Saturday, January 21, 2012

Investment Report - Opportunistic Levered: January 2012

After a strong 2009 and 2010, 2011 was a year to forget for this portfolio. The market hit highs around the end of April and this model was soaring to new heights at the time. Many of the holdings had valuations nowhere near the 2007/08 peaks or even close to what would normally be considered rich. Regardless, leverage was reduced since some gains were significant. Then, unfortunately most of the stocks collapsed and even in a few cases approached 2009 lows. With too much leverage left, the model was hit very hard.

The good news is that valuations started the year as attractive as during the financial collapse of 2009.

2012 Outlook


Portfolio Construction
The portfolio remains overweight on the global growth theme. Most of the stocks in this sector trade as if emerging markets are headed towards a recession instead of continued growth.

The biggest challenge to our investment strategy in 2011 was the major inflation fears in emerging markets like China, India, and Brazil. As 2011 ended, all these countries were reporting inflation numbers at the lows for the year which is supportive of monetary easing that has already started in most cases. This removes a significant headwind for the global growth theme going forward.

2011 ended so badly that finding stocks that exceeded expectations for the year was difficult. Liz Claiborne (LIZ) was probably the best performer as the transformation away from the namesake brand towards kate spade, Juicy Couture, and Lucky Brands was completed. With the announcement of the new Fifth & Pacific (FNP) name and stock symbol, the stock surged to 52 week highs. As kate spade continues reporting astonishing sales comps, more is expected out of Liz in 2012.

Just about every other stock was uniformly disappointing. Even stocks like Riverbed Technology (RVBD) that met original earnings estimates were hit hard. Of course, I'd be remiss in not mentioning the fraud accusations against Puda Coal (PUDA) that sent the stock to the pink sheets and the bankruptcy of MF Global (MF) that wiped out a small position in the speculative stock.

Our top sectors for 2012 include Emerging Markets, Networking Equipment, Life Insurance, and Oil Services. Though the model doesn't generally focus on a sector lead approach, these sectors provide such great opportunities that the model has found multiple investment options.

Global Markets
As mentioned above, emerging markets were a theme from 2011 that has become even more attractive following dramatic selloffs in stock markets such as China and India. Europe though remains the biggest concern. As 2012 began it appears that the ECB 3 year liquidity program has had an unexpected impact on lowering Spain and Italian bond yields. This has led to at least a short term repreve from fears of European contagion. As long as this continues, cheap US stocks can rally. Until the Europeans resolve long term funding issues, the threat will always hang over the market.

As far as individual stocks, the model is more invested in companies benefiting from emerging market growth than headquartered in those countries. Look for that to change as the year progresses.

Some top picks include Weatherford International (WFT) that will benefit from increasing oil demand and Foster Wheeler (FWLT) that will see revenues grow from the need for the construction of more power plants and LNG terminals.

Crane manufacturers, Manitowoc (MTW) and Terex (TEX), are seeing a pick in both domestic and international markets as the need for global construction equipment finally rebounds from the crisis. While Alpha Natural Resources (ANR) will benefit from its positioning as the #3 metallurgical coal miner in the world.

ChinaCache (CCIH) is the leading CDN provider in the fast growing China internet market. Look for that market to continue growing and the stock to rebound as investors become more comfortable that not all China stocks are frauds. Look for more direct investments in Brazil and India as the year progresses.


US Market
US stocks enter 2012 extremely cheap. If Europe ever retracts from the headlines, this market will rally strong. Economics data was strong as 2011 ended suggesting better times ahead.

The presidential election remains a big concern as the year progresses. Obama losing the presidential race would generally be good for the markets at least in the short term. Unfortunately though a good stock market early in the year due to a strong economic rebound could actually place Obama in a position to win the election. This could actually tank the markets in the 2nd half.

US stocks are lead by opportunistic investments in Monster Worldwide (MWW) and SodaStream (SODA). Both stocks were absolutely crushed in 2011 that the model picked them up on the cheap later in the year. These stocks could rally even without a strong economy. SodaStream especially has the chance to expand market share in the home beverage market that will happen irregardless of the economy.

A couple of oil related stocks will continue to benefit from the expanding unconventional shale plays in the US. As the US looks to move closer to energy independence both oil producer Carizzo Oil & Gas (CRZO) and hydraulic fracturing company C&J Energy Services (CJES) will benefit from high oil prices. Low natural gas prices have held the stocks down, but that might not last long as the US looks to begin exporting LNG in the future.

Look for networking equipment stocks Riverbed Tech and Radware Systems (RDWR) along with storage equipment provider OCZ Tech (OCZ) to benefit from the need for faster corporate networks and cloud computing.

Insurance providers Hartford Financial (HIG) and Lincoln National (LNC) trade below 50% of book value and continue to provide solid earnings that increases book value each quarter. Look for the financial sector to break away from group trading as the financially fit such as these two rebound.


Conclusion
At the end of the day, though 2011 was very disappointing the returns for the first 3 years of the model were still exceptional. Investors should understand that this is a high risk, high reward model that will be very volatile at times. Investing after the model has gone through a rough patch typically provides better returns to investors than after a good year.


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