In early January 2011, I outlined my 2011 economic assumptions and investment game plan via Seeking Alpha. The original article is found here.
I provided a mid-year review and update in July. It is found here.
In this article, I offer a year-end review of the premises, the investment game plan, and summarize general results.
First, let me recap the broad 2011 economic premises I used to guide my investment decisions along with a brief look as to how they turned out.
- The global economic rebound continues. The U. S. economy will participate, though our recovery will continue to be sluggish. Housing and unemployment will be weak spots. Manufacturing will show steady improvement. U.S. GDP will approach 3 percent. No double dip recession.
LOOKBACK: Largely missed the mark, but with a couple of asterisks. This premise remained on track until the EU debt crisis created a crisis of confidence that resulted in a wobbly second half global economy. Growth slowed or stalled across much of the world, including the BRIC countries. Europe appears to have slipped into recession. Nevertheless, the overall U. S. economy did continue to improve by many measures, and growth may even have approached 3 percent by 4Q 2011. There was no double dip recession.
- U. S. interest rates will rise, but only moderately. There will be no inflation spike in 2011. Ten-year treasury notes will yield not more than 4 percent. Banks will loosen credit somewhat.
LOOKBACK: Interest rates did not rise. They continued to drift lower, flirting with unprecendented levels. There was no inflation spike. Banks did loosen credit somewhat.
- Gold will continue its march upward. Oil will break $100 a barrel.
Both premises were correct. Gold pulled back towards the end of 2011, but remained solidly in the black for the year posting a 10 percent gain. Oil did break $100 and remains at this level; indeed the spread between Brent and WTI caused Brent to push above the century mark much earlier than the U. S. benchmark.
- U. S. equity markets will trend higher in 2011. While I do not make any numerical proclaimations about the the broad indexes, I see upside for the equity markets based upon my previous macro assumptions, and the belief that corporate earnings will continue improve. Companies will also begin to loosen the reins on their cash hoards, augmenting growth and development.
LOOKBACK: This premise was partially on-track, due once again to the muddled EU debt crisis, as well as the U. S. debt ceiling fiasco. The S&P 500 index did register an approximate 2 percent gain when factoring in dividends. The Dow was up 5.5 percent. Corporate earnings did improve strongly. Companies with strong balance sheets generally increased their return of capital to shareholders.
Now, the Plan and results.
Next, please find the 2011 Plan and a Lookback below.
My 2011 Investment Plan
Concentrate equity investments in three sectors: Industrials, Basic Materials, and Energy. Historically, during the early and middle phases of the economic business cycle, these segments reap the benefit of increasing demand for heavy machinery, engines, capital equipment, and construction materials. It takes energy to build these items. Improving developing economies will require incremental energy, further pressing energy demand. I envision ongoing infrastructure construction in places like China, Brazil, India and Southeast Asia enhancing the bottom line for industrial and construction-related products and materials. I especially like Caterpillar (CAT), Illinois Tool Works (ITW), Honeywell (HON), Nucor (NUE), and Exxon (XOM) in this space. Some of these stocks have run up; however, I believe they are multi-year plays that still have plenty of growth left in them for the long-term investor.
LOOKBACK: It would be difficult to call 2011 the middle phase of an economic recovery by any strech of the imagination. The growth was uneven, halting and within shouting distance of an out-and-out retreat throughout much of the year. The whipsaw "risk-on, risk-off" scenarios made the investing climate one of the most difficult I have ever experienced.
Most of the names mentioned ran up nicely in the first half of the year, but retraced in the third quarter. Exxon held up, as many of the Oils did well. Caterpillar and Honeywell hung around breakeven. Nucor and Illinois Tool Works fell, but their generous yields helped buffer the share pullbacks.
During the course of the year, I added new positions in Halliburton (HAL), Alcoa (AA) and International Paper (IP). HAL and AA were losers. I took a loss on Alcoa, selling out my position but then buying back about half the shares below $10 each. I doubled down on Halliburton which I believe will be an excellent long-term investment. International Paper helped keep the my portfolio in the black.
I executed a nice short-term trade around Eaton Corporation (ETN) in the second half of the year that netted a 33 percent gain in a couple of months. I rarely trade stocks, preferring to invest on a twelve to eighteen month horizon. However, ETN just got too juicy when it fell below $34 a share.
Sans Alcoa, I held onto most of the industrial, material and energy stocks mentioned, and added to some of the positions during the year.
Stay invested in a few select Technology and Financials. I favor the larger banks and technology companies. I plan to stick with Apple (AAPL), Intel (INTC), Wells Fargo (WFC) and Citigroup (C). Citi is my “speculative” play. I believe it could be a double.
LOOKBACK: The tech giants Apple and Intel were core portfolio positions that bolstered my portfolio greatly. I added to my Intel holdings when it got below $20 a share. The bank stocks were duds. Somewhat offsetting the gains, I wrote options around Citi to boost the income, as well as paring the position. The stock performance was abysmal. As noted in my mid-year review, I bailed out of Wells Fargo in the first quarter to reduce exposure to the Financial Sector. I bought a few shares in Hudson City Bankcorp (HCBK) during the year as a speculative play on a downtrodden regional banking concern.
Underweight Utilities, Consumer Staples, and Health Care. I believe even modest interest rate increases will hinder the Utilities; they tend to be debt-heavy. Food and Drug stocks are not where the action will be in 2011. In addition, there's too much uncertainty for me around ObamaCare and drug-patent cliffs for many of the drug comapanis in the Health Care group. For diversification, I'll hold a few shares of Bristol Myers (BMY), largely for the yield. If Pepsico (PEP) or B&G Foods (BGS) share price comes in, I'll pick at them, too.
LOOKBACK: My inital strategy was off the mark, but I was able to adjust and recover a bit as the year wore on. I sold off Bristol-Myers too early, though at a decent gain. I simply missed the move up for big Drug stocks. However, I did reverse course on my view of Utilities and Telecoms by the third quarter. I built good positions in American Electric Power (AEP) and Vodafone PLC (VOD) as I took a more defensive posture. I got into these positions early enough to book some good gains by year-end. I picked up a few shares of Pepsico in the fourth quarter when it fell below $62 a share.
Continue to emphasize dividend stocks with strong balance sheets. My equity portfolio targets an average yield that exceeds the ten-year T-Note yield (currently 3.3 percent). Investments in Telecom, Energy, and some preferred securities help me make the target. Selling options can juice the cash-on-cash return, too. I always start my investment review with a disciplined review of the balance sheet. Good relative debt ratios, ROE, and cash flows are my keys before investing; especially in higher dividend-payers.
LOOKBACK: This strategy, perhaps more than any other, helped preserve my portfolio in 2011. My holdings emphasize stocks that yield north of 3 percent and have a history of raising the payout. Generating extra income via covered calls and cash-secured puts enabled my investments to stay in the black for the year, though the wild swings in the market resulted in my having the rebalance some positions in the second half. The net result was positive.
Seek to invest in U. S. companies with strong international exposure. Most of my previous picks fit this bill. These stocks provide another element of global diversification. I rarely try to pick international stocks. For foreign exposure, I'll go with a good mutual fund or an ETF. For a specific 2011 pick, I like the Brazil market. These stocks were flat last year, while many other Latin America markets surged. I believe Brazil will kick in now that their elections are over and they get a handle on inflation worries. The iShares MSCI Brazil index (EWZ) looks good to me. It sports a 3 percent yield to boot.
LOOKBACK: International exposure did not help the return on my securities as planned. The iShares Brazil ETF was a loser. I did elect to retain the modest position.
Allocate equity securities to roughly 70 percent large cap, 30 percent mid cap, and 10 percent small cap. I've used this weighting for years. It's approximately the weighting of the Wilshire 5000 index. I rebalance holdings slowly over time to maintain it.
LOOKBACK: I permitted my allocation to drift a bit towards the large-caps, but not overtly so.
Continue to reduce exposure to bonds. The bond party's over. Maintain minimal exposure to a few good corporate bonds, or medium-term (five-year) Treasuries only if yields poke up to around three percent. Buy and expect to hold such securities to maturity. I'll put some cash into TIPS and I-Bonds as a way to hold some debt securities and hedge interest rate risk, too.
LOOKBACK: Mixed bag. The TIPS investment was a big winner. I did not buy any Treasuries. In hindsight, perhaps I should have. The solid corporate bond securities I own boosted my cash yield nicely and increased in value to boot.
Flee most bond funds. I will hold limited positions in the PIMCO Total Return Fund (PTTRX), and the Templeton Global Bond Fund (TGBAX) to maintain diversification in the debt markets: but my finger is on the trigger. I like Total Return because it has a demonstrated, long-term ability to navigate down interest-rate scenarios. Likewise, Templeton Global has shown the strength and flexibility to handle the ups and downs. One notable area within the debt universe I will hold: High-Yield bond funds. I believe they still have some gas in the tank. I like the Third Avenue Focused Credit Fund (TFCIX), and the PIMCO High Yield Bond Fund (PHYAX). I'll watch the Third Avenue offering closely as their investment manager just moved on. Nonetheless, I believe this fund is attractive as some others in the HY sector. They have the flexibility to invest in wider range of distressed securities.
LOOKBACK: The sub-par performance of PIMCO Total Return has been well-chronicled, including Bill Gross' mea culpa. As a long-term investor, it did not bother me at all. I added to my holdings in his fund. I scaled down just a little on some High-Yield exposure, due to the wild swings in macro economic sentiment. Via reinvested interest, the positions panned out fine, despite a generally down year for the High Yield space.
Maintain a position in gold. I'll even pick at a little more upon a pullback. The yellow metal will continue to rise in 2011. Fiat currencies in the developed world are racing for the bottom. The dollar remains relatively weak. A rising middle class in developing countries like China and India will demand more gold for jewelry. Low interest rates continue to make the carrying cost for gold reasonable. I prefer SPDR Gold (GLD) for the straight play. The Market Vectors Junior Gold Miners ETF (GDXJ) is another way to play the space and jack up the return (with associated volatility).
LOOKBACK: The SPDR Gold ETF was a top performer for me, and it helped that I added to the position during the year. I believe in holding a portion of my investment in the yellow metal.
Lastly, CASH is king. I tend to hold a fair percentage of cash in my portfolio, and it doesn't bother me to live with today's paltry interest rates. It's a hedge and a cushion. I'll simply ladder a few one-year CDs, even if the interest rates stink.
LOOKBACK: I slept well at night, especially when the market started going bonkers in the third quarter. This was a good call.
This summary and review outlines my investment plan only. I am not trying to sell anything. I simply enjoy sharing my views and commentary gleaned from nearly thirty years of sound, practical investment experience. I welcome all reader comments and questions.
For those of you who follow me on Seeking Alpha, I plan to submit My 2012 Investment Game Plan to the SA editors very soon.
Disclosure: I am long CAT, ITW, HON, XOM, NUE, AA, IP, HAL, AAPL, INTC, HCBK, C, EWZ, GLD, PEP. I also hold positions in the funds PTTRX, PHYAX, TGBAX, and TFCIX.