Layered Over-Weighting Can Maximize Portfolio Strengths

by: Emmet Kodesh

About 70% of the American economy rests on consumer spending. There are serious potential pitfalls in this fact. Total household debt is $13 trillion, approaching the 2007 pre-crash level and nearly as large as the $17 trillion national debt. Additionally, individual net worth and incomes have been falling in real terms despite official measures of inflation that understate its actual level. America's economy has structural problems that continued debt creation, outsourcing and demographic decline do not help.

However, it also is true that many of the most profitable companies in the market are in the consumer sector, particularly consumer discretionary which includes the powerful media-entertainment industry. As I explained here and here, the products that big media prominently sells are lifestyles and government narratives. Sitcoms, films, sports, news and ads all mold behavior, identities and social relations. Thus, media is basic to ongoing cultural change and contains many companies likely to survive and out-perform when rough weather arises, as it surely will, for the economy.

This article considers a layered approach to asset allocation and strategy based mainly on consumer stocks. The method also can be used for primary weightings in other sectors. As we will see, every sector is included here but the weightings reflect my view on the core areas of our evolving socio-economic structure.

For ten weeks I have been discussing the best plays in the consumer space and their prospects for current growth and long-term viability. I also have suggested that for most people, owning a maximum of 12-15 stocks allows one to remain knowledgeable and able to react to month-to-month changes. An experienced person might push this to two dozen plays if he or she is willing to make a full-time passion of it. If many of your holdings are familiar long term positions, this number might be increased further. The size of a manageable portfolio also is affected by the nature of the holdings: Starbucks (NASDAQ:SBUX), Dunkin' Brands (NASDAQ:DNKN) and Whole Food Markets (WFM), all strong buys as I have suggested here and here, require more attention than long-established giants with products entrenched in multiple markets like Johnson & Johnson (NYSE:JNJ), Proctor & Gamble (NYSE:PG) or Coca-Cola (NYSE:KO).

Therefore, a layered approach that includes ETF's gives one broad exposure to a variety of consumer staples and discretionary weighted toward income-producing giants, media, entertainment and companies like SBUX and Apple (OTC:APPL) that mix service, food and technology with definition of social and individual status. Holding about ten companies is a strategic way to maximize the strengths of this sector. In addition to your favorite companies, holding two Vanguard ETF's, High Dividend Yield (NYSEARCA:VYM) weighted 23% to consumer companies, and Consumer Discretionary (NYSEARCA:VCR) can maximize the strength of this sector, mixing income, diversification, growth and staying power.

The consumer-weighted portfolio here is a way to overweight important companies in a vital sector. More conservative investors will lean more on the ETF's, particularly the sector-diversified and income producing VYM. Those who are able and willing to invest more in consumer and media-entertainment can put correspondingly more in VCR and individual holdings. Because of its breadth, value emphasis and lower beta, VYM could serve as a core holding for many people.

VYM yields 3.2% paid quarterly and its sector weightings are 22.4% consumer goods and services, 14.4% industrials, 12.6% financials, 12.3% energy, 11.8% health care, 9.3% technology, 8.2% utilities, 5% telecom and 4% basic materials. It holds 390 stocks and its top ten are 34% of its weight, anchoring you in some of the most deeply rooted companies in the world. As of September 30 these included, in order, Exxon Mobil (NYSE:XOM), Microsoft (NASDAQ:MSFT), General Electric (NYSE:GE), JNJ, Chevron (NYSE:CVX), Wells Fargo (NYSE:WFC), the most fiscally sound of giant American Financials, PG, JP Morgan Chase (NYSE:JPM), Pfizer (NYSE:PFE) and AT&T (NYSE:T). With the next ten including KO, Philip Morris (NYSE:PM), Verizon (NYSE:VZ), Wal-Mart (NYSE:WMT), Intel (NASDAQ:INTC), United Tech (NYSE:UTX) and Boeing (NYSE:BA), the two best of the aerospace-defense group and McDonald's (NYSE:MCD) one sees a base that is strong in energy, technology, Health Care - Pharma, financials, telecom and industrials as well as consumer staples and discretionary.

Be sure to include a strong weighting in health care in your holdings. As I have written, you can get diversification in the sector, income and very strong growth from mixing the Vanguard ETF (NYSEARCA:VHT) with its 39% anchor in pharma and significant presence (21%) in Bio-tech, managed care (7.3%) and medical supplies (15.4%) with the Fidelity Select Bio-Technology fund (MUTF:FBIOX), a more volatile very high growth fund with 99% American companies.

VCR covers the consumer discretionary field with 373 holdings, 34.4% of which were concentrated in its top ten companies as of September 30. The top ten are Comcast (NASDAQ:CMCSA), Amazon (NASDAQ:AMZN), Home Depot (NYSE:HD), Disney (NYSE:DIS), MCD, Fox (NASDAQ:FOX), Ford Motor Co (NYSE:F), Time Warner (NYSE:TWX), SBUX and priceline (PCLN). CMCSA, AMZN, HD and SBUX are near the pinnacle of profitability and growth: the share price of SBUX has increased tenfold in five years. CMCSA, SBUX, DIS and TWX are among the top-rated companies by analysts, all with various degrees of strong buys and deeply embedded in the dynamics of our culture. VCR's top twenty also includes CBS (NYSE:CBS), TJX (NYSE:TJX), Target (NYSE:TGT) and Lowe's (NYSE:L), other highly profitable, highly-rated growth companies in the markets. Among analysts at, only BA, UTX, SBUX, TWX and CMCSA boast ratings like the venerable CBS which has led the pack since the surge that began late morning October 9.

For individual companies that combine strong metrics with staying power one could begin with the last six named above. For profitability, growth and socio-economic positioning one might add debt free WFM, Honeywell (NYSE:HON), General Dynamics (NYSE:GD) and Freeport McMoRan (NYSE:FCX) whose acquisitions in American oil and gas have positioned it for big upside and viability going forward (with a 4.2% yield, paid quarterly).

Most portfolios also should have at least 5-7% PMs (precious metal) companies which continue to give the greatest value in the markets when and if fundamentals become more significant in pricing. The best of them, First Majestic (NYSE:AG), Endeavour Silver (NYSE:EXK), Silver Wheaton (SLW), and debt-free juniors with outstanding management, Fortuna Silver (NYSE:FSM) and McEwen Mining have multiple sites (SLW through its two dozen streaming agreements) enormous growth potential, profitability, production and provision into the markets of essential tech-industrial and monetary metals.

Here is the heart of a great portfolio based on companies that are foundational to what this society is and will be. Like Health Care, I believe that big media like CBS and TWX and extremely profitable consumer service-and-identity companies like SBUX and TJX merit over-weighting. Apportion the triad of VYM, VCR and individual companies according to your need for balance, income and willingness to entertain more growth and volatility.

An effective way to add international exposure is via Vanguard's developed markets ETF (NYSEARCA:VEA), weighted 60% - 40% Europe - Asia. As has been argued here, these companies, like many American majors from industrials to basic materials , energy and consumer issues (MCD, SBUX and DNKN are among those with large and growing global operations) provide access to emerging markets with far less volatility than owning companies based in EM's.

Friday October 18 provides an interesting snapshot of the group profiled here: on a day that the DOW consolidated and the S&P (+.61) made a new high, several companies in the layered-portfolio outlined above led out-performing issues: FSM +2.22%, EXK +1.43%, CBS +1.30%, TWX +1.15%, DIS +1.10%.

One Last Point: Because the markets have sentiment, momentum and QE behind them they are strong but fragile. Events of many kinds can cause drops for a few days or weeks. For example, Rob Arnott of Research Affiliates is among major analysts (like Art Cashin) recently to point to dangers from inflation. Thus, the more equities you hold outside of ETFs, the more important it is to rank order them by those you first would jettison to exit green or limit losses down to those whose fundamentals would lead you to hold and add on dips. Because plunging prices arouse passions, keeping such a list at hand can help you preserve capital when things get rocky and also tell you when to shift gains to cash.

Disclosure: I am long EXK, VYM. 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.

Additional disclosure: I own several of these companies and ETFs.