A Mid-Year Review of My 2011 Investment Game Plan

by: Ray Merola

Back in January, I outlined my 2011 economic assumptions and investment game plan via Seeking Alpha. The article is found here. In this article, I will review the January premises and game plan at the current mid-year juncture.

Please find following my overview statements of the economic assumptions premised six months ago, a brief look backwards, and a go-forward view:

2011 Assumptions

  • The global economic rebound continues. The global rebound has proceeded, particularly in much of Asia and Latin America, less so in Europe and the U. S. I offered the our economy would participate, though the recovery would be sluggish: housing and unemployment would remain weak. Manufacturing has shown steady improvement as evidenced by the ISM index. Whether the U.S. GDP will approach 3 percent and we will avert a double dip recession remains to be seen.

Look back: These assumptions were largely on-track, though I have reservations whether or not U. S. GDP will approach 3% by year-end.

Look forward: No fundamental change in assumptions. I suspect the U. S. growth rate will improve from the first half. I do not subscribe to the camp whereas our economy will fall back into recession.

  • U. S. interest rates will rise, but only moderately. I premised there would be no inflation spike in 2011, ten-year treasury notes would yield not more than 4%, and banks will loosen credit somewhat.

Look back: Assumptions were essentially on-track. Inflation as gauged by the Fed has remained in check. Interest rates have stayed low; I did not foresee rates would fall lower than January. Now that QE2 is over, it is debatable if T-note yields will remain below 4% throughout the duration of the year.

Look Forward: No fundamental change. I envision no dramatic 2011 interest rate uplift.

  • Gold will continue its march upward. Oil will break $100 a barrel.

Look back: These assumptions were on-track to-date. However, gold didn't exactly “march” upward. It's up about 4% in the first half. Oil broke the $100 barrier, but fell back for the time being.

Look Forward: I believe gold will continue to tread water for awhile before resuming an upward trajectory through year-end. Oil may settle around $80 to $95 for several months. However, I believe we remain at risk for another upward spike given any number of geopolitical events, monetary machinations, or supply disruption.

  • U. S. equity markets will trend higher in 2011. I predicated this upon the belief that corporate earnings would continue improve. An ancillary premise was that companies would begin to loosen the reins on their cash hoards. This jury is somewhat out, but appears heading the right direction.

Look back: This assumption was largely on-track. Corporate earnings did continue to improve, and despite all the macro worries, earnings drove the market higher. The S&P 500 was up about 4% in the first half. The ttm PE is 15.8. That's reasonable. The projected 2011 multiple is 12.8. For reference, the ttm PE was at a 17.8 at the end of June last year. Some big companies have boosted dividends and share buybacks. M&A activity has improved.

Look Forward: No fundamental change of this view. I continue to foresee improvement in corporate earnings driving the market up in the second half, particularly large cap companies with broad international exposure.

Next in the January article, I provided readers with my investment game plan, including actionable proposals. Let's walk through how these are panning out:

My 2011 Investment Plan

  • Concentrate equity investments in three sectors: Industrials, Basic Materials, and Energy.

Look back: This foundation premise produced mixed first-half results. Of the ten S&P sectors, Energy finished #2, Industrials were #4 and Materials ended up #8. These sectors looked a lot better in the first quarter than the second. I had premised that we were entering the early and middle phases of an economic recovery cycle, and these specific segments would reap outsized benefits of an increasing demand for heavy machinery, engines, capital equipment, and construction materials. Energy stocks would benefit from the increased worldwide growth activity and associated higher prices. The assumption was partially correct, as select Energy and Industrial companies did well, though they gave up some gains in May and June. Most Materials stocks lagged.

2H plan: While mid-year look back offered a mixed bag, I am sticking with the overall big picture thesis. Worldwide economies will improve in 2011. My take is that the so-called economic “soft-patch” is just that: not a prelude to a double-dip recession. While I suggest the U. S. may continue in a “muddle along” mode, this unto itself will not derail strong sector international corporations. China is not about to roll off the face of the earth. While Japan may not get traction until 4Q at the soonest, Latin American economies will expand. I remain bullish on Caterpillar (NYSE:CAT), Illinois Tool Works (NYSE:ITW), Honeywell (NYSE:HON), Nucor (NYSE:NUE), and Exxon (NYSE:XOM). I have added International Paper (NYSE:IP), Halliburton (NYSE:HAL) and Alcoa (NYSE:AA) to this space. Caterpillar is my favorite stock pick of the lot.

  • Stay invested in a few select Technology and Financials. I favored a select few larger banks and technology companies in January: Apple (NASDAQ:AAPL), Intel (NASDAQ:INTC), Wells Fargo (NYSE:WFC) and Citigroup (NYSE:C).

Look back: I stuck with Apple, Intel, and Citigroup. I'm still happy with Apple and Intel: I believe these stocks continue to offer strong upside value. I thought Citigroup could be a double. No way in 2011. I trimmed my Citi holdings, have been writing options to hedge the position, and have taken up the mantra of a Chicago Cubs fan: “Wait 'till next year.” I sold off Wells Fargo (WFC) in the first quarter in an attempt to reduce exposure to the financial sector.

2H Plan: I'll stay on the program. Apple and Intel remain deep-conviction tech favorites. I bought a little more Apple on the June dip. Within twelve months, I continue to project INTC and AAPL to be $28 and $460 stocks, respectively. I'm willing to give Vik Pandit and Citigroup until early 2012 to get their act together. I contend that the Obama administration is generally anti-business, and particularly anti-bank. Under this scenario, patience may be rewarded, though I suspect that many bank stocks will be dead money in the short-term.

  • Underweight Utilities, Consumer Staples, and Health Care.

Look back: I completely missed the Health Care sector first-half run-up. My premise that there is too much uncertainty around ObamaCare and drug-patent cliffs did not come true, at least for now. Indeed, during the 2Q flight to safety, I did not rush to retool my portfolio with names from these sectors. I sold into the strength by selling my shares of Bristol Myers (NYSE:BMY) at a good profit, and moved into American Electric Power (NYSE:AEP) to maintain diversification. The out-sized yield eclipsed that of Bristol-Myers.

2H Plan: Remaining consistent with my underlying economic expansion premises, I do not plan to rotate from cyclicals to defensive stocks now. Of course, diversification is always in style. Underweight does not imply NO weight. Therefore, swapping American Electric Power for Bristol-Myers is in bounds. I will continue to keep my eye out for a screaming value buy in the Consumers Staples or Health Care sector: Coca-Cola (NYSE:KO), Sysco (NYSE:SYY), Johnson and Johnson (NYSE:JNJ) are on the radar. I remain negative on Big Pharma / Drug companies. I do not plan to return to that sector industry.

  • Continue to emphasize dividend stocks with strong balance sheets. My equity portfolio targets an average yield that exceeds the ten-year T-Note yield (currently about 3.2%; about ten basis points below the January rate).

Look back: I maintained this investment philosophy, shunning some of the high-growth, high-PE names bandied about. In addition to the names listed earlier, I added to my existing holdings of the ETF iShares Preferred Stock Index Fund (NYSEARCA:PFF) and my favorite transportation MLP, Energy Transfer Partners (NYSE:ETP).

2H Plan: Fortress balance sheet companies like Intel, Apple, Exxon, Royal Dutch Shell (NYSE:RDS.A) Illinois Tool Works, and Honeywell will continue to be bedrock investments. I have my sights on any one of several Telecom sector stocks to juice dividend returns further, but won't chase any of them. I plan to continue to write covered calls and puts to add investment income / hedge positions.

  • Seek to invest in U. S. companies with strong international exposure. Most of my previous picks fit this bill. I remain quite comfortable with this approach. For direct foreign exposure, I recommended the iShares MSCI Brazil index (NYSEARCA:EWZ) as a pick.

Look back: As premised, my portfolio emphasized large-cap international corporations. Unfortunately, the iShares Brazil index was a first-half dud. This ETF channeled since last October, leaving me essentially long flat. I was wrong about a post national election “pop.”

2H Plan: Stay the course. I continue to like the Brazil growth story, despite local inflation worries. I'll stick with the ETF index versus trying to pick individual foreign stocks. The EWZ fund continues to offer a 3% yield to boot.

  • Allocate equity securities to roughly 70% large cap, 30% mid cap, and 10% small cap. I've used this weighting for years. It's approximately the weighting of the Wilshire 5000 index. My targets are about 50% ETFs / index funds, and 50% individual stocks and bonds. I cut-and-fill re-balance via the index funds.

Look back and 2H Plan: I rebalanced at mid-year, whereas I was slightly overweight mid-cap holdings since the S&P400 index outperformed the overall market. I plan to retain these percentage targets.

  • Continue to reduce exposure to bonds.

Look back: My January thesis was, “The bond party's over.” While the party didn't exactly end, the punch bowl is looking pretty low with the demise of QE2. I see no QE3, per se. Maintaining exposure to a few good corporate bonds was an acceptable approach. I purchased no medium-term (five-year) Treasuries since yields did not poke up above 3%: This was my buy signal. Some exposure to TIPS provided decent returns in the first half. I bought no I-Bonds. Bottom line is that I may have missed some upside, but did no material damage to my portfolio, either.

2H Plan: It appears to me that interest rates cannot get much lower, though I espoused the same thing in January. Nevertheless, I'm happy with my current bond exposure and first half strategies. I would like to buy some I-bonds, but only when interest rates show a move up. New I-bond base rates will be re-priced in October. I'll stay tuned.

  • Flee most bond funds.

Look back: I held positions in the PIMCO Total Return Fund (PTTRX), and the Templeton Global Bond Fund (TGBAX) to maintain diversification in the debt markets. I trimmed exposure slightly to both positions. I bailed out of all other bond funds /indices in late 2010; sans the High Yield space. The jury is out on my call to hold High-Yield bond funds through the first half. The funds ran up nicely for most of the first half, but tanked big-time in May.

2H Plan: I continue to like PIMCO Total Return because it has demonstrated the long-term ability to navigate down interest-rate scenarios. Likewise, Templeton Global has shown the strength and flexibility to handle the ups and downs. Despite the May drubbing, I still like the Third Avenue Focused Credit Fund (TFCIX), and the PIMCO High Yield Bond Fund (PHYAX). While I offloaded a little of the PIMCO High Yield fun when it got close to the 200-day Moving Average, I am not ready to throw in the towel. As noted in my January article, my cue to head for the exits is when the spread between Moody's Baa bonds and ten-year Treasuries are less than 2%. The current spread remains about 2 ¾ percent. I will take the position that the HY sell-off has been overdone.

  • Maintain a position in gold.

Look back and 2H Plan: Gold netted a bit over 4% during the first half. I maintain the yellow metal will continue to rise in 2011, just as it has for the past ten years. I suspect there may be one more seller blow-out before the SPDR Gold Trust (NYSEARCA:GLD) finds its footing at $140. My gold-thesis premises are intact: The dollar remains relatively weak, a rising middle class in developing countries like China and India will demand more gold for jewelry, low interest rates continue to make the carrying costs for gold reasonable, and countries are racing to the bottom with a collection of fiat currencies. I added GLD shares in April for the straight play, although I suspect I bought in a little too early.

  • CASH is king.

Look back and 2H Plan: Seeking Alpha readers made several comments on my January fundamental premise to hold cash. No matter. It doesn't bother me to live with today's paltry interest rates. Given global monetary policies and excessive sovereign debt, I will continue to use U.S. Dollar cash as a risk hedge. I will not chase stock dividend yield or bond interest just for the sake of avoiding the pitiful current interest rates on cash. No deal is better than a bad deal. I'll ladder a few CDs, none more than a year out, take what I can get and be done with it.

There you have it. My first half portfolio performance did outdistance the S&P500 Total Return benchmark by a solid couple of percent points. This comes with the reduced volatility of carrying fixed investments and cash as part of the capital base. Please note that I did use options to bolster the income return. I've written SA articles to back up many of the positions outlined in this summary.

These views expressed in this article are my own. I am not trying to sell or promote anything to anyone. However, I do consider myself a Regular Joe Investor who enjoys sharing and exchanging views. My platform is nearly thirty years of practical “home-gamer” investment experience.

Good luck with all your 2011 investments.

Disclosure: I am long CAT, ITW, HON, NUE, XOM, IP, HAL, AA, AAPL, INTC, C, AEP, ETP, PFF, EWZ, RDS.A, GLD.

Additional disclosure: pttrx, tgbax, phyax, and tfcix are the mutual fund tickers for several of the positions discussed