My 2013 Investment Game Plan: Year-End Lookback

by: Ray Merola

In early January 2013, Seeking Alpha editors published, "My 2013 Investment Game Plan." That link is found here.

As I have done in years past, I followed up with a 2013 mid-year review.

I am now writing you with a full-year lookback upon the general plan assumptions and accuracy. Then I will review general results by analyzing the primary plan investments.

For simplicity, I've lifted original excerpts from the January article; followed up upon by a short discussion after each section.

Let's get to it.

"My 2013 Investment Plan" Basic Assumptions: Review and Analysis

January Excerpt: The global economy will show improvement. The economies of the United States, China, and Japan will all demonstrate positive growth. Emerging markets will hit-and-miss follow along. Europe has seen the worst of its recession, but ongoing deleveraging will continue to prevent any meaningful economic expansion.

Assumption Correct. On balance, the largest world economies have indeed strengthened. Economies of the United States, China and Japan have expanded. The Chinese growth rate has been 7 or 8%; Japan advanced modestly. Third quarter U.S. GDP grew at a 4.1%, the highest rate since the Great Recession. The EU has found an apparent bottom. Emerging markets of Asia and Africa have been relatively strong; Latin America, notably Brazil, has faltered.

January excerpt: U. S. interest rates will remain low. Indeed, the Fed has stated their intent to keep rates down. Likewise inflation will remain subdued. The banks will continue to straighten themselves out, perhaps with even more vigor than 2012. Residential housing markets will exhibit meaningful recovery throughout most of the nation.

Assumption Correct. These premises were correct. Despite a sharp rise in the 10-year note, the rate remains low by historic standards. Short rates remain very low. Inflation has stayed down. U.S. banks are now amongst the best capitalized in the world. Housing is clearly recovering.

January Excerpt: Gold will continue to rise, though moderately.

Assumption Incorrect. Gold is down big-time. The 10-year bull run is over.

January Excerpt: U. S. equity markets will trend modestly higher; there is a greater chance of extra upside than major downside. I make no numerical predictions on the market averages. I do premise that 2013 will be a decent year for corporate earnings. However, the Washington-manufactured "fiscal cliff" crises will dog the averages, along with both the reality and threat of higher taxes. Cuts to various government programs will not help the situation, either.

Assumption Generally Correct. U.S. equities have surged in 2013. The market shrugged off all manner of political issues. Corporate earnings have been good. Things have actually gone better than I had anticipated.

"My 2013 Investment Plan" Asset Strategies: Review and Analysis

NOTE to READERS: I have authored Seeking Alpha articles on many of the investments listed below. Whereas S.A. editors published a 2013 article of mine about a security, I've included a link to the article for readers who wish to take a deeper dive.

Strategy: Concentrate equity investments in global Industrial, Financial and Energy sectors. I also will retain moderate exposure to the Materials sector. My go-forward rationale is that 2013 will see a marked improvement in many global economies. Typically, business cycles last five to seven years. However, the monetary tinkering by several international agencies has muddled the picture.

Underpinning this stance was the premise that the United States economy would gain momentum. If so, the aforementioned stock sectors historically outperform.

Industrial Sector

In the Industrials space, I began the year with significant positions in Caterpillar (NYSE:CAT) and Eaton Corporation (NYSE:ETN). As the year progressed, I added Union Pacific Corp (NYSE:UNP).

Caterpillar has lagged the averages, up about 5% including the dividend. Nevertheless, CAT remains one of my favorite long-term Industrial stocks despite just about everything going wrong in 2013. Heavy mining equipment demand has cratered. Construction equipment and industrial engine sales are down. Company and dealer equipment inventory drawdowns have exacerbated the earnings decline. Neither corporate management or Wall Street sees much hope for improvement in 2014. Yet the dividend was boosted 15 percent. Operating cash flow has been good. Here is the link to why I still like the Big Cat: "Reassessing Caterpillar from the Ground Up."

Coming into the year, Eaton was a heavy overweight position. Year-to-date, the stock has returned about 43%. Under CEO Sandy Cutler, the company focused upon digesting its major acquisition of Cooper Industries. Cutler and his management team under-promised and over-delivered; I contend this behavior will continue into 2014. Having trimmed the position after a 25% gain, I plan to let the rest run. These thoughts are amplified in a Seeking Alpha article found here.

Aligned with my view to overweight the Industrial sector, in late June I opened a position in Union Pacific Corporation (UNP). This best-of-breed railroad is a transportation kingpin for the western two-thirds of the U.S. On December 11, Seeking Alpha editors published my detailed opinions about the company, "A 2014 Conviction Buy: Union Pacific Deserves a Spot in Your Portfolio."

Financial Sector

My 2013 financial sector holdings included Wells Fargo (NYSE:WFC) and Aflac (NYSE:AFL). Later in the year, I added a small position in U.S. Bancorp (NYSE:USB), and subsequently an additional position in U.S. Bancorp preferred B shares (USB-H). These securities have performed well in-line with expectations.

Wells Fargo is my favorite banking stock. Corporate management has executed flawlessly, reporting 15 consecutive quarters of record earnings growth. WFC originates nearly two-thirds of all U.S. residential mortgages. I like the Main Street banking business model: take in customer deposits, and make consumer loans. A mid-year article detailed my views on the bank here.

I contend Aflac stock is undervalued and misunderstood. This Dividend Aristocrat has an excellent balance sheet, outstanding management, and a niche insurance business model. Nonetheless, the P/E multiple languishes around 10x. I believe investor mis-perceptions around the Japanese / U.S. business structure and yen/dollar exchange conversion rates are factors. For readers who would like to know more about Aflac's corporate structure, my ownership thesis, my article, "Investors Get a Second Bite at Aflac," may be of interest.

In early 2013, I added another financial sector name to the portfolio: U.S. Bancorp. Effectively, I like this bank for nearly all the same reasons I like Wells Fargo. Seeking Alpha editors published my article outlining this thesis entitled, U.S. Bancorp Is A Chip Off The Wells Fargo Block. Later in the year, I also accumulated a position in the Series B preferred shares (USB-H). These floating rate preference shares link its payout to the 3-month LIBOR (London Inter Bank Overnight Rate) plus 350 basis points. Based upon a recent closing share price of $19.33, investors realize a stout 4.63% annualized yield. Given historically low interest rates, the payout should eventually move higher. These shares add gloss to the investment by trading at a 22% discount to par.

Energy Sector

Entering 2013, I overweight Energy sector stocks via 3 industry-diverse holdings: international, integrated Royal Dutch Shell (NYSE:RDS.A); fast-growing energy service concern Halliburton (NYSE:HAL); and pipeline MLP Energy Transfer Partners (NYSE:ETP). Late in the year, I supplemented ETP by purchasing units of its sister company and MLP General Partner, Energy Transfer Equity (NYSE:ETE).

Royal Dutch Shell's 2013 stock performance failed to keep up with the averages, only logging a gain of 3%. However, the dividend boosted total returns by another 5.5%. Corporate leadership is 2 years into a 4-year plan to improve cash flow dramatically and link the performance to the shareholder dividend. Seeking Alpha published several articles I wrote about the Plan and its results, the most recent of which is found here.

On the other hand, Halliburton stock has seen nearly a 47 percent return since January 1. I leveraged the return by utilizing deep-in-the-money long calls on half the total position. I believe this global oil service giant has plenty of additional upside. A combination of strong overseas growth prospects, emphasis on deepwater plays and North American unconventional wells, plus good expense management should result in further margin expansion. My 2014 price target is $64. A more detailed analysis of HAL is found in my article, "Halliburton May Offer a Rare Opportunity in This Hot Market."

The big story behind Energy Transfer Partners isn't its YTD 28% unit price increase. It's the multi-year breakout potential of this high-yielding MLP. Investors have been down on ETP due to a flat cash distribution since 2008. No more. A series of large acquisitions overhauled the corporate landscape. Energy Transfer spent most of 2013 digesting and rationalizing assets. The once Texas-centric natural gas transportation business has expanded into a national, integrated downstream hydrocarbon company. A commodity-driven NGL business model has given way to a fee-based energy transportation and distribution system.

Looking ahead, I believe Energy Transfer Equity, the MLP GP, has even more potential than Energy Transfer Partners. I took profits in some ETP units to begin a new position in ETE. During the second half of 2013, I built a full position in this stock.

Seeking Alpha editors have published a series of my articles covering Energy Transfer. The most recent discusses both companies: "Energy Transfer Investor Day: Explosive Performance Ahead."

Materials Sector

Entering 2013, I retained small core positions in Materials sector stocks Nucor (NYSE:NUE) and International Paper (NYSE:IP). Around mid-year, I booked a decent gain and eliminated a position in Dupont (DD). However, during the remainder of the year I became convinced the economic business cycle was starting to move from early-cycle to mid-cycle. Therefore, I want to overweight Materials sector names.

Nucor is my choice as the best-of-breed American steel manufacturer. The stock has done well: in one sense, too well. Despite a soft steel market and lackluster earnings, the stock has refused to fall. Free cash flow has been good, and the stock has gained 25% this year. I have a close watch on the shares; looking to increase my position on any meaningful pullback.

Management has used the prolonged business downturn to invest heavily for the future. This includes a new DRI (direct reduced iron) facility, an acquisition of a steel fabrication / distribution company, and a JV partnership with energy company Encana to develop gas wells that will directly supply energy to Nucor facilities.

I had better success building up shares of International Paper. Management is currently doing an excellent job integrating the Temple-Inland acquisition. Experienced CEO John Faraci has reported accelerated post-merger synergies. The stock has garnered 23% YTD and bumped the generous dividend. I've tripled the number of shares in my portfolio and look at IP to be a key 2014 performer.

A recent S.A. article that covers my thinking about both these Materials sector favorites is found here.

Strategy: Reduce holdings of selected Tech stocks. My two core investments in this area have been Apple (AAPL) and Intel (INTC). I've owned shares of both corporations for many years. I'd like to trim my exposure to both stocks, but I'll patiently wait for the right price. I plan to take some profits in AAPL if it breaks $600 again. I remain positive on Intel: notwithstanding its legions of naysayers. The balance sheet, cash flow, and yield are outstanding. However, I'm watching for a decent catalyst coming down the road. If not, I may lighten up if the shares firm up to $24 or so.

As noted in my mid-year review, I changed my mind on the aforementioned strategy early in 2013. I elected to increase, not reduce my exposure to the Tech sector. I added to my Intel holdings via 2015 long call options, financed by selling short puts. Due my view that a real U.S. economic recovery was taking shape, I added Oracle Corporation (NYSE:ORCL) to the portfolio.

Unfortunately, Apple's well-chronicled tumble from its $700 perch continued well into 2013. I held my shares under the opinion that the stock was experiencing excessive negative investor sentiment and chronic undervaluation. After hitting a June low of $384, the shares have rallied to as high as $570.

Earlier this year, I outlined why I believe that Apple's P/E ratio is an anomaly in a namesake S.A. article.

As a long-term Intel Corp shareholder, "investor fatigue" has been an issue from time-to-time. Fighting the urge to sell, I instead bought more when the shares dipped earlier in the year. My eye has been on margins, ASP, and the dividend. An October article outlined why I thought the shares had temporarily stalled, and what to watch going forward. It's hard to believe the shares are up 27% this year. I think there's more upside ahead.

In June, I opened a position in yet another old-line Tech company: Oracle Corporation. The software giant has a fortress balance sheet and generates huge free cash flow. After a missed quarter, I believed the stock had bottomed at $30. I bought deep-in-the-money long calls.

Despite registering a good short-term profit, Oracle was one of the few instances where I sold a stock in less than 18 months. The most recent quarterly earnings report bumped the shares up the fair value, so I re-deployed the cash to Materials sector stocks.

Strategy: Get into Healthcare. I missed the boat on this sector in 2012. Nothing in the kitchen for the sector. Boy, does that bug me. I premise, politics aside, that ObamaCare will be a boon for select health care stocks. My problem will be to find value. I don't like the picture for many of the large Drug stocks. I've got my eye on Johnson & Johnson (JNJ), Abbott Labs (ABT), and a few smaller names. I want in, but won't chase.

Ultimately, I fulfilled my objective to diversify into the Healthcare sector by purchasing long calls on Express Scripts (NASDAQ:ESRX). This pharmacy benefits management company recently completed a merger with MedCo and now is the biggest PBM on the block. Revenues, earnings, and cash are expected to grow significantly. Summertime worries over the impact of ObamaCare on the PBM business provided what I believe was an opportunistic entry point. I wrote a S.A. article why I liked ESRX here. My stock has run from $58 to $70, and I continue to like its forward prospects.

Strategy: Underweight Utilities and Telcom. During 2012, I accumulated positions in Vodafone PLC (VOD) and Excelon (EXC). I'm pleased with Vodafone despite its lackluster underlying capital performance. It's an out-of-cycle, beaten-down global telecom that's concentrated in Europe......Since I assumed moderate economic growth in 2013, I see no need to bulk up on either of these sectors [Telecom or Utilities]. Indeed, whereas Utilities used to be considered safe, slow-growers, I am convinced this is no longer the case. De-regulation, government over-regulation, and energy conservation initiatives leave me no catalysts for jumping in now.

During 2013, Vodafone's sale to Verizon Corporation (NYSE:VZ) of its 45% ownership in Verizon Wireless played out into a very pleasant surprise. The stock raced up on rumors, a deal was inked, and the shares have continued to drift north largely on more rumors of an AT&T Corp (NYSE:T) buyout of the remaining assets. My plan has been to retain Vodafone shares, sell when-issued Verizon shares, and start a position in AT&T. An article entitled, "Why I'm Keeping Vodafone, Selling Issued Verizon Shares, and Substituting AT&T" explains why I favor that approach.

Consolidated Edison (NYSE:ED) is an old-fashioned, regulated utility serving the Greater New York metropolitan area. In order to retain modest exposure to the Utilities sector, I built a position after a summer downdraft spurred on by interest-rate jitters. As expected, this Dividend Aristocrat found its footing around $55; now I'll simply continue to reinvest the current 4.5% payout and methodically accumulate more shares. In June, Seeking Alpha editors published a detailed stock analysis I wrote about Con Ed here.

Strategy: Look for bargains in Consumer Staples. Given my premise that we will see moderate economic growth in 2013, I suspect the Consumer Staples sector will lag the averages. Therefore, this will be precisely the time to look for some bargains. I currently hold a solid position in stalwart General Mills (GIS); I'm happy to add to the position if the stock gets oversold. I also have a small position in tobacco company Lorillard (LO).

This strategy morphed as 2013 progressed. The stated premise was incorrect: the Consumer Staples sector did not lag the averages. Therefore, my lone current Consumer Staples sector stock remains General Mills. Meanwhile, I sold shares of Lorillard earlier in the year at a good profit.

General Mills stock, along with many other Consumer Staples names, looked overheated for most of the year. It has since cooled a bit, especially after the most recent earnings release. Nevertheless, I'll hold it as a core position. The company has several long-term positives going for it: a sound international business plan; excellent dividend growth; an industry-best supply chain; and unquestionably strong management. Opinions on why I'm sticking with "The General" is found here.

Strategy: Hold my lone position in Consumer Discretionary. I carried over a solid stake in TRW Automotive (TRW), a global manufacturer of automobile safety systems and equipment. I like the stock, but it's approaching what I believe is full value. If I get my price, I would be very selective about another Consumer Discretionary stock. I do see some decent value in certain retailers, but I envision too many other stocks that trump them.

In accordance with my plan, I began lightening my TRW Automotive stock when it reached $60, and finally exited the entire position over the summer with an excellent gain. In its place, I opened a position in General Motors (NYSE:GM) via stock warrants. I contend the company is high on the comeback trail: offering a fine vehicle lineup, improved overseas operations, and a cash-laden balance sheet, all against a backdrop of a multi-year runup in North American auto sales. I envision GM as one of my top 2014 prospects. Indeed, the warrants have logged an outstanding return since purchase.

Strategy: Hold some bonds as a placeholder. Last year, I re-learned a valuable lesson: no matter how upbeat or bleak the situation for any class or sector, stay diversified. I thought bonds would go nowhere in 2012, but my holdings turned out to be a very pleasant surprise.

Bonds were not the place to be in 2013; and as noted in my January premise, I continue hold down exposure to fixed income investments.

For the last two years, with a few exceptions, I have advocated reducing or eliminating all bond funds. The fixed income part of my portfolio is held primarily in the form of individual securities.

During the course of the year, I scaled back, exchanged, or hedged most bond funds.

These included the Pimco Total Return Fund (MUTF:PTTRX), the Pimco High-Yield Bond Fund (MUTF:PHYAX), and the Templeton Global Bond Fund (MUTF:TGBAX).

I sold the Total Return Fund, and exchanged the proceeds for a far smaller position in the Pimco Total Return Fund ETF (NYSEARCA:BOND). This ETF, also managed by Bill Gross, sports better returns and lower expenses. Furthermore, I hedged the position with a position in the ProShares Ultra Short 20-year Treasury ETF (NYSEARCA:TBT). The combination of the two securities effectively net out capital gains and losses; each works inversely against the other. I skim off the interest distributions from BOND each month and attempt to fully protect the underlying capital.

I continue to hold positions in the high-yield bond space and international bonds through Pimco and Templeton funds. Neither are as closely tied to U.S. interest rates. My plan for the Pimco High Yield Fund is to watch the spread between the 10-year T-note and Baa corporates. If the differential falls below 2 percent, I will begin to scale out. This has not occurred: the latest spread is comfortably above my bogey at 2.37%. Rock on, high yield.

Rounding out this asset class, I sold about half of a long-term position in the Vanguard Convertible Securities Fund (MUTF:VCVSX). The spread between the 10-year T-note and Aaa-rated corporate bonds has blown out to greater than 2 percent. That's my signal to sell. I will continue to systematically sell down the position unless that spread narrows.

I also have small core positions in a TIPS ETF.

If you would like to read more about my views on managing fixed income in today's economy, my Seeking Alpha article entitled, "Current Strategies and Premises for Managing Fixed Income Investments," may be of interest.

Strategy: Hold Gold and Increase Real Estate. I believe that the yellow metal should always be a part of my portfolio as I believe that the yellow metal should always be a part of my portfolio as a hedge. While I premise that gold will rise yet again in 2013, I am happy with a 5 percent allocation of the total portfolio via the iShares Gold Trust (GLD). On the other hand, I plan to increase my interest in income-producing real estate and the mREIT Annaly Capital (NLY).

Gold has been a very poor performer this year. My expectation for a modest rise this year...well, I blew it. My losses were partially buffered by the sale of 25% of my iShares Gold Trust shares very early in the year. I have let the rest ride. Nor do I have any plans to buy or sell gold in the near-term. I consider a small gold position a hedge against a weak dollar and global turmoil. My current allocation is now 2%.

Conversely, I bought into sharp declines in mREIT Annaly Capital Management shares via outright purchase and dividend reinvestment. In addition, I have taken up a good position in the discounted Annaly Capital Preferred D shares (NLY-D). The current yield on this discounted security is nearly 8.5%.

I believe the mREIT sell-off has been overblown, bordering on panic. Annaly's share price is currently 20% below net book. The stock price relationship versus the 2 / 10-year Treasury note spread has reached a divergence unseen since the inception of the Annaly Capital enterprise.

Back in June, Seeking Alpha published an article about my thought process around NLY stock ownership. It's found here.

And finally,

CASH is king. I tend to hold a fair percentage of cash in my portfolio; this year I may let the figure float to as high as 15 percent. I'm here to say that it doesn't bother me an iota 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 barely above one percent.

Indeed, I remain committed to holding some cash. Cash as a function of my total portfolio is now about 12%. These funds allow me the flexibility to take advantage of underpriced securities, and act as ballast for the rest of the portfolio. As a younger retiree, I maintain asset allocations of approximately 65% to 70% in equities, about 20% in fixed income, and the balance in cash.


On balance, the year 2013 has been an excellent year. I was pleased with my overall portfolio performance. Most securities performed in-line with benchmarks or meet expectations; with a few notable exceptions.

Significant underperformers Caterpillar, Annaly Capital, and gold were offset by outperformers Eaton, Halliburton, General Motors warrants, TRW Automotive, Vodafone and Wells Fargo. While beyond the scope of this article, the use of equity options further enhanced returns on many stocks, too.

Heading into 2014, I am bullish on Union Pacific, Energy Transfer, Apple, and despite the naysayers....Intel and Caterpillar. My portfolio equity exposure is now most concentrated in the Industrial, Financial, and Energy sectors. I will seek to also overweight Materials stocks, while trimming back some big gainers. I believe these 4 sectors will benefit from accelerated economic improvement, even if interest rates rise a bit.

Fixed income holdings are currently scaled back and/or hedged: I have no intention to change much in this space.

Real Estate via mREIT Annaly Capital Management and gold were terrible performers in 2013. Nonetheless, I have no plans for any drastic moves here, either. My holding period for Annaly is at least 4 more years.

Note to Readers: These views are my own. I am not trying to sell anything, nor providing specific investment advice to readers. Indeed, I simply enjoy sharing / exchanging views with fellow S.A. investors, based upon thirty years of practical experience.

Good luck with all your investments.

Disclosure: I am long CAT, UNP, ETN, WFC, USB, AFL, RDS.A, HAL, ETE, ETP, NUE, IP, GIS, ESRX, VOD, T, GLD, ED, NLY, AAPL, INTC, GM. 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.