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Q4 Gameplan and Outlook

|Includes:JNJ, McDonald's Corporation (MCD), PEP

Investing real money in the stock market these days is not a game, and as Roy Neuberger once told me, "Wall Street can be a cruel place." No doubt the man had wise words for me when I had the pleasure of meeting him in 2006. When I asked him what his secret was to a long life, he told me he "took alcohol" regularly. I have to admit, Mr. Neuberger was and is one of the most colorfull and vibrant individuals I have had the pleasure of meeting. Although he knew prior to our meeting that I was a small time investment manager who was a devoted fan of his work, he treated me as one would treat a promising pupil of investment management. I have been lucky to meet many successfull business owners in my life, but have never met someone as down to Earth as Neuberger.

What I learned most from my interview with Roy Neuberger was that you have to be not only a great value investor but also a great trader to be successful over the long term. Roy considered himself a Trader and not an Investor. Personally, I believe he is more of a master value investor who knew how to short-sell when the absolute worst case scenarios for markets unfolded. This is what we need to focus on in today's turbulent markets and economic landscape. His prescient short selling of RCA common stock in 1929 produced enough profits to make up for most, if not all, losses which the great crash inflicted on Roy's personal stock holdings -- an 89% winner! 

To put this another way, by hedging risk, Roy Neuberger prevented the 20 year comeback fight that the average investor and money manager faced at the time -- the Dow did not make back the 89% drop in the depression until WW2. I would imagine that after a 400% rise in the stock market from 1925-1929, Roy was not a member of that era's equity cult, shorting the most popular stock on the market (think TV and radio here). I would futher imagine that he did not believe stocks had reached a "permanently high plateau" as most others in his generation believed at the time. When I met with him in 2006, he said similar things about the market at that time, which was very astute as I now know from hindsight.

What was clear to me from investing in the markets of 2005 until now was that those who could manage the macro and industry specific risks as well as the company specific risks could profit from long positions over time. If investors were nimble enough to cut losses and even go short when the macro risks appeared in the financial statements in the form of losses and writedowns, these savvy hedged investors could beat the system at its own game. I had a lot to learn.

Another one of Nueberger's axioms in investing, is that you should sell stocks that drop more than 10% from where you buy them. As a value guy, I did not appreciate and still do not completely appreciate this strategic rule as much as I should -- in hindsight this prevents major losses in bear markets, and keeps you invested in undervalued stocks that are moving up right now. Still, I believed Roy had an equally strong sell discipline once a stock hit his target valuation. He was also interested in growth stocks and found that value and growth were both important.

One of the best ways to learn about a subject is to go straight to the experts for advice. In this case, I was truly blessed to be able to learn from a wizard of the art of investing -- someone who is truly among the very best in the world all time at investing money in my book. When adding in risk adjusted returns, he may very well be the best investor in history.

Which makes me think to myself, if this guy who was investing at the age of 100 is telling me to "take alchohol," I should go out and get a drink! It's pretty awesome that the man is 107 and still in the game! It's a tough market these days and the only way to protect capital is to research heavily. I would think today Roy is skeptical of the valuations in the market, but one thing about a market mastersa like Neuberger is that they nimble and can change their positioning in the market with the weather. Nueberger had the right motivation for trading -- he wanted to donate to the arts. Neuberger's philanthropy towards fine art is unrivaled. From what I can tell from my one hour meeting, Roy and his daughter Ann are immensly unique and good natured philanthopists with a pragmatic street sense or street smarts that made for serious profits in stocks.

Next week, and throughout Q4, I will look to be a trader. I am on the defensive, hoping to preserve capital if a bear market or correction emerges, while at the same time profiting from smaller investments in commodities, and short put option positions in stocks like MCD, NE, SHLD, GNK, INTC, AIG. In addition, I am invested in covered calls on stocks like PEP, JNJ, KND, MSFT, GILD, COP, MRO, CVX, STO, etc....

Although this strategy is not extremely aggressive, the annualized yield from the short calls, dividends, and short puts should produce 10%-15% or so returns on average.

However, should the ECRI leading indicators prove correct and we head into another round of dollar strength, economic weakness, or a mortgage crisis; I will look to short (likely through puts or put spreads) IWM, NFLX, OPEN, DRM, DRN, TNA, SPG, DAL, AMR, WMG and others against my covered call positions to create a collar. The collar will be alpha producing in up or down markets if the shorts underperform the market and the covered calls yield their full potential along with the short puts.

If the dollar keeps falling out of bed, I will be buying back the call options I sold against my SLV deep in the money leap calls that I own on the long side. Also, I will have to add to either RJA or DBA in that scenario. I do not feel dollar weakness is a net positive to the US economy or stock market at this point, as the market is forward looking enough to not surge on policy that will greatly increase the prices of raw materials without necessarily increasing the consumer's standard of living, real wages, or finished goods prices -- a potentially painful scenario. $4.50 per gallon gas really put the hurt of a lot of regular people in early 2008 long before the stock market collapsed. The airlines, financials, and trucking industries were all crushed. This time around, I will be looking to short airline stocks such as DAL and AMR if the markets begin to roll over or if the dollar drops and oil rises.

So, there are basically two strategies in my humble opinion.... Go with the Fed, which means stay in covered calls on the boring dividend stocks like JNJ and MCD and stay long commodities; or, bet that the Fed is going to fail and QE2 will be halted as the dollar weakness will determine how they play their hand, staying fully hedged in equities.

I am not ready to commit to either side of this trade just yet so I am waiting until the market decides which way it wants to head before making a bet on Fed policy.

In either scenario I am looking for ways to diversify out of a dollar heavy portfolio. Domestic companies earning money in foreign currency that are undervalued include:


Foreign names I own include:


Good luck and stay diversified

Disclosure: Long NE, NWLI, JNJ, PG, MCD, PEP, and all others mentioned long and short (short Open, NFLX, TNA)
Stocks: MCD, JNJ, PEP