Like many investors, I want big returns over short time frames. This led me to over-analyzing technical indicators in an attempt to make a quick buck. I've made hundreds of trades that just had no fundamental basis to them at all. My blog, The Monthly Stock Portfolio, was set up to force myself to look at long-term (year or more) value plays. The primary focus was finding low PEG ratio stocks (low P/E ... with high growth forecasts). I added several other fundamental screens to that to pick out the cream of the crop (at least as I saw it). It wasn't totally mechanical, as I would not pick stocks that were in sectors that I was bearish or even neutral on, but only sectors that I was bullish on. So the purpose of this post is to set the ship's course for 2008.
Primarily, I will lay out the areas that I believe will do well over the next 12 months. In that respect, I will use these principles to guide me in the selection of stocks for my The Monthly Stock Portfolio as I go forward. But I will also introduce a new portfolio. For simplicity sake, I will call it the "Aggressive Trader Portfolio". It is in order to appease my trading side a little, but to do so on a fundamental basis. This portfolio is for the more aggressive investor and will require the ability to trade stocks, options, and commodities. As always, only invest what you can afford to lose, and trade at your own risk.
With that short introduction, let me give you a quick take on risk. Often times, the novice investor feels that they have a surefire way to get rich quick and plows 100% of their equity into a single idea. This is one of the quickest ways to erase your entire account...especially when playing with commodities and options. It is much better to come up with several of these ideas and DIVERSIFY among them. You may get 80-90% of them wrong, but if 10-20% of them are right, you could make a large return overall. I've always felt that 7-9 positions was a good balance between diversifying risk and seeking return. The more positions you have, the closer you will be to receiving market-matching returns. If that is what you want, buy an index fund. But if you want to beat the market, you need to put your money in areas that you believe will beat the market. As mentioned before, one idea is not safe enough, no matter how strongly you feel. So 7-9 works for me. So after several years of following the market, I have come up with eight themes that I feel are surefire ways to play 2008. These are presented in no particular order.
#1) China. I know, I know! China is in a bubble. Don't you remember the 2000-2001 Dotbomb? Yes I do, and I paid handsomely for that lesson. China returned 98% in 2007. By anyone's definition, that looks like a bubble. The problem is that you don't know how big the bubble will get until it pops. China is the next mega-economy. The Communist regime is rapidly allowing a shift to free-market capitalism. The Yuan is rapidly appreciating, and the stock market is reacting to that. I do believe the bubble will pop one day (don't they always?) and a lot of people will get hurt. But I also believe that exposing a small portion of your portfolio to the China revolution will give you a chance at a big return while minimizing losses if the bubble does pop. The only way to play this theme is with small-cap stocks that are extremely undervalued. You have to do a lot of research to find the right stocks, but here are six to get you started: China Housing and Land (CHLN) (PEG=0.15), China Northeast Petroleum Holdings (CNEH) (PEG not yet defined but I estimate it to be below 0.40), Shengdatech, Inc. (SDTH) (PEG=0.80), Shanda Interactive Entertainment (SNDA) (PEG=0.59), Universal Travel Group (UTVG) (PEG=0.56), and Zhongpin Inc. (HOGS) (PEG=0.19).
#2) The unwinding of the Yen Carry Trade. The Carry Trade has been highly profitable over the last couple years as investors borrow money in a currency with a low interest rate (Yen = 0.50%) and invest that money in currencies earning a higher interest rate (typically the US Dollar, the Euro, the British Pound, the Aussie Dollar, the Canadian Dollar, or the New Zealand Dollar). The idea is that you will earn the difference in the interest charged and hope that the currency you are invested in will either stay neutral with or outperform the Yen. Hedge funds have been pouring trillions of dollars into this trend. There is much speculation that the Yen Carry Trade is ripe for "unwinding". Here's why. With all the attention on a possible US recession, and tightened global liquidity, investors (and hedge funds) will need to reverse these positions to cover their over-leveraged highly-margined investments. The only way to reverse these positions is to buy the Yen, and sell the higher interest currency, like the US Dollar. If you have been following the US Federal Reserve Bank, you have noticed that they have dropped the Fed Funds rate by 100 basis points since August. The market is anticipating more cuts. The Yen cannot afford to cut, and may actually raise rates towards the end of 2008. All of these factors lead me to believe that the USD will depreciate while the YEN appreciates. So my fundamental position for 2008 is to go short the USD/JPY. I will be doing this with Options and will be timing my entries and exits throughout the year on overbought and oversold indications. I currently think we are at an excellent level to enter this trade right now.
#3) Buy the Loonie! The Canadian Dollar is closely tied to the price of commodities. I'm a big fan of Jim Rogers, and he says we are in the beginning stages of a long-term bull market in commodities. If 2007 is any indication, he is spot on in this call. The Canadian Dollar has already showed remarkable strength against the US Dollar in 2007. The US Dollar posted a late-year rally in 2007, which sets us up nicely for an entry right now to go short the USD/CAD. Like the USD/JPY, I will be playing this with Options and will be timing my entries and exits throughout the year.
#4) Short the Sterling! Many experts are predicting that the British economy will be following on the heels of the US economy next year. In other words, it could be tough sailing ahead for both the US and the UK. In 2007, the US Dollar was hammered, while the British Pound maintained its strength until later in the year. If you followed the bank run story on Northern Rock, you can see that the English are having the same problems in the financial sector that the US is having. Those problems have not been reflected in the British currency until just the last few weeks. I believe 2008 will be a tough year for the Sterling. Like the other two currencies, I will be playing this with Options and will be timing my entries and exits. I will keep you posted.
#5) Buy Gold! Gold has had a remarkable run in 2007, and many people are calling for it to top out at its current level. It also may correct substantially due to the 2007 run-up. But I believe the outlook for 2008 (financial sector nosediving, US Dollar continuing to slide, political instability, possible/probable US/UK and possible global recession) will have people looking for that proverbial safe-haven. Gold is still well below its inflation-adjusted high, and I believe will continue its upward climb throughout 2008. I will be playing this theme with Gold Futures and will be timing my entries and exits. The recent run in the last week has me holding off for right now, but I will be back into gold in the near future. I'll keep you posted.
#6) Short REITs! By now, everyone is familiar with the financial problems going on in the US economy. The subprime mortgage mess has led to the tightening of credit standards. This tightening of credit has not only affected low-income, low credit home-buyers but has even caused banks to reject other banks from receiving credit. The word is already out about the financial sector. Many experts are pouring money into the already-surpressed bank stocks. Two industries are extremely dependent on the ability to receive credit. One is home builders. The word is out on them already as well. The second area is REITs. REITs have had a substantial run over the last 5-10 years, and have only been moderately affected by the current financial quagmire we are in. When REITs can no longer invest in real estate because banks can't afford to loan money, the REITs success will come to a screeching halt. Generally, I do not like to short equities as the long term picture has always been positive. But I believe that REITs will have a hard time posting profits in 2008. I also believe that if banks can manage to turn around in 2008, it will take the REITs a bit longer to return to profitability. Because of that, I will be short two REIT ETFs (VNQ and RWR) for 2008.
#7) Play the Ag Boom! They've been called many things (Third World Countries, Emerging Markets, Underdeveloped Countries, etc), but if 2007 is any indication, they can no longer be treated as Third World or Underdeveloped. These smaller countries are rapidly catching up to the "Developed" Countries in technology and standards of living. Their economies are thriving, and with that, the demand for higher quality and higher quantities of food are soaring. You can see it in the price of the grain commodities. Although you could play this theme with the grain futures, I'm more inclined to use equities and ETFs for this play. I expect just about anything tied to agriculture (from machinery, to food production) to do well in 2008. My ag-basket of ETFs and equities will include: Caterpillar (CAT), Potash Corporation (POT), Landec Corporation (LNDC), DB Multi-Sector Commodity Master Trust ETF (DBA), Barclay's (JJJ), (RJA) and (JJG), Agrium (AGU), KMG Chemincals (KMGB), American Dairy (ADY), Manitowoc (MTW), SYSCO (SYY), Overhill Farms (OFI), and Corn Products International (CPO).
#8) Profit from Volatility. Due to the current global financial crisis, the multiple moves by Central Bankers, and our own Federal Reserve tinkering with interest rates and pumping dollars into the system, I expect the market will be quite jumpy in 2008. Both up and down, but primarily down. The play here is to capitalize on this volatility by going long on Futures on the Volatility Index. This play will also be selectively utilized throughout the year based on overbought and oversold timing indications.
In summary, "The Aggressive Trader Portfolio" will start with equal pots of money in all eight themes. For the sake of tracking, we will start with a fictional capital base of $1,000,000 with each theme starting with $125,000. This will kick off tomorrow, 31 December 2007 in the following manner:
- Theme 1) $125,000 split evenly between CHLN, CNEH, SDTH, SNDA, UTVG, and HOGS
- Theme 2) $125,000 in Options Contracts on March Yen 92.00 Call (XDN.CW)
- Theme 3) $125,000 in Options Contracts on March Canadian Dollar 104.00 Call (XDC.CB)
- Theme 4) $125,000 in Options Contracts on March British Pound 204.00 Put (BJF.OK)
- Theme 5) $125,000 in cash (awaiting a good entry point to go long Gold).
- Theme 6) $125,000 split evenly in shorting VNQ and RWR.
- Theme 7) $125,000 split evenly between CAT, POT, LNDC, DBA, JJA, RJA, JJG, AGU, KMGB, ADY, MTW, SYY, OFI, and CPO.
- Theme 8) $125,000 in cash (awaiting a good entry point to go long the VIX).
Best of luck in 2008.
Disclosure: I am not investing $1,000,000 in this portfolio, but I will be investing smaller amounts in some or all of the themes throughout 2008.