My 2012 Investment Game Plan: Year-End Lookback

by: Ray Merola

In early January 2012, Seeking Alpha editors published my article, "My 2012 Investment Game Plan." The link is found here.

As I have done in years past, I followed up with a 2012 mid-year review that was published in July.

I am now writing with a full year lookback at the general plan assumptions and their accuracy. Then I will offer results and analysis of the primary investments contained in that plan. Included is commentary on 2012 portfolio adjustments, and finally, my promise to write you again shortly with my "2013 Investment Game Plan."

For clarity, I have italicized original segments from the January 2012 article, then followed up with a short discussion after each section.

"My 2012 Investment Game Plan" Basic Assumptions

The global economy continues to move forward, but the European wildcard has the ability to create an unusually wide range of growth outcomes. Indeed, the EU debt crisis remains an overhang on the world economy that I find very difficult to handicap. If this issue does not blow up, I believe the economies of the United States, China, and emerging markets will do just fine. In any event, Europe will experience recession. If the EU situation is mishandled (which I think is a significant risk), then a world flat line scenario is likely. That said, I forecast a low likelihood of a global recession in 2012.

Lookback: Partially correct. The EU debt crisis did roil global markets, but the crisis did not "blow up." It certainly was difficult to handicap. However, the economies of the U. S., China and emerging markets did not "do just fine." They experienced net muddle-along scenarios. There was no global recession.

U. S. interest rates will remain low. Indeed, the Fed has stated their intent to keep rates down. Corresponding inflation will be low to moderate. Banks will continue to mend themselves, but the pace will be glacial. Housing will see spotty recovery. I see no rapid economic expansion until the banks are healthy. However, robust bank health is not part of my 2012 vision.

Lookback: This premise was generally correct. Despite the Fed-bashers, we've seen no spike in U.S. inflation or interest rates. Our banks have emerged from the 2008 crisis in much better financial shape than a year or two ago. By the same token, I would not classify our banking system "robust," either. We experienced no rapid economic expansion in 2012.

Gold will continue to rise.

Lookback: Correct. Yes, gold oscillated during the year. Nevertheless, the yellow metal's YoY price rose once again. Gold continues to have a significant and important function in my investment portfolio.

U. S. equity markets will advance. While I make no numerical predictions on the broad markets, I premise that 2012 will be a reasonable year for overall corporate earnings. Therefore, modest market gains are assumed, though dividends will be a major component of this year's investment return.

Lookback: A presidential election year tends to be favorable for equities. Last year was no exception. Overall, corporate earnings were generally good. While earnings were soft in 4Q, on the whole it was a solid year, and the market placed a decent P/E multiple on those earnings. The combination provided a tidy return for those who didn't try to outsmart the tape. Indeed, my opinion is that many pundits extrapolated geo-political events into doom-and-gloom scenarios without considering a critical element: corporations are like living organisms. They act and react to events and circumstances. I contend that despite negative macro events, most well-run companies don't just sit there and take it. They adapt and change. They are good at it. And that's exactly why I don't pay too much attention to macro events. Or the talking heads.

"My 2012 Investment Plan" Strategies and Critique

Concentrate equity investments in the Industrial, Materials and Energy sectors. My go-forward rationale is that 2011 was a "lost" year. The economic cycle neither advanced convincingly nor retreated. Typically, business cycles last five to seven years. Therefore, I plan to maintain an overweight of many of the same cyclical companies as last year.

My favorite Industrials include Caterpillar (CAT), Honeywell International (HON), and Illinois Tool Works (ITW); these stocks emphasize diversified global giants. Basic Material picks include Nucor (NUE), and International Paper (IP); both sporting good yields and strong balance sheets. My Energy investments are centered around Royal Dutch Shell (RDS.A), Exxon Mobil (XOM), and Halliburton (HAL); Shell offers a generous yield, Exxon plays to the boom in natural gas, and Halliburton is a beaten-down favorite to capitalize on the need for energy services, especially in North America.

I also like Energy Transfer Partners (ETP), a pipeline MLP that offers a generous 7.5 percent distribution yield and focuses upon the Texas natural gas / shale gas infrastructure.

Results and Critique: This strategy cost some points. Energy and Basic Materials dwelled near the bottom of the 2012 S&P 500 sectors' performance list. Being overweight in these sectors kept me from meeting or beating the overall averages.

Indeed, my two largest Energy holdings were Royal Dutch Shell and Halliburton; neither of which provided much portfolio performance. At least Shell yielded nearly five percent. I further mitigated the lackluster performance by selling some income options.

I continue to believe Halliburton remains an undervalued security. I bought more into the depths of its weakness.

I also increased my exposure to Energy Transfer Partners. I wrote several Seeking Alpha articles about this MLP during the year. ETP's acquisition and divestiture story is complicated, and investors don't like a complex storyline. However, I have renewed faith in its management team after attending its Dallas investor conference this fall. I continue to reinvest the Texas-sized 8.5 percent yield while the price consolidates. I expect the distribution to increase in the first half of 2013.

During the first quarter of the year, I sold my Exxon shares into strength to reduce exposure to the Energy sector. That turned out well. I bought the shares back on the last day of this year.

My Materials stocks peaked in March, fell back, then rallied into year-end. I thought hard about paring them back when they were fully valued back in March, but did not. I waited until the fourth quarter to begin to take some profits. I started to scale out of positions in International Paper and Nucor after some strong gains. These two stocks are solid companies with sound balance sheets, both generating good cash flows, and are well-managed. International Paper's merger with Temple-Inland is a winner. Nucor has a game-changer in its natural gas and DRI pellet processes. Despite the sound future, I held both stocks since the 2009 generational low. It was time to take some profits on big gains. I remain long-term bullish on both equities, and they are core positions. I'll buy shares back on any weakness.

In addition, I bought into Dupont (DD) during the second quarter. While classified as a Material stock (Chemical industry), the company is a play on technology and agriculture, too. The company took a tumble after surprising the Street with a dismal 3Q earnings announcement. I was really miffed when there was no pre-announcement of the miss. The shares stayed in my portfolio; the 3.5 percent yield helps.

The Industrials were a roller coaster ride. I was overweight in this sector for most of the year. I sold off a chunk of my position in Caterpillar during a late-February pop, and hedged much of the remainder with options through August. Then I bought back the shares and even increased the original position when the P/E fell to 8x in the second half of the year. There was way too much pessimism around a best-of-breed stock. I sold off Illinois Tool Works after I felt it reached full value and had good long-term gain. Honeywell had been a favorite holding for several years, but in June, I swapped the position at a nice gain and scaled into shares of Eaton Corporation (NYSE:ETN). I really like its recent Cooper Industries acquisition. The stock has rallied hard into year-end.

Eaton and Caterpillar were two of my largest portfolio positions as 2012 ended.

Increase holdings of selected Tech stocks. My two core investments in this area are Apple (AAPL) and Intel (INTC). These two represent bookends of this sector: one high growth company and the other a dividend star. I believe both remain undervalued.

Results and Critique: Well, these winners turned ugly... sort of. I added to my Apple position during the year. It's now my largest single holding. Income-generating options added luster to the underlying shares throughout most of 2012. For me, Apple has long been an investment, not a trade. Having purchased most of the position years ago, my cost basis is quite low. But for many us who owned AAPL shares, the autumn swoon that saw shares dip from $700 to $500 was a real bummer. In my case, it was a chance to buy more. I continue to see the offering as undervalued. Sure, if I were smarter, it would have been better to sell all my shares at $700 and buy it all back at $500. But I'm not smart enough for that. Apple still booked me a good paper gain for the year.

Intel was a different tale. I continued to sell cash-secured puts against the shares, collecting nice premiums for much of the year, then had some shares put to me during a grinding second half downtown. In hindsight, I should have trimmed the position when the price was $28 or so, having registered a strong gain. Instead, while waiting for my $30 limit sell order to come in, I ended up riding the stock back down to near my original basis. My problem is that I still like the company. I continue to believe in the long-term fundamentals and the dividend-growth story.

These two tech giants ended up a net winner for me in 2012, but it was not a comfortable ride.

Underweight Financials and Health Care. I suspect that the risk-reward profile for Financials will remain weak and volatile. Therefore, I will remain largely on the sidelines for this sector. I have small positions in Citigroup (C) and Hudson City Bankcorp (HCBK) to stay in the game. I do like the iShares Preferred Stock ETF (PFF) for the high yield coupled with low European bank exposure.

I bailed a bit early on the run-up in Health Care stocks last year. Now I believe the prices are too high to get back in.

Results and Critique: I was underweight Financials in January, but adjusted my thinking and beefed up on this sector as the year wore on.

I took a beating in January on shares of Citigroup and Hudson City Bankcorp early in the first quarter. I sold both stocks and parked all the proceeds plus more into my favorite Financial sector stock, Wells Fargo (NYSE:WFC). After analysis, I believe that Wells is the best-of-breed large U.S. Bank stock. Its acquisitions, scale, and strong management team had positioned the company to dominate the Main Street banking business for years. It's a play on the dawning recoveries in the U.S. Housing and commercial loan markets. I like the fact that Wells Fargo management has kept the company's business model and metrics simple. I own both the common shares and the warrants that expire in 2018. It's now my #2 portfolio position overall.

In November, I swapped long-term shares of the iShares Preferred Stock Fund for the insurance company Aflac (NYSE:AFL). I had bought the PFF shares during the 2008-09 crash; while I bought them for yield, over the years they added some good capital appreciation, too. I reasoned that most preferred shares had reached par value by now, so there wasn't much capital upside. On the other hand, AFL appeared deeply undervalued. My problem now is that AFL shares have spiked up since I started my position; I won't chase it to buy more. I'll continue to wait patiently.

Having accumulated a sizable position in WFC securities, I'm happy with the results. I ended up adjusting my initial plan to underweight financials, but ended up with a concentrated emphasis within the sector.

On the other hand, Health Care stocks remain an enigma to me. This was one of the best performing sectors, so I missed the boat. I was on the sidelines. Frankly, I looked into the Drug companies, but didn't like the valuation and forward prospects enough to buy. I hesitated due to the ObamaCare debate, Supreme Court calculus, and go-forward expectations. So I did nothing. I've got my eye on a couple of Health Care equities for 2013, but ended 2012 with zippo in the portfolio for this sector.

Retain moderate exposure to Utilities, Telcom and Consumer Staples, holding current securities. During 2011, I picked up positions in American Electric Power (AEP), Vodafone PLC (VOD) and PepsiCo (PEP) when the valuations just got too compelling. I think the price tag on these shares are now too rich to buy more, with the exception of Vodafone. I'll continue to hold and collect the dividends, but won't add to the positions unless they "come in." Big picture, I'd like to accumulate more Utility/Telcom sector stock to round out my portfolio. However ,during the EU crisis last year, the field became too crowded with investors flocking to companies with high yield and little European exposure.

Results and Critique: The Utilities were a 2012 sector dog, so I took my lumps here. However, all was not lost. I swapped out of my long-term shares of American Electric Power with a good gain; in hindsight, I should have held on. I had become less confident that an Ohio rate case and the anti-coal EPA regulators would work out acceptably for the company. I scaled into Excelon (NYSE:EXC) during the second quarter. The decision was a crash-and-burn disaster. This past November, I owned up to my loser and wrote about it on Seeking Alpha.

Vodaphone has remained a sound, high-dividend holding. Unfortunately, it did nothing for my portfolio's capital appreciation. I added more when the price fell to $25, and I view the holding as needing patience. The company's southern Europe exposure is killing it. Nonetheless, I am pleased with its management, the business plan, and of course, the 45 percent ownership in Verizon Wireless. Those special dividends are quite welcome.

Lastly, I opted to sell my long-term shares of Pepsico north of $69 on the basis of my opinion they reached full value. To remain in the Consumer Staples sector, I took small positions in Lorillard (NYSE:LO) and General Mills (NYSE:GIS). The U. S. tobacco company has a strong balance sheet and grinds out excellent dividends. The price action has been disappointing. I purchased "The General" on what I considered exceptional stock weakness after its June earnings report. A pending dividend increase that offered a 3.5 percent yield just added gloss. I added more shares during a December pullback.

I like these positions as a stable counterweight to my heavy exposure to Energy and Industrials -- both sectors that tend to be cyclical.

Other Investment Notes:

While not part of the original January investment plan, I staked a position in TRW Automotive Holdings (NYSE:TRW) in February, then watched as this auto safety parts manufacturer took a bath. Despite upbeat North American auto sales projections and an improved balance sheet, the stock was snakebitten by its exposure to the European auto market, an industry antitrust investigation, and lack of yield support. I rode the shares down 15 percent. Since my original thesis for owning the stock had not changed, I bought more. Indeed, as the year wore on, the company settled its antitrust issues and the EU situation stabilized. Meanwhile, North American auto sales skyrocketed, just as predicated. Then management made good on its pledge to return capital to shareholders. The shares rallied strongly into the end of the year and now are a big green light on my portfolio dashboard. As they say, "Give yourself time to be right."

In addition, I've long held some real estate securities to diversify my portfolio. I staked a position in Annaly Capital Management (NYSE:NLY) during the second quarter. I was saddened by the loss of CEO Mike Farrell over his battle with cancer. His leadership was outstanding, and his business commentary was both profound and entertaining. The shares have taken a bit of a tumble after repeated distribution cuts; I believe the prime catalyst has been Fed monetary policy, not a negative turn in management prowess. As a longer-term investor, I view current Federal Reserve policy as temporary, not terminal. Interest rates will rise again, whether you pick 2014 or 2018. When they do, mREIT margins will improve with them. I don't much worry about the current state. I plan to reinvest the double-digit dividend into more shares and just let history take its course. My view is that Annaly is a broken stock, not a broken company.

Keeps some bonds as a hedge, but basically, the party is over. I still like the PIMCO Total Return Fund (MUTF:PTTRX), despite last year's performance and Bill Gross' mea culpa. Rounding out some fixed income exposure, I will continue to hold a Global Bond fund and a High Yield fund to stay balanced in the bond space. The run-up in Treasuries was a pleasant surprise last year, but I don't think it will be duplicated again this year. So I'll take some profits on a TIPS fund.

Results and Critique: Here was a great lesson in why to remain diversified. I thought bonds could have a very rough go of it in 2012, but I stuck with my portfolio allocations. These funds became anchors. PIMCO Total Return Fund (PTTRX) provided a nifty 10.1 percent uplift. The High Yield space was likewise accommodating, with two funds clocking a combined 14 percent total return. I added to both High Yield positions in January/February with very good results. My view was the economy was not going to crater, and the junk bond yields were pricing in an overly pessimistic year. It was a good call. I trimmed a little of my TIPS fund holding around mid-year, and increased shares of a foreign bond fund. Neither move had a material effect on the overall rewarding fixed income performance.

Increase exposure to Gold: Now. I believe that the yellow metal should be part of my portfolio as a hedge and insurance. I think the dip in gold prices now is an opportunity to accumulate the position on the cheap. Last year, various institutions and investment houses were forced to sell gold to raise cash. Now I see gold continuing its climb upward in 2012. No silver, copper or mining stocks for me. I will add to iShares Gold Trust (GLD) as my preferred access to the precious metal.

Results and Critique: I did not follow through on my initial plan to buy more gold. Early in the year, the price ran up, and I refused to "chase" the commodity. Then when it weakened, I didn't like the chart. So I just held tight. Gold is one of the largest single positions in my portfolio, so it's not like I'm going to miss a train. Hence a tremendous advantage individual investors have: we only answer to ourselves. Yes, I had a plan. No, I didn't follow it, but for what I considered sound, rational reasons. And I don't have to answer to anyone for it. I continue to hold my entire position into 2013.

Lastly, CASH is king. I tend to hold a fair percentage of cash in my portfolio, and it doesn't bother me to live with today's near-zero interest rates. Holding some cash permits me to sleep easy at night. I simply ladder some one-year CDs, even if the interest rates are awful.

Results and Critique: Yes Virginia, Cash is King. I hold a considerable amount of cash. I might deploy some if the market tanks, or I might just continue to stay put. My current cash percentage is 13 percent, and my "regular" portfolio target is 10 percent. So I'm overweight. While the returns are lousy, I ladder some CDs, and grind out the best, safe, yields that I can with the rest. No remorse, no apologies. I sleep well at night, too.


My broad investment premises were reasonably accurate. A number of my specific stock picks looked pretty dismal around mid-year, but several rallied into the close and ended up all right. On the whole, I trailed the S&P 500 by several points, but this includes cash and fixed income securities that tend to drag me down when the market is rocking. I'm OK with that. I generally invest conservatively and emphasize income.

My "all-in" portfolio return was approximately 12 percent. That trailed my benchmark, the S&P 500 total return, which booked 16 percent. My objective is to meet that benchmark with less volatility due to being diversified into fixed income securities and cash.

Losers like Intel and Caterpillar were offset by Apple and Eaton. Option income, dividends, and interest were key components to my total return. As is often the case, I found strength where I expected none (bonds) and weakness where I expected outperformance (Energy and Tech).

That's why it's best to always remain diversified.

I promise you to write the Seeking Alpha editors with "My 2013 Investment Game Plan" within a few days. Pending their approval for publication, I trust you will find the article simple, straightforward, and of value to you.

Readers, please note these views are my own. I am not trying to sell anything, nor providing specific investment advice. I simply enjoy sharing/exchanging views with fellow SA investors, based upon my 30 years of practical experience. Your comments help me keep sharp.

Disclosure: I am long AAPL, CAT, EXC, VOD, DD, GIS, HON, LO, WFC, AFL, ETN, GLD, INTC, NLY, XOM, RDS.A, ETP, HAL, IP, NUE, TRW. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.