Deploying Cash for a Slight Upward Market Bias

Includes: BTU, COST, EA, GS, PBR, SWY
by: Ryan Barnes

There’s little to do when one is wrong but admit, find a lesson, and move on. In that spirit, my decision to trim the majority of the Petrobras (NYSE:PBR) position in the Secular Trends Portfolio was ill-timed, to say the least. I was concerned about several straight weeks of rising crude inventories, and I didn’t like the company’s leveraged position to crude futures in that light. As mentioned in my previous post:

I’ll be looking to re-beef the PBR position as soon as crude inventories stop shooting to the moon…

Well, this week the EIA showed a surprise drop in crude inventories of 8.4 million barrels, a metric I was quite shocked to see after weeks of surprising on the upside. As a result, crude has rallied more than 7% since the release, while PBR has risen more than 5%.

I was tempted to rebuild the position Friday before the close, but I’m a believer in the not-so-famous axiom of “one metric could be anything, but two can set a trend” (copyright pending). So I’ll wait it out until next Wednesday’s report to see if there’s a real drain on supplies happening, or if this week’s report was just an aberration. In the meantime I’ll lick my wounds and gaze fondly at the attractive chart for Petrobras.

Mr. Market on a Confusing Diet of Uppers & Downers

Despite my constant attempts to cancel out the diverging data and anecdotes, I confess that I just can’t peg the next 10% move in the equity markets. My slight hedge is towards up, but I can’t remember a time when there were so many crosscurrents swirling around a single economy. With options expiration Friday and volume remaining extremely thin, there’s not a lot of conviction to be found despite the direction of the proverbial tape.

One thing that stands out to these restless eyes is that our government’s stimulus, both via direct legislation and indirect monetary means, is having a delayed effect. Meanwhile, the cost-cutting (leading to margin-boosting) efforts of Corporate America have been occurring in a parallel process, which implies some built up gunpowder going into the remainder of the year. The market anticipates this already, which is the only reason why the S&P 500 dismissed 950 so easily and shuttled its way past 1000.

Helping this process along has been the ratcheting up of 2009 S&P operating earnings estimates by nearly every macro guru, putting the market’s run-rate P/E in the range of 13-16x, depending on who you believe and at whom you scoff.

Portfolio Update

The Secular Trends Portfolio has been holding its gains steady against the broad market, but I’ve been disappointed with the near-term performance of names such as Safeway (NYSE:SWY), Costco (NASDAQ:COST), and Electronic Arts (ERTS). The cash position is a little top-heavy at 10%, so I’ll be looking to add another healthcare name in addition to possibly cutting Goldman Sachs (NYSE:GS) and Peabody Energy (NYSE:BTU).

As the one year mark since the Portfolio’s inception nears, I have a very base desire to crack the 35% outperformance barrier over my benchmark S&P 500. I don’t know why 35% feels so much more “validative” than the 30% I sit at now, but 35 points of alpha is my goal, and I’ve got just under a month to get there. To that end I’ll be employing all the cash on Monday, in line with my slight hedge toward an upward market bias and the fact that there’s just a few stocks out there that look ultra-attractive.

Disclosure: Author does not hold personal stakes in the companies mentioned.