The US stock markets churned throughout the first quarter of 2014. The performance of the major indices for the quarter were:
- DOW down 0.7%
- S&P 500 up 1.3%
- Nasdaq up 0.5%
Despite the cacophony of voices now claiming we are on the verge of another recession or a 25% pullback, the performance of the markets should be viewed in the context of the macro news flow that influenced it. A recap of the past few months events include:
- Disruptive weather across the US driving earnings estimates of S&P 500 from 6% growth to 1% going into earnings season. Most economic indicators for the quarter were worse than consensus.
- The Fed rejection of the Citibank capital allocation plan.
- The botched General Motors ignition defect recall
- The biotechnology segment decline triggered by a letter by several House Democrats to Gilead Sciences asking for an explanation about pricing of Sovaldi. The letter also requested information as to available discounts for government health programs and the potential public health impact should access be blocked or delayed due to cost.
- A Russian invasion of the Crimean region of the Ukraine and growing concern over Russian troop buildup along the northern border.
- The lost Malaysian jet with 239 passengers and the ineffectual search for it.
- A cooling of the US-Saudi Arabia relations. This alliance, bound by the common interests of fighting terrorism and petro energy, became strained when the Obama administration retreated from its "red line" threat relating to the use of chemical weapons again civilians in Syria.
- The first Chinese bond default in history when Shanghai Chaori Solar failed to make a $15m interest payment. This led to reports that Chinese banks were becoming much more discriminating in their lending and concerns over the shadow banking system.
- A China economic slowdown greater than expected or projected by the government. China represents roughly 10% of the world GDP.
In the context of the gains recorded in 2013 and the negative news flow, the stock market held up extremely well. Several months of consolidation can be viewed as a healthy breather. Investor have rotated into equities with less risk and volatility, creating a correction under the surface in many market segments. Consider the previously white-hot biotechnology segment. The IBB ETF has dropped 14% from its recent high. This compares to corrections in 2011, 2012 and 2013 of 25%, 11% and 12% respectively. High flyers such as AMZN, DDD, FB and TSLA have dropped 17%, 37%, 17% and 20% from highs attained earlier this quarter. Even the Bitcoin speculative fever has apparently subsided.
My equity investment approach this year is to remain fully invested with a diversified portfolio unless inflation or economic indicators dictate a change. My outlook is that the overall market should achieve roughly 6% returns. If so, I should be able to see 10% returns including yield achieved through dividends and option income.
- Keep enough invested in dividend stocks to provide an annual yield of 3%. This will dictate a somewhat higher yield requirement to compensate for some portfolio positions that have no dividend. This target fits because the overall REIT market has sold off in anticipation of interest rate increases, prematurely in my opinion.
- Sell covered calls and puts throughout year to achieve an annual yield of 3%. Sales of both puts and calls will be important to diversify the portfolio. Puts will be sold on selective equities approaching target prices and mostly just out of the money. Covered calls will be sold on positions that are approaching target sell prices. By definition this should provide some natural rotation in addition to income on options that expire out of the money.
- A separate tax deferred portfolio will be fully invested in dividend stocks with some covered calls utilized.
Q1 2014 Performance
My taxable portfolio was up 2.4% for the first quarter of 2014. The portfolio is tracking my 2014 objectives so far. Dividends and options both yielded 0.8% for the first quarter representing an annualized 3.2% return. The valuation increase of 0.8 is in line with the overall market. The month of March was worse than the overall market due to some premature purchases of equities (or sale of puts) toward the end of the quarter. Stocks such as FB, GM, INSY, LGF, NPSP, PXLW, TWTR were bought as they reached target levels. Unfortunately they became "more attractive" by quarter end, bringing overall performance back to the market. The cash balance at the end of the quarter was 4%.
The tax deferred portfolio had similar returns, up 2.3% for Q1. The cash balance was 3%.
Disclosure: I am long ABBV, ADMP, AHT, APU, ARCC, ARCP, ARLP, BA, BAC, BMY, BX, CLDX, CLF, CODI, DAL, DLR, EVEP, FB, GDXJ, GE, GM, HCP, HIIQ, HTZ, INSY, IP, JBLU, JNJ, KKR, KMR, LAD, LGF, LINE, MMM, MS, MSFT, NPSP, PRU, PXLW, RGDX, RIG, SGEN, SIRI, SQNM, STX, TSYS, TWTR, TWX, WYY.