2012 has started off with a furious rally -- the NASDAQ has already logged a nice year's gain of 13.3% in just 2 short months, a full 6 points above my portfolio return in the same time span. With the exception of the Dow, I am lagging the major indices.
2012 Returns as of Mar 5th, 2012
- Enlightened-American Portfolio: +7.3% in 2012 (my actual IRR, including cash balance)
- Dow Jones Industrial Average:+6.1%
- Nasdaq: +13.3%
- S&P 500: +8.5%
- DJ Wilshire 5000: +9.1%
- Russell 2000: +8.5%
As I have often mentioned, my primary investment objectives are to outperform in down markets and keep within shouting distance during up years. However, having beaten the S&P 500 in each of the last 5 years, it would not be entirely truthful for me to state I do not feel any pressure to make up this gap. But such wrong-headed thinking must be resisted -- chasing returns is a common investment pitfall.
If I had been fully invested, my return this year would be ~10%, so the stock picking is not at fault, but with over 30% of my assets in cash, I was bound to fall behind as stocks kept racing higher. February was a rather subdued month as only one new stock was added: Frontier Communications (NYSE:FTR). While I am bullish on the stock and confident that management can stem the revenue slide, FTR would not be an ideal candidate to anchor one's portfolio, which suggests the market may be approaching fair to overpriced territory, making attractive opportunities scarce.
While a strong up market precludes buying opportunities, it does have some perks. During February, I sold Applied Material (NASDAQ:AMAT) Jan 2013 $15 calls for a ~5% premium. This continues my trend of selling covered calls as stocks approach my estimated fair value. The strategy provides two benefits: first, it allows me to squeeze out a few points of return should the stock hit my sell price and second, the call premiums will offset some losses should the stock price drop or go nowhere. I have written covered calls on the following stocks:
- Applied Materials $15 calls (current stock price: $12.03)
- Yamana Gold (NYSE:AUY) $17 calls ($16.80)
- Penn West Petroleum (NYSE:PWE) $20 calls ($21.22)
- Cisco Systems (NASDAQ:CSCO) $22 calls ($19.60)
These calls are written near my estimated fair value of the underlying stocks. If the market continues to run up and I am exercised out of these positions, my cash holding will balloon to 40-50% of assets. While this would likely cause me to fall further behind the market, capital preservation is the key to investment success, something investors regularly forget during bull runs.
While I make no predictions about the future direction of the market, as a value investor looking at a fairly priced market, I remain cautious. To use Warren Buffett's baseball analogy, investors can stand at the plate as long and take as many pitches as they wish, so there is no need for us to swing at pitches nibbling at the corners. Eventually, Mr. Market will offer up a fat pitch down the middle.
Additional disclosure: Short AMAT, AUY, CSCO, PWE covered calls.