David Merkel Positions For 2012: Overweight Insurers, Information Technology, Energy

by: David Merkel, CFA

This is the 18th piece in our Positioning for 2012 series. Readers can find the entire Positioning For 2012 series here.

David Merkel is the founder and chief of Aleph Investments, LLC, through which he manages stock and bond portfolios for clients. He was an early presence in the financial blogosphere through his site The Aleph Blog. Prior to founding Aleph, David was Chief Economist and Director of Research of Finacorp Securities.

Seeking Alpha's Jonathan Liss recently spoke with David to find out how he planned to position clients in 2012 in light of his understanding of how a range of macro-economic and geopolitical trends were likely to unfold in the coming year.

Portfolio Construction

Seeking Alpha (SA): How would you generally describe your investing style/philosophy?

David Merkel (DM): I’m a value investor. I buy companies that are either relatively or absolutely cheap. I tilt my investing toward sectors that I think have better prospects.

SA: Within equities, are there any particular sectors or themes you are currently overweight or underweight? If so, why?

DM: I am overweight Insurance, Energy, and Information Technology. These are fundamentally cheap sectors/industries with good growth prospects.

I am underweight everything else.

In Energy, I am currently long Chevron (NYSE:CVX) and ConocoPhillips (NYSE:COP). In Information Technology, I am currently long Intel (NASDAQ:INTC) and Oracle (NASDAQ:ORCL). And in the Insurance space, I am currently long Chubb Corporation (NYSE:CB) and Travelers (NYSE:TRV).

SA: Care to explain why you like Insurers in the present environment?

DM: Most insurers run asset portfolios that are much higher quality and more liquid than that of the banks. Insurance companies fail far less frequently than banks because their liabilities are longer-term, and generally more stable.

SA: Some describe the current era as “The Great Deleveraging”. Do you agree/disagree, and does this macro consideration affect your investment planning process?

DM: We really have not deleveraged yet. This process has a long way to go, and we are still in the beginning phases. The main upshot of this is to avoid banks, and pseudo-banks, like REITs, etc.

SA: Do you believe gold is a genuine hedge in uncertain markets? If so, how much exposure to it or other precious metals do you have? If not, where are you turning for potential downside diversification?

DM: There are no perfect hedges but gold is pretty good. Long Treasuries are pretty good. Cash is pretty good. Stocks are pretty good. A blend of them is best.

I don’t own any gold. Stocks are good against inflation, especially if you are tilted toward resource production.

Global Markets

SA: Will the threat of Eurozone contagion continue to drive the market’s direction, and how are you protecting client assets from potential fallout there?

DM: I don’t protect anything, it can’t be done. Yes Eurozone contagion will still have impact, but it will eventually burn out.

SA: International equities proved volatile for both developed and developing markets over the past 2 years. Do you see a clear winner going forward?

DM: There is no clear winner at present, only diversification. If you invest in European equities directly, which I don’t, you probably have a lot of cheap ideas to work with. Focus on those that cater to external demand.

SA: Where are the real growth stories overseas right now?

DM: There are none – at least in relative terms. In the present, we are in a low growth world until we reconcile the high level of indebtedness globally.

SA: How much exposure to emerging markets do you have both in terms of stocks and bonds? Are China, India or other major EMs better positioned to withstand a serious global economic downturn than the U.S.?

DM: 10% of my portfolio is tilted towards emerging markets. Emerging markets are not better or worse prepared for a serious global downturn. A lot depends on the specifics of the downturn. Most opinions in such topics are facile, and do not consider the variability of outcomes. For my emerging markets exposure, I only buy companies traded on US exchanges.

U.S. Market

SA: Inflation or deflation? Growth or recession? Which way is the U.S. economy headed and how will you be positioning clients?

DM: I think there will be inflation in energy, and the energy sector will grow. There will be deflation in other areas of the economy, but I don’t know where.

The US economy will muddle, with little growth, and people will not be happy about it, but for no good reason.

SA: How about the U.S. housing market - is it still an issue weighing heavily on the economy and markets, or not so much anymore? Will prices continue to fall? Do you have exposure to either REITs or residential real estate in client portfolios?

DM: Housing prices will continue to fall on the high end. The lower end, supported by the GSEs seems to have hit bottom.

This is not a sector of interest for me, because we are still in oversupply. I have no exposure here.

Bonds/Fixed Income

SA: Where do you see Treasury yields in 12 months? Are Treasuries worth buying at current (low) yields? For clients requiring income, where have you been turning in this low yield environment?

DM: Long Treasuries will trade into the mid-2% region as global growth prospects sag. Yes, they are a buy.

I have been buying corporate loan funds, with my preferred vehicle Eaton Vance Senior Income Trust (NYSE:EVF), a CEF. I have also been buying two currency ETFs: CurrencyShares Japanese Yen Trust (NYSEARCA:FXY) and CurrencyShares Swedish Krona Trust ETF (NYSEARCA:FXS). I do not care about yield in bonds as much as capital gains.

SA: Have you changed your allocation to muni bonds in client accounts? Do you view them as riskier than they have been in the past given state and local budget challenges?

DM: I don’t do munis. It takes a lot of work to analyze municipal credit, and I have other things to do. There is also a fundamental mismatch in munis. Municipalities want to finance long, while lenders want to be short lenders. That is part of what makes this market unstable.

Disclosure: Long CVX, COP, INTC, ORCL, CB, TRV, EVF, FXS and FXY.