2012 Portfolio To Date: Better Safe Than Sorry

by: Davy Bui
  • Enlightened-American Portfolio: +6.1% in 2012 (my actual IRR, including cash balance)
  • Dow Jones Industrial Average:+4.1%
  • Nasdaq: +9.3%
  • S&P 500: +5.3%
  • DJ Wilshire 5000: +6.2%
  • Russell 2000: +9.3%

Markets got off to a blazing start in 2012 and while my portfolio is keeping pace with the broader indexes, the tech-heavy NASDAQ and small-cap Russell 2000 are well ahead of the pack. If stocks continue to move up at this pace, I expect my portfolio to eventually fall behind due to my heavy cash holding (~30% of assets).

The question is whether stocks can maintain this torrid pace in the face of such overwhelming global economic uncertainty. While most problems are well-known at this point -- the euro crisis, possible China comedown, anemic U.S. growth -- my sense is that investors are a bit complacent to the possible fall-out if bad-case scenarios should unfold.

In today's hyper-paced society, memories are short: the Great Depression scarred a nation for a generation but the Great Recession barely registered on our collective psyche. After all, the country looks prepared to elect a Wall Street insider as President only a few years after Wall Street brought the world's economy to its knees. So who can blame investors that wish to forget the pain of late 2008 / early 2009?

But with pain comes risk avoidance, one of the most important lessons to be gleaned from the financial crisis. This tenet -- better safe than sorry -- underlied many of the moves I have made thus far in 2012.

  • I swapped my stake in Exxon Mobil (NYSE:XOM) for Total SA (NYSE:TOT). I outlined my reasons for the swap previously, but it basically boiled down to valuation. XOM was approaching fair value but TOT looked undervalued based on reserves, even as that company struggles with operational deficiencies. Investors may also be concerned with any fall-out from the euro crisis, but Total SA is leveraged to energy prices-- so even if currencies may change, the value of its reserves and production would reflect that.
  • I wrote covered calls in Cisco (NASDAQ:CSCO) and Penn West (NYSE:PWE) to lock in gains and protect against a fallback in share prices. While I remain positive on Cisco, the stock was approaching my fair value estimate, so it seemed prudent to pocket a 6% gain in the form of long-dated call options while still leaving room for another 10% upside. As I am committed to the stock long-term, the only downside-- of being locked into CSCO until 2013-- is negligible. However, PWE is a company I have soured on and thus, chose to write in-the-money calls to fashion an exit from the stock while generating additional gain. The stock has moved up further since then, meaning I left some money on the table... but as stated above, the operating theme right now is better safe than sorry.
  • I continue to be bullish on Xerox (NYSE:XRX) despite the company's bad earnings call. But in the spirit of playing it safe, I decided to write naked puts as a way to go long instead of buying shares. While I think Xerox's issues are short-term and fixable, my options play allows me to either build a position at ~$6.55 (vs. $7.70 price at the time I wrote options) or net a 12% gain.
  • I closed out my Hudson City Bancorp (NASDAQ:HCBK) deep-in-the-money calls for a 34% gain. The calls had moved up enough in price that they had a delta of 1.0. This means they moved penny for penny with the stock. Again, HCBK may have further upside but my caution won out over greed.

While stocks don't look grossly overvalued, investors may be well-served by a cautious approach. It is clear from the Fed's stance that the financial crisis that came to bloom in 2008 is not yet over. But it seems inevitable that the intervention undertaken to stave off a true bear market and a recession (yes, listed in order of priority) will generate devastating consequences. When this will occur is impossible to predict. After all, Alan Greenspan's genius status persisted into his retirement, until the reckoning for his loose money policy manifested itself in the housing and financial crisis.

In the meantime, I intend to continue my micro approach to investing, which should do relatively well even if markets head towards the bear. Right now, opportunities exist in some energy stocks. I mentioned TOT before. Hess (NYSE:HES) may also be a nice play with some desirable assets. It has moved up past $60 since hitting my $55 target-- but as I failed to buy then, I remain on hold now. I expect markets will give us a chance to get in at a nice price down the line.

Disclosure: I am long CSCO, PWE, TOT.

Additional disclosure: Short CSCO & PWE covered calls. Short XRX naked puts.