Davy Bui's  Instablog

THE ENLIGHTENED-AMERICAN PORTFOLIO SPREADSHEET

• Enlightened-American Portfolio: +34.0% YTD (my actual IRR, including cash balance)
• DJIA: +10.7%
• Nasdaq: +34.7%
• S&P 500: +17.0%
• DJ WIlshire 5000: +20.1%
• Russell 2000 (smallcap): +21.1%

September was kind to our portfolio. Obviously, I am  pleased with the 34% return for the year but I am more gratified to have generated these returns while holding ample cash throughout the year. Currently, cash available for investment sits at 37% of investment capital. The large cash position has built up due to a flurry of activity last month:

• As mentioned on my premium website, I exited the bail-out play which was probably more speculative than my temperament could handle. While I sold the AIG and CIT Group bonds at a reasonable profit, I have always emphasized process over results in the belief that right process leads to good results over time (and vice versa -- bad process eventually equals subpar returns). In this viewpoint, I consider these positions to be mistakes, despite the profit gained.
• The summer months saw a slew of micro-cap, going-private transactions which were perfect for small retail investors. These reverse stock splits limited the ability of institutional investors to participate, thus leaving attractive spreads for the little people. Using multiple brokerage accounts, I put some money to work in stocks like Zareba Systems (ZRBA), Cuisine Solutions and Maxxam (MXM) for annualized returns of 313%, 50% and 25%, respectively.
• As mentioned previously, I sought to hedge a possible pullback in my gold mining positions with gold hovering around the $1,000 mark. Selling calls in Yamana (AUY) and Minefinders (MFN) allowed us to collect 5% - 10% premiums upfront while still leaving room for 25% - 40% upside before being assigned. These stocks have fallen back since then.

All this selling activity leaves me with a chunk of cash laying around, earning little interest.  So what is the market outlook and the prospect for deploying this cash?

October started poorly but I am still waiting for a scary pullback, not one where everybody is waiting to buy the dip. However, I have been waiting for this drop for six months, to no avail. That I have managed to generate strong returns despite being wrong is hopefully a testament to the investment strategy I have laid out.

While carrying a 37% cash position is a bit irritating, it also means I have locked in much of the returns for the year, even if the market does drop from here. Will that happen? I have been preaching caution all year and certainly continue to do so now. In fact, words of caution are more prescient at times like these than at scary points like the March lows. In true contrary fashion, risk aversion abounds at market plunges and abates during strong rallies.

The market has priced in recovery and growth for an economy that is fundamentally unhealthy. Yes, the economic data shows that the bleeding has stopped but the patient is still sickly at his core. The fact remains that the economy is on government life support -- the Fed's reluctance to pull back on its extreme measures and the auto industry's reliance on the government and cash-for-clunkers provide some proof. In a 70% consumer economy, can corporations continue to grow earnings even as the populace sees income deflation? In the long term, this seems implausible but  markets can do funny things in the meantime.

As a value investor, I base my investment strategy on fundamentals, not on macro calls or market timing. While a few unsavory stocks turn up on my watchlist, stocks seem too expensive based on valuation. I am inclined to continue dabbling in non-correlated opportunities while waiting for more attractive opportunities in the stock market.

Disclosure: View the spreadsheet containing all disclosures for my complete equity portfolio, including initial entry points, YTD returns, total returns, etc. through September 30, 2009.