C.S. Jefferson's  Instablog

Buy, Hold, Or Fold?

As we sit at consolidation levels around 1,000 on the S&P 500, we are witnessing the critical nexus point of a binary event waiting to happen...

If you want to be invested in the market now after such an incredible run up from the lows, then you better buy only what you are willing to own even if the market collapses and sells off again.  Don’t chase anything and definitely don’t hold high beta junk unless it’s speculative money you can truly afford to lose.  Personally, I wouldn’t touch 80 plus percent of the S&P 500 as I really try to streamline my portfolio to story specific stocks against the backdrop of an overall macro-economic theme.   Within my own portfolio, I continue to hold a substantial overweight position in commodities, more specifically, base metals that I’ve written about previously and played very aggressively since the collapse in the markets last year.  In particular, stocks such as Freeport McMoran (FCX), BHP Billiton (BHP), U.S. Steel (X), Anglo-American (AAUKY), Alcoa (AA), and Aluminum Corp. of China (ACH) have never looked back by trading anywhere near their 52-week lows, most of these companies hitting that bottom mark in the fall of 2008, despite the much deeper overall index lows this past March.  With respect to commodities in general, the real bottom in the market was in the fall of 2008, not March of 2009, which is why I continue to argue that there were no less than two market bottoms within the last year depending on what your positions and specific exposure to risk were.

These stocks in particular are viewed as long-term positions that have made triple-digit returns off their lows and  may still continue to run higher if we are in a recovery cycle.  While I haven’t closed out any of these core positions, nor do I intend to, I maintain a defensive posture by implementing hedging strategies to protect against any potential or impending selloff.   I cannot, in good conscience, recommend to anyone that isn’t already invested in these sectors to chase performance.  This being especially anxiety ridden the more I hear analysts coming on late to the trade which begs me to question:  Are we nearing a blowoff top in the commodity trade?   The run has been incredible, but buying now is tremendously risky unless you enter the trade as a collar (buy shares against covered calls to finance put protection) or, at a minimum, add-in protective puts along the way.  I think these stocks can go much higher, no question, but the risk to reward ratio must be respected to the downside at these levels from this point forward.  I won’t go so far to say they are overpriced at current market levels, but they certainly aren’t cheap like they were last fall, even though I am biased to the upside by not being remotely tempted to close out the positions.

In fact, the weaker dollar, higher commodity theme based on global infrastructure demand and China stockpiling commodities in lieu of currency weakness is one of the main drivers in the market since last year.  Since commodities tend to be dollar denominated, stockpiling not only serves as a currency hedge against inflationary policy, it also underscores savvy asset allocation by utilizing universal resources and raw materials as a currency in of themselves.  These are all high beta plays based on actual fundamentals and the market, overall, is doubtful to continue higher if this theme is ever broken.   Dollar denominated commodities, including petroleum, have truly become a means to stockpile global currency protection and may be less about actual infrastructure demand.   Somewhere down the line, supply and demand must be in synchronicity, otherwise, the commodities could crash just like they did last year--and that would not portend well for the entire overall market.  So, if you’re looking for leading indicators up or down watch commodities like a hawk; until then, even though I hope this negative scenario never winds itself out, play what works until the game is broken.

To be clear, I would characterize the March lows as a deeper financial sector sell off which I really tried to minimize by limiting exposure to the payment processors, and not the credit issuers.  I’ve written about this in an article previously, but the only “safe financials” to me are the payment processors that don’t hold direct  consumer debt exposure.  More specifically, relating to stocks such as Visa (V), Mastercard (MA), and, of course, the exchange  bourses:  Chicago Mercantile Exchange (CME), InterContinental Exchange (ICE), New York Stock Exchange (NYX), and the Nasdaq (NDAQ).  Other than that, banking stocks don’t interest me other than an option trade and certainly not as a long-term hold.

Allow me to list several more stocks I believe are worth owning long-term and that I continue to hold no matter where the market trades on any given day.  In addition to those aforementioned holdings, stocks such as Dupont (DD), Dow Chemical (DOW),  Boeing (BA), and Lockheed Martin (LMT) are also major components of my core portfolio.  All of which, despite moving higher, still remain at very attractive entry levels to long-term investors.  Chemicals, Agricultural-Sciences, and Aerospace-Defense are worthwhile themes that inject stability and long-term growth with appreciable dividend yields to a well balanced investment portfolio.

If I were to advise someone who was itching to play catch up to the markets and didn’t know where to place money by being unwilling to stand on the sidelines anymore, these four stocks would allow conservative participation if the market continues higher without chasing, or worse, overpaying for momentum.  More specifically, Boeing (BA) and Lockheed Martin (LMT) offer a serious defensive posture outside of the obvious nature of their business models with an extremely positive cash dividend.  Boeing, in particular, is probably one of the best plays to the long-term investor by being undervalued anywhere below 55 dollars.  While it isn’t as cheap as it was in the low 30’s recently, the downside seems limited now to the mid-40’s unless the entire market breaks down or fundamentals change radically.  As far as (LMT), this stock is underpriced below 85 dollars where it seems to find resistance.

Boeing (BA) positions itself as an interesting option play due to the implied volatility being so low relative to other momentum based stocks.  It remains as one of the few option plays I’m willing to go long on in a market climate that has run so far, so fast.  There are not that many long call option plays that look cheap to me anymore as investors are scrambling to participate in the market with upside call volume.  Just within the last several weeks, we saw a nice intraday pop based on announced scheduling of the 787 Dreamliner.  It paid off handsomely on some front month options I was holding--ironically, I had applied this same trade several months ago and, mistakenly, left a lot of profits on the table when they disappointed the markets by delaying their test flight prior to the Paris Air Show.  Not wanting to repeat this mistake again, I immediately sold off 2/3 of my front month September call options and 1/3 of my back month November contracts on the initial pop, simply to take the entire cost of the trade and significant profits off the table.  This still kept me in the trade, but maintained the discipline to take profits when they are dangled in front of your face like a carrot on a stick.  With only several trading days until September option expiration, premium decay is no joke and unless it continues to move higher within the next several trading sessions, my remaining front month calls would most likely have become ripped up tickets at the race track.  Rather than watch the September calls expire worthless, I rolled the remaining front month positions forward into October.  However, I did not sell out of any LEAP positions because I truly believe there is serious upside in this story that may take longer than my ability to precisely time the trade in the near-term.

As far as the underlying security itself, I continue to hold (BA) stocks as a long-term investment and have no inclination whatsoever to sell out of this position.  My cost basis is low and the dividend yield is significant when you consider many other companies in the S&P 500  have suspended or reduced their cash payout as a result of the crisis since last year.  The only reason I am not adding to this position in shares is because I already made my commitment throughout the last year and remain overweight.  If you don’t play the options, keep it simple and buy the stock by averaging in over time, regardless if we face an up or down market.  Or, add some inexpensive put options against purchased shares simply to protect your positions.  If I were making a projection on where this stock will trade, you have to rule out short-term volatility, or worse, stagnation.  However, 75 is a target I think it can achieve with relative ease by mid-2010 and, if you press me on the long-term, I don’t think crossing the century mark above 100 is out of the realm of reasonable expectation if, and only if, our global economy truly recovers into 2011.   

Unlike many of the commodity stocks I hold in the core portfolio and can’t recommend people chasing if they aren’t already invested at this point, Boeing has tremendous, yet sustainable, upside whenever they have a successful test flight of the Dreamliner and ramp up  production for their scheduled 2010 delivery.  Unfortunately, timing this trade has been very difficult due to multiple delays and one let down after another,  but you will see another major upside move in this stock and the options based on two conditions:  The first being the successful test flight of the Dreamliner with strong  affirmation of guidance for existing orders on their books and, second, a continued run higher in the overall market.   Remember, (BA) is a major S&P/DJIA component and aside from aberrations due to intraday pops like several weeks ago, Boeing cannot move higher with an inverse relationship to the overall market.  It represents a play on expanding global economic demand, a replacement cycle in the airline travel industry, and capital goods strength which require better and more favorable market conditions.

While I believe there are at least several more significant moves in the stock down the line, the stock could easily drift lower which means these pops will be on a relative basis from where the stock settles over a period of time prior to headline breaking news.  The test flight will be a catalyst, but you must recognize that  their delivery schedule isn’t slated until late 2010.  Of course, if markets are behaving, then the stock will run well ahead of schedule.  And don’t forget that (BA) is still the second largest defense contractor behind (LMT) so, to be sure, this company is not a one trick pony which is further validated by pretty impressive earnings reports.  If you are not a day trader or tempted to time this stock to perfection, you will be afforded opportunities of multiple entry points along the way.

Filtering Out The Noise

Ask yourself the question:  If the market sold off again anywhere near the bottom, what would you do and how would you trade it?  More importantly, if you want to be long the market, ask yourself what stocks are you willing to own long-term no matter where the market trades?

I tend to believe if you listen to too much background noise you can become distracted and lose focus, perhaps even trade yourself out of a good position, or miss opportunity as fear takes grip and refuses to let go of its hold.  You can watch a trade move higher waiting for a pull back or sell off that never comes.  Regardless, try to pick your positions based on companies you have conviction about buying and holding, or are simply willing to own regardless of the price action during crisis and volatility.  I have not sold any of my core holdings despite the market crisis throughout the past year and, in fact, made very aggressive accumulations of stocks throughout this debacle to bring my cost basis down considerably.  While I will trade in and out of options and speculative stocks in a heartbeat, I believe that as a long-term investor you continue to hold certain stocks with solid balance sheets, fundamentals and projected dividend yields that comprise your core portfolio if, and only if, you can effectively manage the risk to the downside.

While any stock is good for a trade, I would repeat, in my opinion, that more than 80% of the entire S&P 500 is not even worth holding as a long-term investment.  Many have had their dividends shredded and retain significant credit risk exposure, on top of which, the landscape is much more competitive for fewer consumer driven spending dollars, such that this is about an almost dystopian Darwinistic survival of the fittest.  Namely, those with bailout TARP money, and those without; those with access to the Federal Reserve’s balance sheet, and those without; those too big to fail, and those that simply aren’t.  And since I don’t, as well as most retail investors, have to mimic the underlying performance of the entire S&P 500, you can be more of a discretionary and selective stock picker rather than a broad based participant. 

After all, for a money manager to say they beat the S&P 500 last year doesn’t mean they made money--it just means they didn’t lose as much on a percentage basis as the overall index.  Losing less money was the new mantra and threshold of financial genius until the market started performing.  Now, with the S&P 500 up significantly, a lot of last year’s geniuses that went to cash on the sidelines will be underperforming the benchmark index.  Make no mistake, this is a stock picker’s market.  And those that need to hold baskets of stocks or broad based index trades will probably underperform nimbler and swifter hedge funds.  In this respect, retail investors can serve themselves up much better performance by picking best-of-breed stocks in each sector and ignoring anything less.  Add to this cocktail recipe a tight dose of basic hedging with put protection, covered calls and collars, you should be able to ride the bull kicking and screaming all the way up without being too afraid of being tossed amid short-term volatility.   This is why even long-term holders of index or sector specific ETF’s may be less appropriate for retail traders who may try to opt for safety and, instead, find that like any cumulative, pre-digested basket fund, there’s a lot of garbage collecting  going on with only a few remaining diamonds in the rough.

Author’s disclosure:  Long BHP, FCX, AAUKY, AA, ACH, X, V, NYX, NDAQ, DOW, DD, LMT, BA.