Dear Mr. Market:
We understand you’re likely quite busy the past couple of days with some of the whip saw action in the markets. Maybe all the debt crisis news with Cyprus has you in a sour mood? Perhaps you haven’t had time to look at your NCAA brackets? What if we asked you to choose Indiana or Intel? Now are you interested?
March Madness is here! We’re proud to roll out another year of our spin on March Madness. How does a collegiate basketball tournament that captures the majority of America tie into the investment world? Well, aside from the massive amounts of money and time that gets allocated to this event, there are some connections worth looking at. For the past few years we take this time to pontificate which asset classes and what specific stocks may outperform their respective benchmarks over the next year. We happen to be avid sports and hoops fans but as financial advisors we’re joining both passions to attempt to connect some dots.
You may be asking what does a basketball tournament have to do with managing your portfolio or the investment world in general? At first glance it may not, but we thought we would have a little fun and couple it with some asset allocation parallels. After all, there are many folks who have simply thrown their hands in the air at one time or simply succumb to the notion that investing is like educated gambling. There could be some truth to that depending on your approach…
For those of you that are not familiar with the NCAA and its annual basketball tournament there are 68 teams selected and each is seeded according to their season results and relative rankings. Every March the NCAA holds a single elimination tournament to crown the number one team. Part of the appeal of such a tournament is that theoretically any team that makes the “big dance” has a shot at winning it all. Each and every year there is a proverbial “Cinderella” team that surprises everyone including all the ‘so-called’ experts. Prior to the tournament there is always plenty of banter and opinion on who wasn’t invited or further arguments around the seeding of the teams that did make it. That’s where we see a parallel of sorts to investing and having to make decisions among the multitudes of investment choices. With so many investment choices available, there are also about as many differing opinions…
Last year we noted several “can’t miss/slam dunk” type teams and investment choices. Specifically, Kentucky was a heavy favorite and eventually crowned the National Champion as so many expected. With regard to stocks, almost everyone loved the Apple (AAPL) story last year and we of course gave them the #1 seed. Although it wasn’t popular we actually thought the Apple story was getting a bit too much hype and somewhat frothy. Not only did we have them “losing” in our investment bracket but in the real world we sold it for several clients who owned it, locking in profits. More on Apple in a bit since there is obviously plenty to talk about with this stock. Lastly, as we always mention…in the history of the tournament a #16 seed has never upset a #1 seed but when it comes to investing…this happens much more frequently. As you’ll see in our investment summary, we actually believe this year is ripe for that…We don’t believe there is a “Kentucky” or an Apple this year so watch out for the year of the upset. Stay tuned!
Before we begin digging into each “region” of our bracket, let’s please revisit something everyone claims they know but so very few actually follow with consistent discipline. (Asset Allocation)
If you have ever looked at a chart of all the different asset classes and how they perform year to year…there is rarely a pattern or consistent way to determine next years “winner”:
For the purposes our annual investing bracket we have “seeded” or ranked four major asset classes (like the regions) and chosen several individual picks within each. There is some basic science applied to this process. We consider how the “pick” did over the past 12 months and also how it had trended over the past three months. In some cases we gave a lower performing investment a higher seed if it was trending well with recent strength or was more consistent over a longer period of time.
Each asset class (Large Cap, Small Cap & Mid Cap, Bonds/Alternatives, International) was ranked and seeded and then corresponding seeds were given to “picks” that we are either adding to the portfolio or establishing new positions in. Note that we’re not highlighting 68 new investments and will only discuss some investments that we are either actively involved in or looking to add to most portfolios.
Click here to see the 2013 Investing Bracket
OK…Let’s dig into some of the key match-ups and explain why our Final Four going into Q2 2013 looks the way it does:
Large Cap – What we typically do here is break down this fairly “efficient” asset class and choose some favorite companies within the 10 major economic sectors. For the sectors that we favor right now we have selected a few individual companies to consider. We’ll do the same thing for a few Small and Mid Cap companies in the opposing regions.
Key match-ups and seeds:
Let us begin by saying that obviously “past performance can’t predict future performance” but the bracket aims to highlight stocks that have either shown tremendous performance or ones that could be very undervalued in the year to come. We’ve also highlighted a number of companies in sectors we see continued strength in over others that may lag in the near-term. Of the 10 major economic sectors, especially within Large Cap, we’re trying to play the “trend is your friend” game but also complimenting it with sectors that have some value or potential hedge qualities should we ever get this correction that somehow has yet to come! Let’s get into our brackets:
#5 Chevron (CVX) vs #11 Conoco Philips (COP)
We start the Large Cap bracket with two of our favorites. It’s hard to drop Chevron but in this case we’re looking at a sector where in some cases you almost can’t miss. That said…while Chevron is certainly worthy of holding in almost any portfolio we’re giving the nod to Conoco Philips ..at least in 2013. This is based on one being more beat up than the other. We are taking COP over the next few months and even if the market corrects investors will be rewarded with a 4.47% yield. What does your bank offer you on your cash?
#6 Apple (AAPL) vs #12 Ford (F)
Boy…do we ever love Ford (F) but it gets knocked out by the now down trodden glory stock of yesteryear…Apple (APPL). Ford has clearly revamped its lineup and there are few companies like this that can come back from the dead as they have. We enjoy the almost 3% dividend, surging global sales, five-year growth rates north of 11%, and a forward P/E of about 8.03. Although we still believe this is a company to own…when compared to one that is getting beat up by the press and nervous investors…. We’ll take Apple over the next few months. It’s not worth repeating all the reasons you should fundamentally consider a position in it …Just please remind yourself how when rookies run for the exit doors, wise investors consider the opportunity. Yep…we almost felt silly telling people that this stock got ahead of itself at $700 but now that it’s trading in the low $400 range…we are close to pulling the trigger for every single client in our Disciplined Investor Model portfolios. By the way…has anyone told you that the Dow Jones has reached an all-time high? If Apple was a Dow Jones component the Dow would have been around 16,600 when Apple hovered around $700 per share. More on that on another day…as the Dow Jones is a price weighted index and expensive stocks move it more than others. If only the media knew or communicated this simple fact. Please slap us if you ever hear us call the Dow Jones…”the market”. That’s simply uneducated.
#9 Kinder Morgan Energy Partners (KMP) vs #11 Conoco Philips (COP)
If you haven’t heard of Master Limited Partnerships in the energy sector…let us lead you to perhaps the best one in the bunch. Very few such partnerships show comparable growth figures in income or distributable cash flows. KMP kicks off almost a 6% yield and should continue to be a benefactor from the natural gas story. We’re betting that KMP continues to do well but we do have some valuation concerns on the company and with that said believe that COP gets the nod over the next year. With COP’s recent spin-off of Phillips 66, the company is able to focus on its key focus of oil exploration and production. We also are optimistic about COP’s opportunity in developing floating liquefied natural gas with the only major competitor of Royal Dutch in this space. Lastly, COP enjoys more political stability relative to many of its peers since almost three quarters of its oil production comes from the US, Canada, or Europe. Avoiding some of the issues in Africa or the Middle East (think “Arab Spring”) provide the company this welcomed stability.
#10 Intel (INTC) vs #8 McDonald’s (MCD)…and all the rest!
Without getting too far ahead of ourselves, Intel (INTC) storms its way into the finals this year and takes it all. Could any number of other picks in this bracket beat INTC over the next year? Of course…but what we see here is an opportunity to buy a quality blue chip stock that has been beaten up. The largest semiconductor chipmaker in the world got whacked about -24% over the past 12 months and we believe the steady march back will reward patient and disciplined investors. Normally we would favor other blue chip plays like McDonald’s or even using an instrument like the Vanguard Dividend Appreciation ETF (VIG), but in this case there is simply too much value relative to a market that has been running hot for a while now. Value investors will nibble more at INTC with any correction that comes as well.
Large Cap Summary:
We encourage you to read the Investing Bracket article we put out last year. We wrote about selling Apple when most firms and the world saw the stock climbing each and every day and there were $1,000 price targets on it. One was being “conservative” if a $700 price target was placed on it. We’ll try not to pound our chest too hard for saying that Apple profit should be taken, or that Facebook (FB) was our best stock pick of the year (because we did NOT buy it when everyone said it was a can’t miss). We suggested buying REIT’s and specifically American Tower (AMT). AMT gets thrown into a different region this year but one other major theme does not change…We believe investors should aim to “hit singles” here. Go for deeper value and solid dividend yields. Swing for the fences in other asset classes. Large Cap for 2013 is where you want to find some value and yield north of 4%…like INTC and COP.
Small Cap & Mid Cap–
We have done the same thing with this “region” as for Large Cap but also added Mid Cap to this portion of the bracket. One could argue that Mid Cap should have its own bracket, as it is a very distinct asset class. Some firms and investment advisors incorrectly lump the two asset classes (small and mid) together, but for simply the sake of this illustration we will join them!
Key match-ups and seeds:
#5 Arena Pharmaceuticals (ARNA) vs #11 Weight Watchers International (WTW)
Welcome to a fun matchup of the “battle of the bulge”. It’s no secret that the weight-loss industry rakes in billions of dollars each year and will continue to do so with obesity on the rise. With constant changes in this industry there is both speculation and a cyclical spin when trying to choose between these two companies. Weight Watchers (WTW) and Arena (ARNA) have basically gone in two separate directions this past year with WTW being down about -49% and ARNA up over 356%! The FDA approval of anti-obesity drugs (like ARNA’s “Belviq”) was obviously incredibly well received by investors but has since died down. That being said, there is a temporary lull in the stock price action for ARNA, which currently trades in the $8 range. While the company awaits a much anticipated launch of Belviq, we think the potential upside is there. This is more of a speculative play and will continue to be volatile so don’t treat it like a lottery ticket. Think long-term and depending on potential approvals for distribution in Europe…this stock could see dramatic upside.
#9 Mid Cap Index (VO) vs #7 Small Cap Cap Index (VB)
Last year we had our #9 seed Dean Foods (DF) in the bracket as a somewhat boring and deep value play. Here was a company that was restructuring a bit and licking its wounds. It ends up spinning off its Silk soy milk and Horizon Organic into WhiteWave Foods and DF was up over 53% the past 12 months. Stories like this can happen when working through Small and Mid Cap stocks but on a year that has already brought many quite a few surprises; we’re going to stick with the indexes here.
Getting right to our matchup we like Mid Caps; not just this year but almost always. It doesn’t take too much tire kicking to learn that Mid Caps usually outperform all the other equity asset classes. Over the past 15 years you’ll find Mid Caps beating both Small and Large Cap and we simply are not going to try and fight the odds miss out on that type of performance. It is a part of every model within our Disciplined Investor portfolios and is basically a “sweet spot” of equity investing. Lately Small Cap (VB) has outperformed but we think that as this bull market matures investors will be better served by weighting more towards Mid Cap (VO).
#2 Ryder System, Inc. (R) vs #8 Windstream Corp. (WIN)
Here’s another match-up of two companies that went in opposite directions over the past 12 months. Ryder (R) is up about 10% versus Windstream (WIN) being down -27% during the same stretch. We typically wouldn’t pursue a company sporting over an 11% dividend like WIN does but the stock advances two rounds in our bracket this year. The analyst community has recently put out favorable ratings on WIN and positioned this volatile stock as a potential “Cinderella story” in this year’s tournament. It beats another speculative and troubled company in Herbalife (HLF) and a more stable bank holding company that caters to the Asian-American community, East West Bancorp (EWBC). WIN has the unfortunate challenge of being a landline communications provider in a very “mobile” driven world. That said, we see opportunity in opening a position in it anywhere from the $7 to $10 range. (currently trades at about $8.80). Consider the robust 11.34% dividend almost like a cushion for downside pressure on the stock price.
WIN loses to R long-term though. This can be a tricky stock as with any in this space due to a bumpy and slow economic recovery. That aside, we really think Ryder is on to something with their focus on getting into leasing and maintenance of natural gas powered trucks. R does far more than rent vans on the weekends. They’ll be around for many years and investors owning this stock have a well-managed company that is positioned for consistent growth.
Small & Mid Cap Summary:
This part of our bracket typically holds the absolute outperformer of all stocks each year. Our #1 seed Jamba Juice (JMBA) is a stock we normally wouldn’t buy for clients due to being rather small and trading under $5. That being said, we nibbled at it late last year and over the first three months of 2013 it’s already up over 30%. Will that continue…We aren’t going to bet the farm on it but with it being a potential acquisition target it remains a small holding and part of our diversification strategy in this asset class. Even though any one of these stocks could have a dramatic run this year we’re sticking with the index as being a solid bet. Last year we had Cooper Tire & Rubber (CTB) making it to the Final Four. That stock is now up over 63% from when we put the bracket out. Conversely we had MAKO Surgical (MAKO) in the bracket and it wasn’t chosen to go as far and it got clobbered over 60%. That’s what you get in this asset class so sometimes it’s just best to buy the index. “As the tide rises…so do all the boats”.
The majority of investors ignore international investing or simply don’t allocate enough towards it. More than half the world’s opportunities are overseas (58%) so for one to not have exposure here is a major mistake. Properly constructed and well allocated portfolios suffered in 2011 due to Developed International and Emerging Markets. The tide turned in 2012 and we believe there is plenty of steam left in this area. It’s without question that the troubles in Europe are nowhere near put to bed but there is some value and upside to be had. We are starting to see a shift here. While investing in foreign funds and companies presents unique risks such as currency fluctuations and economic/political uncertainties, you can actually lower your portfolio’s volatility over time by being exposed to this asset class. Recall that emerging markets trounced all asset classes from 2003 to 2007 but then lost -53.18% in 2008. Should we run away from that volatility? Let’s take a look at what the rest of 2013 has in store for us…
Key match-ups and seeds:
#5 Austria (EWO) vs #11 Peru (EPU)
We still like the Peru story. EPU (iShares MSCI All Peru Capped Index) captures South America’s fastest growing economy. Historically investing in Peru was always associated with a play on Gold, Silver, and Copper. (those make up over 50% of their holdings). That has begun to change, however, with expected economic growth of seven percent. Peru is one of the emerging market countries that is truly recovering and able to show rising lower and middle classes. The financial sector now makes up approximately 27% of the index and the country’s entire banking system is prospering.
EWO (iShares MSCI Austria Index ETF) actually wins out in this round and all the way until it meets VWO (Vanguard FTSE Emerging Market ETF). We see Austria as winning out over other hot markets like Turkey (TUR) and most EU countries that are still working through credit challenges. Austria is still one of the richest countries in the world and has a very high standard of living. We want increased exposure to Europe in 2013 as economies slowly recover but Austria (EWO) is an area to overweight.
#6 Japan (EWJ) vs #12 Yanzhou Coal Mining (YZC)
Normally you wouldn’t see us consider a beaten up Chinese company like Yanzhou Coal Mining (YZC). Here’s a stock we took a small position in for a few select investors a couple of years ago. Sure.. there was a premise for buying it with massive Chinese infrastructure projects and YZC being a well- positioned benefactor. What wasn’t predicted was seeing the stock double in such a short period of time. Call it dumb luck or simple profit taking discipline, but we sold it and are glad we did. Now the stock is down over -33% in the past year and guess what?…It’s on our radar again. This time we see it as a value play with some yield (5.5%) and we are patiently noticing that YZC seems to be stabilizing and building a base around the $14 range.
Japan (EWJ) has been tricky to invest in over the past few years if not decades! For those that have owned it this past year we are suggesting to trim your positions and take some profits. Over the past three months alone it’s up over 12%. If we get a sizeable enough correction we would be buyers of EWJ on most market dips.
#8 Toronto-Dominion Bank (TD) vs #10 Total SA (TOT)
For starters, our choice of Toronto-Dominion Bank (TD), has nothing to do with the fact that we primarily custody assets at TD Ameritrade Institutional. It didn’t hurt to learn, however, that as a major North American bank it was one of the few worldwide that actually saw its credit rating get upgraded during the financial crisis of 2008. This company was recently added as one of our holdings in our MPG Dividend Driver strategy. It has a healthy yield of 3.8%, tons of cash, is impeccably managed, and is still trading at a reasonable valuation.
TD beats Total SA simply on valuation. We do still like TOT and can see it as a part of an investors International allocation. They too have solid management and also boast an appealing acquisition strategy. While investors hold the stock they will be rewarded with very attractive yield of 6.34%.
Last year we called for Emerging Markets to have been oversold and that an opportunity was there. We’re proud to state that this indeed played out. Emerging Markets led all of the major asset classes that we track with a return of 18.63% in 2012. We believe there is considerably more upside here even though so many “experts” are now saying it’s too risky. The same goes for Europe but in this case we are calling for most portfolios to begin to overweight exposure to Europe. In summation, don’t sweat trying to pick the perfect stock in this area…just join the party. We suggest doing so with VEU (Vanguard FTSE All-World ex-US ETF). That’s our pick to make a run all the way to the final of our bracket. As investors build their position in something like VEU, they’ll enjoy a yield of 5.77% right now and that’s not too shabby in this interest environment. Speaking of dismal interest rates…here’s a nice transition to our next bracket…
Yes…the writing is and has been…”on the wall”. Any investor who hasn’t been told that rates are going to rise and that the bond market will “pop” is either in denial or not awake. As we’ve pointed out before, however, most people (experts included) have been as wrong as they could have been on this so far. Bonds still have a place in every portfolio and historically provide a natural hedge to the risk and volatility of the equity markets. So…what does the typical investor who is in a standard 60% Stock and 40% Bond portfolio do when they are being told a 30 year bull market in bonds is about to end?
Key match-ups and seeds:
First off, in this bracket we are not going to focus on specific match-ups but rather touch on a few major themes that we believe are developing. As you’ll notice we have one mutual fund in this area of the bracket and this is for good reason. We’re the first to admit that in most cases we run for the hills and away from most mutual funds for a variety of intelligent reasons. The data on this stance speaks for itself. North of 80% of all mutual funds do not outperform their passively managed index/benchmarks! So why own them? Why would investors pay fees for active management only to lose to inexpensive and passively managed indexes? Perhaps they haven’t met advisors that are not paid based on commission…
So…excuse the digression but it’s actually related. We will suggest a fund in this case for an area that we do not want to pretend we are experts in or where we don’t want to try and read the ‘tealeaves’. Managed Futures is such an area. We have written several pieces on this so for more information please feel free to contact us. At a minimum we believe most portfolios should hedge the inherent risks in both the Stock and Bond markets with something that is not correlated at all to either one.
Our current recommendation in this space is to allocate a total of about 15% towards a combination of commodities, currencies, and REIT’s (Real Estate Investment Trusts). We recently presented an educational event on this very topic. Most investors incorrectly perceive alternative investments to be riskier but in all reality , adding them to a portfolio actually lowers the overall risk (standard deviation) and moves portfolio mixes “up and to the left” on the Efficient Frontier. If all of this intrigues or confuses you…there are excellent resources out there and we’ve kicked plenty of tires so feel free to contact us for more information.
Final Four Summary:
This year’s Final Four is centered around a recovering market that now is a bit frightening but also tempting to many. Don’t let recent performance sway you into thinking you’re more aggressive than you really are- stay focused on your game plan. Get a strategy in place that encompasses several if not all of the themes we highlight here.
As we mention every year, the advantage and distinction an investor has in choosing their “Final Four” over that of a basketball bracket is that you need, and should…. choose more than one winner. It’s almost too cliché to state that one “shouldn’t have all their eggs in one basket” but we can’t stress this enough. Too many investors get caught up in chasing the most recent winners. Data shows that if one were to overweight investments each year based on last years winning asset class, they would be consistently wrong, frustrated, and eventually broke. Why do so many investors do this? If you’re ever in line at the grocery store it doesn’t take long to see a financial magazine touting the “10 Must Own Stocks of the Year” or “Hottest Mutual Funds you Need to Buy Now!”. How many of those are actually in the top 10 the next year? Very few… One recent study showed that of all Large Cap funds that beat the S&P 500 Index one year, only 41.6% managed to do it again the following year. After three years that same group had only 9.7% still beating the index. What a fund, index, or advisor did one year (or five) tells you nothing about how the performance will look going forward.
In summation, enjoy the game and don’t allow yourself to get hung up on just one team. This year will be “the year of the upset” and bring unexpected twists! Hedge your bets with some of the nuggets we share in this article but stay focused on your overall asset allocation. Stocks have risk…they always have and always will. While you’re patiently picking up positions in solid blue chip names, focus on some of the ones we mention here. You’ll see several top quality and dividend yielding companies that make up part of MPG Dividend Driver strategy. The real winner every year in the “Investing Final Four” is the one who typically has a solid Sweet 16 showing. Take a look at your investment mix now and make sure you have a healthy dose of some of these “teams”. Enjoy the Tournament!