2011 came to a close with the S&P 500 (SPY) marginally higher after a volatile year. Optimism about strong corporate earnings, improving economic data, and hope for a resolution to the European debt crisis helped fuel a late 15% surge in the fourth quarter for the S&P.
There is still an overhang of the risks that were in play for 2011, especially the ability of European sovereign nations to meet their debt obligations and shore up their finances. Spain quietly warned that the budget deficit would be higher than expected just as the year drew to a close. Slowing in Asia is a major concern as well with the Shanghai Composite dropping over 20% in the past year with signs China's housing bubble may be cracking and the government's grip on the economy is slipping. Stateside, one of the biggest risks remains political uncertainty with a presidential election coming up, another debt ceiling increase impending, re-visiting the payroll tax cut in two months, and various industry specific legislation.
That being said, there is still tremendous opportunity in US equities at this juncture on valuation alone and the Q4 market performance confirms that. Strong holiday sales will be a key growth driver for upcoming quarterly earnings and are a positive reflection of consumer sentiment. This also happens to be the time of year that year-end bonuses get spent and tax refunds find their way back into the economy. Here are five investment themes and equity picks to consider heading into 2012.
2011 wasn't a great year for commodities but 2012 should prove to be better if economic conditions continue to improve. Gold and crude oil managed gains but natural gas, grains, and base metals moved lower. The entire commodities complex should benefit as economic growth stabilizes and Asian central banks cut back on easing. Inflation expectations are low at the time and growth is becoming the primary concern of policy makers. The rally of the US dollar hindered commodity prices but could reverse in 2012, increasing the value of dollar-denominated assets. Like all over-crowded trades, the popular short euro positions will eventually need to be unwound.
Agriculture in particular looks poised for a strong recovery. At the end of the day food is a necessity with strong supply/demand dynamics. On the supply side, farmland is shrinking and facing tough weather conditions with the drought in Argentina a prime example. The middle class continues to demand meat, and grains are the primary feed to produce meat. For an in-depth breakdown of the industry factors, please see here.
Earlier in December, the USDA boosted global stockpile estimates for wheat, soybeans, and corn. The impact on prices was overblown - wheat supplies came in at 11-year highs, soybeans at 5-year highs, and corn is at 2-year highs. While higher than expected, those numbers are not enough to change the investment thesis.
With the tightest supplies of the three, corn is the preferred investment. The Teucrium Corn Fund (CORN) is an ETF that invests directly in corn futures. This should perform well if weather conditions remain less than ideal. On the corporate side, the fertilizer companies look best positioned to capture the upside in the overall agriculture industry. Valuations are very reasonable and the big players have been positioning for the future. CF Industries (CF) is in the sweet spot with strong exposure to nitrogen fertilizer, which is used for corn. The company is trading at just 8 times trailing earnings, and 6.3 times forward earnings. An aggressive stock buyback of $1.5 billion shows just how confident management is in its outlook and how undervalued management believes the stock is. As the 2012 spring planting season begins, the pricing power of the company coupled with scale from the Terra Nitrogen acquisition should pay off. There is support at the 135 level so 135-145 is a good initial entry point.
Potash Corp of Saskatchewan (POT), Mosaic (MOS), Agrium (AGU) are the other major players in fertilizer. Those seeking dividend yields should consider the MLPs Terra Nitrogen LP (TNH) and CVR Partners LP (UAN) that produce nitrogen fertilizer and pay out a 10% annual yield. As fertilizer prices tick up, so should their value and dividend payouts.
The cloud is transforming from a buzzword to the wave of the future as companies try to optimize their operations and cut costs. IT budgets have been slashed to the necessities but opportunities lie in companies that offer solutions to provide cost savings. One company doing just that is Fusion-io (FIO). Fusion-io makes products that make servers more efficient through the use of flash memory modules. What separates the company from competitors is that it integrates the hardware with proprietary software that improves data center performance and efficiency. Two of its bigger clients are Facebook and Apple (AAPL) with many more likely to follow thanks to the value proposition of $10,000 server cards that can ultimately end up saving magnitudes of this cost over the long run. The cloud is all about data centers storing information and providing access anywhere. The nature of Fusion-io's business in speeding up this vital piece of infrastructure to cloud computing solidifies its importance in a rapidly growing industry.
Fusion-io went public in June at $19 a share and traded as high as $41 in November before falling back to its current $24 level. Part of this is attributable to a secondary offering in November of 3 million shares at $33 and IPO lockup expirations diluting the float. One more big lockup is looming on February 15, 2012, for 43.1 million additional shares but that one appears to be priced in at current levels. The market cap stands at $2 billion and Apple's recent acquisition of flash memory storage provider Anobit for somewhere between $300-$400 million highlights the importance of the technology. The company is ramping up its sales efforts and its technological advantages should pay off. It could even be a potential takeover target for one of the bigger players.
Technical analysis using fibonacci retracements reveals support at the 23 level for the 78.6% retracement and first resistance at 27 where the 61.8% lies. Earnings are due out on February 2, and should be a positive surprise if the first two reports were any indication. Last time the company reported in November, annual revenue guidance was raised from 40% to 55% and gross margins were guided higher. Companies usually try to strategically time their IPOs when earnings are accelerating and whenever times are good leave a cushion for additional future surprises. I expect management saved a little more good news for the upcoming quarters.
The strong holiday sales figures show the resilience of consumers and the consumerist society we live in. Coupled with the desire to have the latest and greatest, this is a great time to be invested in consumer technology. One way to do this is through those that benefit from the proliferation of smartphones. Smartphones are becoming a central necessity for consumers and enterprise users alike. Case in point is Christmas Day when 6.8 million Android and iOS devices were activated, a 140% increase from prior year.
Apple returned over 20% in 2011 but was essentially flat since August levels. Last quarter's earnings did not live up to their usual hype, but this was due to a product shift to the iPhone 4S and consumers putting off purchases until the product was released. Concerns about Google's (GOOG) Android taking market share are overblown because as more consumers switch to smartphones, the pie is growing larger so a slightly smaller slice can still translate into unit growth. Furthermore, once people get entrenched in the Apple ecosystem, they are highly likely to purchase other products. This halo effect is a boon to driving growth across the Mac and iPad lines, which are both likely to see refreshes in 2012. The loyal user base ensures strong sales as long as the company continues its execution excellence.
The valuation is compelling at 10 times forward earnings with $81 billion of cash for a company valued at $376 billion. The holiday season was extremely strong for Apple as the iPhone 4S launch saw sales of 4 million on the opening weekend and plenty more throughout the quarter. Expectations are at a low bar after last quarter's softness, but earnings whispers are marching higher. The Bullish Cross blog came out with a forecast that is plausible and yields an EPS beat of 39%
Another conservative play on the industry as a whole is Qualcomm (QCOM) which makes chipsets for wireless telecommunications and owns a broad portfolio of patents that translate into a significant royalty stream.
The financial industry has been beaten down by the European debt concerns abroad and a tough operating environment at home. The industry is still reeling from the financial crisis of 2008 and the liabilities of mortgages on the books. Sentiment may be overly negative as banks have taken measures to clean up their balance sheets and write down bad assets. This is a speculative trade and timing is important as there could still be another capitulation before any recovery.
Bank of America (BAC) was the worst performer of the Dow for 2011 with a 60% decline. The franchise is trading at a $56 billion market cap and has the backing of prominent investors like Warren Buffett. This is a name to watch as it's underperformed its peers and trading below book value. Just like the recent rally in homebuilders, the industry will be kick started once investors believe the worst is behind. It’s all about future expectations.
Short US Treasuries
Treasuries had a blockbuster year with long-term bonds rallying 35% as the Fed pledged to keep rates near zero through the middle of 2013 and the US bond market served as a safe haven in an increasingly insecure world. The long US Treasuries trade is growing crowded and has pushed the yield on 10-year notes down to 1.89% and 30-year bonds to just 2.89% at current levels. Borrowing costs are unlikely to stay this low and it's hard to fathom that investors are willing to accept a sub-3% yield for locking up capital for 30 years. Inflation, future interest rate risk, and a shift back to riskier assets could have a negative impact on treasuries and push yields back up.
Several ETF products provide easy and liquid access to the short side of the long-term treasury trade: ProShares Short 20+ Year Treasury (TBF) for unleveraged exposure, ProShares UltraShort 20+ Year Treasury Bond ETF (TBT) for double daily leverage, Direxion 30-Year Treasury Bear 3X ETF (TMV) for triple daily leverage.
Just like the trade on financials, timing is key on this as geopolitical events like a meltdown in Europe could facilitate another flight to safety and cause another leg down for yields. It is prudent to use caution with the double and triple leveraged ETFs until an extreme shakeout occurs and the trend reverses.