Adjusting Your Portfolio For Success Using A Macro Look At 2H 2012

by: Larry Meyers

What's happening at the global economic level is going to affect your investments. Here's a look at some broad issues and suggestions I have for changes in your portfolio in the second half of the year.

Real unemployment is close to 15%. This continues to be the biggest drag on any kind of sustained recovery, although there are tiny upticks in new jobs each month. Still, the Bureau of Labor Statistics shows that only a few hundred thousand net new jobs have been created since January of 2009. Unemployment compensation has been reduced by Congress, and states like California no longer qualify for the fifth tier of benefits. While some of these unemployment recipients will return to the workforce, others will not. All together, consumer spending will continue to lag, and therefore, keep a lid on revenue gains for consumer discretionary and other stocks. Wealthier folks, however, appear content with their situation, given the robust earnings seen in luxury stocks.

The decline in commodity prices and gasoline, and a very tempered demand increase, is keeping a lid on inflation.

Monetary policy will continue to focus on liquidity matters, since there's very little in the way of interest rate cuts that can even be instigated, given that rates are so low. It's difficult to project if we'll see more quantitative easing, and that itself may depend on how is in the White House next year.

Everyone seems to have a different report regarding credit availability. In a meeting I had with a large real estate investing firm, they reported that banks are simply not lending to Floridians, even those with sizable down payments, great credit and plenty of assets. Meanwhile, corporations are de-leveraging and holding onto massive amounts of cash.

The dollar appears to remain a safe haven as the Eurozone struggles. Further quantitative easing, however, will put a lid on further strength.

As always, it's uncertainty that weighs most heavily on investor's minds. What will happen to European debt? What will the November elections reveal? Are the required spending cuts passed by the Congressional super-committee actually going to occur?

How does this translate to stocks?

I've been writing about domestic large cap stocks both here and elsewhere for the past year, and the theme is that they are overvalued on a PEG ratio basis, even when accounting for premiums and large cash positions. While any long-term diversified portfolio should hold these names, it may make sense to take some profits in these names and allocate those funds to other asset classes. Large cap value names may be one place for these funds, as these companies have sizable businesses and strong cash positions.

Midcap and small cap names are also expensive, although values exist here and there.

I'd be wary of overweighting in international stocks just yet, until the global economy picture clarifies. However, emerging markets are trading below historical valuations. Commodities have experienced a big sell-off and also offer value. I'd put capital into the emerging markets if you believe commodities will recover, as their fortunes will rise and fall with commodities.

Real estate remains compelling in areas like apartment REITs, hotels, and government-centric REITs. Their dividends provide both income and a hedge against inflation. Plus, bond yields are bad. Speaking of bonds, with 3 California cities having declared bankruptcy, I'd stay away from municipals unless they are in a broadly diversified mutual fund, although their yields are tempting. All other classes of bonds should continue to have a place in your portfolio, but not overweight. If it's income you seek, I remain a big fan of preferred stocks. While it's best to avoid having too many financial-based ones, you can load up on many others, as you can with Business Development Companies. With the Fed keeping rates low until 2014, bonds will not provide any competition.

Specific Suggestions

Apple (NASDAQ:AAPL) remains the most compelling large cap value play. The company seems poised to grow at some 20% annually, which on this year's earnings of $47 per share, and suggests a fair value of $940. But even if you only give it a 15x multiple, the stock's fair value is closer to $700, a full 15% above the current price. Plus, you get the $30 billion in cash in its coffers.

Intel (NASDAQ:INTC) is slated to earn $2.45 this year and grow 12% annually, suggesting a fair value of $30 and trades at $25. The company announced a $5 billion state-of-the-art chip plant in Arizona, so the company obviously believes there's plenty of room to grow, even in the current economy.

Portfolio Recovery Associates (NASDAQ:PRAA) is a great small-cap play. It buys off charged-off accounts for next to nothing and successfully collects on these accounts. The company has virtually no capex and is a cash flow machine - spinning off $164 million of FCF last year. It leverages its $265 million in debt extraordinarily well in this manner, and is slated to grow at 14% annually. It's a bit overpriced at $88, but it's a monster business that is growing continually.

First Cash Financial Services (NASDAQ:FCFS) and EZPW (NASDAQ:EZPW) are pawnshop operators. First Cash cut back its payday exposure significantly to focus on pawnshop expansion in Mexico, where there is no usury cap, and 80% of the population is a potential pawn customer (vs. 20% in the U.S.). First Cash is generating net margins of 21%. Q1 free cash flow was $49 million, up 50% over the previous year. First Cash is the leader in large-format pawnshops in Mexico at this point. It raised earnings expectations to $2.72 for this year, up 20% year over year -- the same growth level the company has been experiencing for several years, and will continue to experience going forward. So you'd think the stock would be up around $54. Instead, it's at $39 when you include its net cash. That's a 30% discount.

EZCorp is looking for $2.92 in earnings this year, an increase of 13% over last year. Analysts are looking for 17% growth after that. I would put a 15 times multiple on this year's earnings, giving a fair value of $45. The stock inexplicably sold off to $23, making it more than 48% undervalued.

On the income side, Investors Real Estate Trust (NASDAQ:IRET) owns 266 properties, over 9,000 apartment units, and over 12 million square feet of commercial buildings, primarily in the upper Midwest. Twenty-eight percent of its assets are multi-family, 32% commercial office, 26% commercial medical, and about 7% each in commercial industrial and retail. The company has been in business for over 40 years. It presently yields 6.5%.

Ashford Hospitality Trust (NYSE:AHT) remains the premier hotel play, with its solid balance sheet, geographically diversified portfolio, and 5% yield.

The Buckle (NYSE:BKE) is a great retail play because of its conservative management, and the fact that its interests are strongly aligned with shareholders due to high insider ownership. The company throws off a special dividend every year in addition to generating solid free cash flow. It has a steady and consistent customer base and doesn't experience the fickle behavior other retailers do.

Spectra Energy Partners (NYSE:SEP) is a midstream natural gas master limited partnership yielding 6.2%.

Preferred stocks are the way to go, and I love Ashford Hospitality's Series D 8.45% and Series E 9% shares (symbols vary). I try to underweight financial preferreds, but you cannot find a bank that is more solid than US Bancorp (NYSE:USB). Their 6.5% Fixed to Floating Perpetual Preferred is a great deal. I'd take a look at Stag Industrial (NYSE:STAG) and their 9% preferred. The company is a leader in class B single tenant industrial acquisitions.

Readers took me to woodshed suggesting PG&E (PGE) as a good utility choice, so instead let me suggest a nice diversified ETF instead. The Guggenheim Equal Weight Utilities ETF (NYSEARCA:RYU) yields 3.36%.

I avoid individual bonds and instead stick to highly rated mutual funds, including Oppenheimer International Bond (MUTF:OIBAX), and Fidelity US Bond Index (MUTF:FBIDX).

As for commodities, you can go with individual plays, but I vastly prefer a mutual fund to avoid the associated volatility. I own the Barclays Bank PLC IPATH ETN (NYSEARCA:DJP). There are plenty of ways to go with emerging markets, but as I don't specialize in individual stocks in this arena, I've selected Harding Loevner Emerging Market (MUTF:HLEMX).

Disclosure: I am long (FCFS), (EZPW), (AHT), (USB).

Additional disclosure: Also long (AHT) Preferred D, (OIBAX), (FBIDX), (DJP), and (HLEMX)