Wednesday, August 4, 2010

August Investment Report

July was a good month as this portfolio regained a significantly part of the losses from May/June. A lot of the issues that we incorrectly thought wouldn't impact the markets were mostly resolved during July providing for the strong market reversal. In the end our theory was correct, but it took the market a couple of months to accept it.

China & Copper
One of the biggest concerns in the market was the slowdown in China leading to a major bottom in the Chinese stock markets at the start of July. This major reversal of a leading market that peaked in December is leading the way for this global market advance. At these levels, China still needs to gain 20% just to return to the recent April highs so the gains have likely just started.

Copper made a major reversal just as many a technician expected further declines. Copper now sits at $3.4/lb and could easily retest the recent $3.6/lb and possibly the highs in the $4+/lb range. As such a short on Freeport-McMoran (FCX) was covered at the start of July and quickly turned into a long position. Towards the end of July, China recycler and producer of refined copper products, Lihua International (LIWA), was bought. LIWA recently added another copper smelter to double production yet with the stock trading at a sub 10 PE before this news it hardly budged the stock.

Other investments to take advantage of a return to China is local coal producer Puda Coal (PUDA), along with US met coal producers Alpha Natural Resources (ANR) and Massey Energy (MEE). Small Chinese stocks trading in the US continue to be the cheapest plays, but they do offer a high level of risk hence the diversification into much larger domestic plays that benefit from the return of China.

Earnings Yield
With the double dip likely out of the way, many stocks remain at extremely cheap levels with 10%+ earnings yields. Too much focus is placed on dividend yields, but not much focus is placed on the amount of earnings a company has compared to its valuation other then the PE. This is while the 10 year Treasury yields only 3%. This makes stocks earning a lot of money much more attractive then fixed income. Some of the companies in this portfolio such AerCap Holdings (AER), Foster Wheeler (FWLT), Hartford Financial (HIG), Atwood Oceanics (ATW), and Teradyne (TER) have earnings yields far in excess of 10%. For example, AER has a yield of nearly 16% with the potential for plenty of growth in global airplane leasing. These incredible yields provide great growth opportunities providing for superior return options. On top of that, leverage is being utilized to invest in yields substantially above margin rates.

Conclusion
All in all, the markets remain extremely cheap even after a strong July. The volatility will remain high going into the elections in November. Since the Democrats and Obama will likely lose power, this should be bullish for the markets going into the elections unlike the normal cycle where uncertainty leads to market declines. The likelihood that gridlock will block anti market, pro regulation environment should push stocks higher. At this point, the portfolio will likely remain stable until selective opportunities present themselves to prune positions.

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