The year has gone by and left us with a sense of disappointment. We had hoped for an expansion in the market’s price-earnings ratio, but were disappointed when the government again gridlocked over fiscal policy.
The resulting uncertainty has crushed investor confidence leaving the markets with a lower than average market price to earnings ratio. Much of this malaise is attributable not only to Washington but also to extremely low growth projections for the economy.
Recently GMO Capital published a paper calling for GDP growth below 1% for the foreseeable future. Although this may be the most dire of forecasts, in our opinion, others are not much better. Wells Fargo economic group is calling for growth of only 1.5% next year. Currently the most bullish forecasts being issued are from Goldman Sachs. The investment bank believes the economy in 2013 will grow at an anemic 2%.
Although Goldman believes the S&P 500 index (SPX) will rise to 1550 next year, the investment bank is also predicting S&P earnings of $107 or better. This would be a 7% increase and, although in line with historical norms, may be hard to achieve under the current circumstances.
In our opinion, we believe that economic growth may be flat in the fourth quarter of 2012 and the first quarter of 2013. Although this may not technically be a recession, it will make 2013 a back loaded year if we are to achieve reasonable economic growth. We believe that is what is holding the market back and is the reason why we still have a large cash position in our Macro Plus Income portfolio.
Because we believe many investors are so focused on the situation here in the US we think they are missing opportunities to invest overseas. Therefore we have deployed capital in our ETF Only model with overseas growth in mind.
Approximately 50% of the portfolio is weighted to emerging and developing markets with particular emphasis on Latin America and China. These holdings are the iShares MSCI Brazil Small Cap Index Fund (EWZS), the iShares MSCI China Index Fund (MCHI), and Guggenheim Frontier Markets ETF (FRN).
We have taken care to choose ETF’s which deemphasize financial stocks, particularly in China and Brazil. At the same time, the investment selection in US companies–the iShares S&P 100 Fund (OEF)–is tilted toward mega-cap companies which derive much of their revenues from overseas.
On a tactical basis we have added the Select Sector SPDR Utilities fund (XLU) and the Select Sector SPDR Technology (XLK). These are shorter term holdings designed with the objective of taking advantage of current market imbalances. We consider them trades.
The Macro Income model remains 35% in cash awaiting more clarity from Washington. We are not dogmatic, and we believe the markets have almost discounted whatever outcome Congress and the White House negotiate.
Therefore we may be 100% invested before any deal is announced. That will depend on market action. The Macro model is more stock specific and we may be able to take advantage of securities whose future value is not highly dependent on political outcomes.
For example, we believe development of the Bakken shale play will continue regardless of political and economic conditions. Therefore we own Inergy (NRGY), a company which has restructured and is expanding its rail loading capacity.
We think the company’s master limited partnership structure and GP status give it a great leveraged opportunity to grow its cash flow (and therefore its payout) over the next few years.
In a more speculative vein, we have taken a small position in Halcon Resources (HK). Its chairman, Floyd Wilson, was the founder of Petrohawk Energy, and he is attempting to replicate that success with Halcon.
The company has significant exposure in Bakken along with major positions in other shale plays. Halcon’s price is down sharply from $12 as of December 14 and has recently seen heavy insider accumulation around the $5.60 level.
We believe this may be a winner in 2013. Another stock which we believe has significant upside potential is Coinstar Inc (CSTR), which owns the Redbox DVD kiosk business. The play is controversial since there is a large short position held by bears on the stock who think that DVDs are obsolete.
We agree that at some future time DVDs will no longer be in use. But by that time we think Coinstar’s online services will be well established. That venture, Redbox Direct, is a joint effort with Verizon (VZ) and is in beta testing.
Coinstar earnings have been reduced this year by a goodwill write off from its acquisition of NCR’s kiosk business. Still the company’s earnings are estimated at $4.62 this year and $5.19 in 2013. With manageable debt and ROE in excess of 20%, we agree that the analysts’ consensus price target of $63.50 is achievable.
We are cautious in the very near term as market volume is low and managers are trigger happy concerning events in Washington. However we think this environment is providing a great atmosphere to pick up specific stocks whose potential upside more than outweighs short term risk.
The investments discussed are held in client accounts as of December 5. These investments may or may not be currently held in client accounts. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable.
Any index comparisons provided in the blogs are for informational purposes only and should not be used as the basis for making an investment decision. There are significant differences between client accounts and the indices referenced including, but not limited to, risk profile, liquidity, volatility and asset composition. The S&P 500 is an index of 500 stocks chosen for market size, liquidity and industry, among other factors.
Certain information contained in this presentation is based upon forward-looking statements, information and opinions, including descriptions of anticipated market changes and expectations of future activity. The manager believes that such statements, information and opinions are based upon reasonable estimates and assumptions. However, forward-looking statements, information and opinions are inherently uncertain and actual events or results may differ materially from those reflected in the forward-looking statements. Therefore, undue reliance should not be placed on such forward-looking statements, information and opinions.
