed and subtracted from performance.

Home Stretch

While we expect volatility to remain elevated, we feel the market has bought some time and are looking for a positive close into year end. As always we reserve the right to be wrong, and change accordingly.

Disclosure: I am long FITB, USB, EWBC, MA, NBL, OIS, BA, MPC, EBAY. AA has been eliminated from the Alpha Select Portfolio.