Brunch, Craft Beer And Investing: Embracing Volatility And Managing Risk

|
Includes: AAPL, ADBE, AET, ALB, CLX, CMCSA, CVS, EMN, FB, FDLO, FDX, FTEC, GOOG, JNJ, LAC, MSFT, MTN, OROCF, SKYAY, SPMV, SSTI, SWKS, T, TCEHY, THO, TM, USMV, V, WLK, XLY
by: Andrew Hesch
Summary

Reviewing strategy: mitigating risks and capitalizing on volatility.

Justifying trades from the quarter and what I'm looking at in the short term.

Giving my perspective on trade (briefly) and other concerns I have for the market.

Welcome to the Brunch, Craft Beer, and Investing Portfolio Review. If you've been here before, you know the holdings have nothing to do with brunch or craft beer. These are just hobbies of mine. My last portfolio review will give you a brief overview of the portfolio's origins, goals, and evolving strategy. Per usual, the strategy continues to evolve.

I wrote this while the headlines were fraught with fear and the S&P hovered around its 200-day moving average. I paid more attention to my concentrations this past quarter. Below is a list of ones with which I'm concerned, excluding exposure via ETFs.

  1. ~40% FANG+BAT concentration
  2. ~46% concentration in large-cap Ex-FANG/BAT
  3. 48% of the total 76% large-caps are FANG and Johnson & Johnson (JNJ)
  4. JNJ is 17.5% of the 26.5% total "recession-resistant stocks"

Coincidentally, the pondering, the sell-off, and quarter-end all came around the same time. Hence, I delayed the release of this review. Here's an outline of my musings:

FANG stocks carry significant weight in numerous ETFs, so cutting exposure by ~50% should be easy. The ETFs I focused on for FANG replacement are Fidelity MSCI Information Technology Fund (FTEC) and Consumer Discretionary Select Sector SPDR (XLY). These two funds have low expenses and I can buy FTEC commission free.

I want to maintain exposure to recession-resistant stocks, but reduce my exposure to JNJ. The only other stocks "recession-resistant" stocks I hold are Clorox (CLX) and AT&T (T). I would be comfortable selling ~10% of JNJ over the next year to fund purchases in other recession-resistant stocks.

I intend to have a basket of stocks that can balance the volatility of speculative positions, and another basket that emphasizes growth. Amidst the brief rebound on Friday, I decided to implement the strategy over time. While the economy is relatively strong, I need to be in a better position to take advantage of volatility and rebound from it. Downturns will be opportunities to buy things I've been waiting for: pro-risk stocks that took a beating and recession resistant stocks that didn't fall so much. To account for the lengthy delay, this review will include trades made through Friday, 10/12/18.

Portfolio Composition

Through the end of the 3rd Quarter, YTD performance was +10.72%, and over a year was 14.65%. The difference compares favorably to the S&P 500 on a YTD basis (+0.16%), but not so over a year (-3.26%). Performance was stifled by the change in strategy and the exposure to China.

Buys

Thor Industries (THO) was an impulsive buy. I came across it looking into manufactured housing and trends into low-cost and alternative-style homes (Thor manufacturers a variety of lines of RVs). It has a great leverage positions and a well-covered dividend. It's P/E is well below its 10-year median P/E and its historical average P/E, and its ROIC is 26% per gurufocus.com. I consider this to be outside-the-box of comfortable investments, but wanted to take advantage of its apparent value. Its primary risks include a current over-supply of RVs, and its recent acquisition of a German RV manufacturer. Still, leverage is favorable, and its 1.8% yield is well covered (18% payout ratio). Since purchasing, shares have declined further and an insider purchased shares, so it may be a target for buying down.

Comcast (CMCSA) was another value play below its 10-year median P/E with an ROIC of >20%. It has a sufficient payout ratio, with exposure to media mediums that AT&T doesn't offer (i.e. theme parks, animation, etc.). Numerous allegations of mismanagement, and I'm skepticism that content is king make this an uncomfortable investment. After buying AT&T (T) last quarter, I thought my adventure into the debt-laden land of media giants was over. Nonetheless, Comcast ended up in my portfolio prior to new, mismanagement allegations at NBC. Its Sky (OTCPK:SKYAY) acquisition is also a risk.

Orocobre (OTCPK:OROCF) was purchased to average down, reducing my cost basis by 20%+. Typically my rule to average down is that my cost basis must decrease 10%; however, I waited for 20%+ because the the stock is more speculative. Despite industry concerns of oversupply, I believe lithium will be a strong play well into the foreseeable future. My confidence in Orocobre stems from the JV with Advantage Lithium (OTCQX:AVLIF) and the corporate partnership with Toyota (TM), an automaker typically ahead of the broader innovation curve. It's one of two lithium stocks I own; the other is Albemarle (ALB). Combined, lithium makes up ~5% of my portfolio. Although, I'd hesitate to increase exposure going forward, further declines of similar magnitude will make me a buyer.

Tencent (OTCPK:TCEHY) was doubled to reduce my cost basis by 10%. The primary causes of its decline is related to geopolitical tensions and China's government monitoring game time. While I've come to terms with the lack of trade-tension-abatement and believe it will carry-on without economic rationale, I have a long-term horizon for Tencent to stomach single-president political tensions.

ShotSpotter (SSTI) has been on my watchlist for quite some time. It fell ~33% from its highs, so I initiated a small position. It makes gunshot detection equipment and software, supplying local governments and police departments with an innovative and more-accurate way of responding to emergencies. I consider this investment to be speculative. Although it has numerous locales currently using its products, it has not turned a profit. However novel, it relies on public spending when municipalities/police departments may not have sufficient funding. It recently acquired HunchLab to venture into AI and predictive policing. This is a position I'll consider increasing should it fall.

Fidelity MSCI Information Technology Fund (FTEC) was purchased on Friday's rebound. While researching, I realized that the chart of FTEC and Alphabet (GOOG) matched quite well. Apple (AAPL), Microsoft (MSFT), Google, and Facebook (FB) make up ~41%. FTEC pays a small dividend (~0.9% yield) and only costs .084%. Although I'm not a proponent of diversifying stocks for the sake of diversification, the ETF exposes me to a large basket of high-quality tech stocks. Therefore, I felt this a good first move to reducing FANG exposure, diversification, and freeing up some cash for any future downturn. The chart below compares FTEC (candles) to Google (Dark Blue) and the Nasdaq (Light Blue).

Sells

Comcast (CMCSA) didn't appreciate much, but the aforementioned concerns led me to prioritize my cash position to buy lower in other holdings. I'm concerned its mismanagement of PR issues is indicative of the broader management ability. It's yield isn't that appealing, and I have plenty of leverage with AT&T and [soon to be] CVS (CVS), via Aetna (AET). Still, it's tough to find a ratio to be upset with, and its broad lines of business offer growth potential. Competition in content is getting tougher, though. The resulting available cash was put to good use in the sell-off.

Google was sold in Friday's rebound in conjunction with the FTEC purchase outlined above. Selling one of the pillars of my portfolio caused me some anxiety. I wholeheartedly believe in Google's long-term viability and rigor through a recession, but given my low cash position, the presence of an adequate substitute, and a little dividend (from FTEC), I felt this move was best for me.

Looking Forward in My Portfolio

Fundamentals and value will be the primary focus for recession resistant picks. A possible way to accomplish a better allocation of recession-resistant pick is a minimum volatility ETFs. A couple considerations are Invesco S&P 500 Minimum Variance (SPMV), Fidelity Low Volatility Factor (FDLO), and iShares Edge MSCI Min. Vol. USA (USMV). I have yet to decide how to approach this part of the strategy. I have pondered luxury good manufacturers, consumer staples, and utilities, but haven't become comfortable with any yet.

As for pro-risk stocks I'm looking at during continued volatility, Adobe (ADBE), Vail Resorts (MTN), and Visa (V) are honorable mentions. I'll hold out a while longer to buy my Chinese and cyclical stocks lower. The cyclical stocks are being sold like a recession is on the horizon, so I want to wait. The ones I'm watching are FedEx (FDX), Skyworks Solutions (SWKS), Eastman Chemical (EMN), and Westlake Chemical (WLK).

Looking Forward in the Market

Washington seems to be a primary factor in market volatility. Mid-terms may contribute to market volatility as uncertainty persists, policy goals change, and political posturing occurs. Another source of market volatility may stem from dollar-denominated debt in emerging markets. The health of China's economy should concern its dominant trade partners, which includes many emerging economies, and countries that have a significant trade relationship with China, including the US, Germany, Australia, and much of the East Asia region.

The late-cycle stimulus and initial effects of tariffs are shown in economic indicators. For my brief take, I present the following chart.

Simply put, there are not enough people out of work to fill the job openings. This is lost productivity. While this has been the case, the tariffs have stimulated short-term demand for cheaper products (before tariffs cause prices to increase), and the fiscal stimulus has enabled companies to justify the necessary expansion to handle the increased demand. That demand goes unmet because there aren't enough workers filling the jobs at the rate they need to be filled. Manufacturing job openings are also the highest over the period, but are a significantly smaller proportion of job openings. This may minimize the plausibility of actually accomplishing our goal with the tariffs (i.e. revitalize manufacturing in the US). The macroeconomic numbers indicate that there aren't enough unemployed people to support current economic capacity, let alone capacity that is being sought via tariffs. Ultimately, this mutes the result of any concessions the US achieves in unforeseen trade negotiations with China. Should tariffs persist, Chinese-located manufacturers would be more financially motivated to just move to a different, low-labor-cost, more-tax-friendly country, but not the United States. However, regional or local data may provide alternative indications. Some economic indicators in other developed countries indicate slowing growth (Germany's manufacturing productivity declined in August). Although my economic outlook remains cautious, the US economy is humming along by a variety of measures.

Stay tuned! If you enjoyed the outlook synopsis and want to stay up to date on my portfolio, hit the orange follow button!

Disclosure: I am/we are long ALL STOCKS LISTED IN THE CHART. 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 may initiate a long position in ANY STOCK LISTED over the next 72 hours.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.