By David Sterman
Although it may seem that most fund managers are simply glorified stock pickers, their task is actually quite different. They don't beat their benchmarks by simply cobbling together a set of compelling investments. They take a snapshot of the U.S. and global economies and then decide the best ways to capitalize on big macro trends.
In effect, these folks conduct a top-down analysis, setting goals in terms of sector and asset-class exposure, and then, through bottom-up research, find the best vehicles to fulfill those goals. As an example, I'm bullish on the auto industry, which as a group looks set to post ever-rising results into the middle of the decade. With this in mind, I focused on Ford (NYSE: F), a member of my $100,000 Real-Money Portfolio because it strikes me as having the best balance of risk and reward.
Frankly, I think GM (NYSE: GM), and a wide range of auto parts suppliers such as TRW (NYSE: TRW) and Goodyear Tire & Rubber (NYSE: GT), represent compelling bargains as well. Yet it would be foolish to build a portfolio holding only these stocks.
I've been thinking about this a great deal recently as my portfolio gets fleshed out. My recent pick of Marathon Oil (NYSE: MRO) has put more money into play, and I've spent almost $80,000 of the $100,000 allotted to this portfolio.
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I was moving quickly to get fully-invested because I saw a clear opportunity as the year began. As my recent defensive pick of Marathon Oil shows, I am not in as much of a hurry these days, thanks to robust market gains. Indeed, I see Marathon as something of a hedge for the rest of my portfolio, should rising energy prices derail a few other picks.
What will I be doing with the remaining funds? I'll be making sure I have a truly diversified portfolio. With Alcoa (NYSE: AA) and Marathon Oil giving me exposure to commodities, Hasbro (NYSE: HAS) and Zipcar (NYSE: ZIP) giving me exposure to the U.S. consumer, Ford and Exide (Nasdaq: XIDE) exposing me to industrials, Citigroup (NYSE: C) bringing me the proper weighting in financials, and Ligand Pharma (Nasdaq: LGND) giving me a play on biotech drugs, I will likely seek to avoid any exposure in those areas.
What's left? Several other sectors that come to mind, though they don't all necessarily hold great appeal in this phase of the economic cycle.
• Utility stocks represent more income than growth, and that's not my current focus.
• Healthcare is such an important part of the economy, but there is so much uncertainty in the next few years, highlighted by considerable pressure to rein in costs, that I would only want to find healthcare companies that offer considerable savings to insurers or patients.
• Telecom and technology also have a key role in the U.S. economy. I continue to search for plays in this group that appear to have solid downside support and strong potential upside.
I'm also in search of more foreign exposure. I'm extremely bullish on the long-term outlook for many emerging markets (which I note in this article). Though they always carry the risk of downside, due to their high volatility, a broad-based fund may be the way to go.
For that matter, if the U.S. market continues to scale new 52-week highs and rallies into the spring, I'd look to add a hedge such as the ProShares UltraShort S&P 500 (NYSE: SDS). It's too soon to make such a move now, but we're getting closer every day.
Hitting a wall?
So what happens when I become fully invested, having deployed the $100,000 in real money allotted to this portfolio? Will I simply stop making fresh additions to my portfolio? No way. At that point, I'll have to identify investments that are ripe for profit-taking, freeing up cash to keep adding names. I can also lighten exposure by selling half of a position in certain stocks to free up funds.
This won't be a high-turnover portfolio. I'm using the figure of 200% as a benchmark. This means my average pick should be in the portfolio for an average of six months (implying 200% annual portfolio turnover). Some picks will be held for a lot longer than that. Some will be held for a much shorter time frame. As I've noted before, I am striking a balance between investments (with long holding periods) and trades (with short holding periods).
Down the road, as we make any changes to this $100,000 Real-Money Portfolio, I'll also slightly tweak the nature of my communications. In addition to the full complement of (hopefully) compelling stock picks that you can expect on a regular basis, I'll also be quite active in keeping you abreast of the latest behind-the-scenes actions taking place with my picks. (I'll give you a few examples in a moment).
I also expect to finish every update with other investment ideas and topics about which you need to know. They may not involve the picks in my portfolio, but they should help you become even more informed about the trends impacting the market, key industries and various stocks.
The resolution of the Greek crisis further underscores my bullish view of Alcoa and Ford. The biggest risk I saw in these two investments is that the Greek crisis would spiral out of control, leading to severe erosion in economic activity across the continent.
I don't think we've heard the last of Greece, nor do I think Europe can avoid a recession in 2012. But there is a big difference between tepid demand and sharply-falling demand for cars and aluminum. Current share prices in each of these two stocks appear to be bracing for a worst-case scenario, which is now less likely in light of the recent deal in Greece.
Alcoa's story isn't just about demand, it's also about supply. The company, along with other major aluminum producers, has been curtailing output to help supply levels move back below demand levels. You're not seeing the impact yet in aluminum spot or futures prices, but the bias toward rising aluminum prices is now much greater than the bias for downward-moving prices. Alcoa's stock price will closely mirror this metric, so you may want to track it yourself if you haven't already bought shares.
Lastly, I wanted to give a fresh view of Zipcar now that the dust has settled on a so-so quarter. Shares are below the point where I recommended them and took another hit this week as the company made an investment in a peer-to-peer car-sharing company. This is a wise hedge for the company, ensuring it doesn't miss out on what looks to be a burgeoning trend. Exposure to both the car rental and peer-to-peer car sharing market, if eventually housed on one platform, could become the proverbial "killer app." Meanwhile, shares languish (for now) as investors mistakenly focus on near-term results.
Disclosure: David Sterman does not personally hold positions in any securities mentioned in this article. StreetAuthority LLC owns shares of C, F, AA, ZIP, XIDE, HAS, LGND, MRO, in one or more if its “real money” portfolios.