March Madness: Final Four Investing Bracket 2015

basketball on cashWelcome to the fifth year of our March Madness Investing Bracket! This series of articles is always one of the most popular investing articles on the internet! We’re proud to admit that we were one of the first investing nerds to combine our love for the markets with the passion that college basketball brings!

It’s common knowledge that people love excitement and surprises. It’s also human nature to root for the underdog and many times those two themes can certainly play out on the basketball court as well as on the stock market floor. Much like two college basketball teams that never play each other our imaginations are swept up in wondering who will “win” between a relatively unknown investment or a popular stock that has the media in a frenzy.

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 there might not be much 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 succumbed 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 results throughout the regular season and their relative rankings. Every March the NCAA holds a single elimination tournament to crown an undisputed champion. 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 as many differing opinions.

In the “real” March Madness tournament this year there appears to be a hands down favorite with the undefeated Kentucky Wildcats. Hardly any office pool or basketball analyst is betting against such a heavily favored team. If they win it all it will be the first time in over 30 years that a team stays unbeaten the whole season. Our own version of this (using investment themes and choices) shares the premise that we have four very decent #1 seeds but there is no slam-dunk pick that everyone agrees on. For this reason, our 2015 bracket is perhaps as important as ever to understand that a dark horse could win it all…

Before we begin digging into each “region” of our bracket, let’s 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 has 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, and International) was ranked and seeded, then corresponding seeds were assigned 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.

OK…Let’s dig into some of the key match-ups and explain why our Final Four going into Q2 2015 looks the way it does (CLICK HERE to view our 2015 Bracket):

Large Cap

This is typically viewed as the ‘efficient’ asset class. This term is credited to the famous economist, Eugene Fama who coined it in 1970. His thesis stated that it is very challenging for an investor to outperform the market because all possible information is already built into stock prices. We will focus on broad based investments and specific stocks in the ten major economic sectors.

Key match-ups and seeds:

The NCAA Tournament always has a variety of teams that make it to the ‘Big Dance’. There are the teams that are peaking just at the right time winning their conference tournament to earn their ticket and then those that get in just by the skin of their teeth! We feature a variety of investments with similar stories associated with them in this year’s tournament. This year the Large Cap ‘region’ hosts some truly undervalued stocks, some investor favorites, and broad based indices. Before we discuss anymore let’s dive in and look at the key matchups!

#8 iShares S&P 500 Index (IVV) vs # 12 ConocoPhillips (COP)

The current bull market just celebrated its sixth birthday party earlier this month on March 9th. The talking heads on the various media outlets enjoy questioning and reminding us of the fact that this will eventually change and a correction is in the cards. While the debate continues about the future of the S&P 500 (IVV), one thing that cannot be debated is how it has performed over the last six years.   Any investor brave enough to invest in the S&P 500 back in March 2009 would have returns in excess of 200%. Even the brightest minds in the industry can’t beat this index on a consistent basis. Last year 86% of investment managers could not beat the index; on a five-year basis it is 89%, and 82% over the last decade! The S&P 500 should be viewed in the same light as the Kansas Jayhawks or Duke Blue Devils, both of these basketball powerhouses have been in the NCAA tournament over 20 consecutive years!

ConocoPhillips (COP) is a true leader in the Oil and Gas industry. It was founded in 1917 with headquarters in Houston, Texas. ConocoPhillips explores, produces, transports and markets crude oil, natural gas and liquids worldwide. You would have to be ‘living off the grid’ to not be aware how the price of crude oil has dropped since last summer. West Texas Intermediate (WTI) crude is currently at its lowest price in the last six years. COP is an example of a quality company that appears to be undervalued due to competitor, industry and economic news. Currently its dividend ranks among the highest in its group, over 150% above their peer average. Recently several analysts raised their target price on COP from $70 to over $80 per share, it is currently trading at $61.

This match up features two ‘teams’ with drastically different resumes coming into the tournament, IVV (S&P 500) with an incredible six year run and COP barely squeaking into the big dance. As Geoffrey Chaucer said, “All good things must come to an end.” That is exactly what happens as COP knocks IVV out in dramatic fashion. We expect a name like COP to reward patient investors in the coming months and possibly years, IVV is a quality investment but only one can claim the victory…congratulations COP!

#1 Kroger Company (KR) vs #5 Northrop Grumman Corporation (NOC)

Kroger Co. (KR) is worldwide retailer that offers a diversified portfolio of stores and is not simply a chain of grocery stores. As of February 1, 2014 the company has 2,640 supermarkets and multi-department stores, of which 1,240 had fuel stores along with 320 fine jewelry stores and 786 convenience stores. The company is based in Cincinnati, Ohio and was founded in 1883. Shareholders have been rewarded with impressive returns, since 2013 it has increased 180% in price. The company grew net sales by over 10% in 2014 posting sales of $108.5 billion in sales. KR has proven that it should be considered as a world-class retailer that can compete with the well-known names that have dominated this industry.

Northrop Grumman Corporation (NOC) is a security company – offering systems, products and solutions to a variety of industries (aerospace, electronics, information systems, commercial companies and government). The company is the world’s fifth-largest defense contractor by sales and recently reported profits of $506 million or $2.48 a share, up from the 2014 results of $478 million and $2.12 a share. Investors have feared a slowdown with this company due to defense budget cuts that began in 2012, the U.S. military is their largest customer by a wide margin. In an effort to not be over reliant on military spending, NOC has focused on developing cutting edge technology that is used on unmanned aerial vehicles (drones), electronic surveillance and intelligence systems.

This matchup is a tough one with two high quality names going down to the wire. KR pulls out the win as time runs out to avoid the upset. Kroger has been on an incredible run and it doesn’t appear that it will be slowing down anytime soon. They’ve been able to address competition from names like Whole Foods (WFM) and their aggressive expansion separates them from their competition. The #1 seed marches on….

Large Cap Summary:

Investors have been hearing a common theme for several years as this bull market continues to push forward… ‘get ready for a correction’. It’s not a matter of “if a market correction of -10% or more is coming but rather when.”   For those that have maintained broad based exposure to Large Caps they have been rewarded handsomely the last several years. Several stocks that have played key roles in this run are starting to experience a slow down in earnings and have brought down their forecasts for future announcements. Intel Corporation (INTC, #9 seed) is a perfect example of this; a well-known name and leader in their industry that posted impressive results last year but is now down -15% year to date. With increased discussion about the Fed raising rates we see consumers possibly slowing down their discretionary spending, this will play into names like KR and COP – the final two contenders in this bracket. COP emerges as the surprise winner as a #12 seed due to oil volatility and the fact that their management has allowed them to outperform their peers on both a three and five year basis.

Small & Mid Cap

2013 was a year that anyone who was late to the equity party but still wanted to get in, typically followed the hottest area and took a chance. Many people saw Small Caps return an amazing 41% but the following year (the one that counted for those late comers) came in at just above 8%. That return is nothing to complain about but it trailed Large Caps and the S&P 500 by about 5% in 2014. With the bull market possibly running out of steam, or at the very least, acting quite “mature”… we believe you should exercise even more caution than normal with selections in the Small and Mid Cap area.

Key match-ups and seeds:

#5 Vanguard Mid-Cap ETF (VO) vs. #11 Evolving Systems (EVOL)

Often times we’ll favor a passively managed ETF in asset classes like this but for our 2015 bracket you’ll see that both the mid cap ETF (VO) and the small cap ETF (VB) lose in the first round.

Evolving Systems (EVOL) provides software solutions and services to the wireless, wireline, and cable markets. This is a small company based in Englewood, CO but we believe the upside for this stock is quite appealing. It’s trading around $8.49 as of this writing, which is on the lower end of its 52-week range. Revenue growth for 2014 increased by 18% which is quite healthy compared to most of their competition with their respective growth rates in the single digit range.

EVOL knocks out the #1 seeded Steelcase Inc. (SCS) and #9 Owen & Minor (OMI). Even if our predictions don’t pan out entirely in this region, shareholders of EVOL will see another reason to remain patient with holding this stock…it has a quarterly dividend of $0.11 which works out to be 5.18%. How does that compare to the money market or savings account at your bank?

EVOL is not heavily traded and there are only two firms covering the stock but each have “strong buy” ratings on the company. This small company won’t be on too many radars but offers patient investors an opportunity to pick up shares trading just north of its 50 day moving average of $8 and under its 200 day moving average of $9. We have a 12-month price target for this stock at $12 per share.

#2 Scotts Miracle-Gro (SMG) vs. #3 Six Flags Entertainment (SIX)

Over the past 10 years Scotts Miracle-Gro (SMG) has outperformed the S&P 500 even though it got clobbered in 2008 and also had a rough stretch in 2011 and 2012. We believe SMG is back to its winning ways and will outperform the broad market this year.

SMG manufactures and markets consumer lawn and garden products. It’s a $4 billion company based in Marysville, OH and employs almost 7,000 people. The company currently trades at $68.99 per share which is towards the higher end of its 52-week range. ($52.38 to $69.27). SMG also sports a quarterly dividend of $0.45 which is about a yield of 2.61%.

Although we believe this company has plenty of upside growth potential we think it’s the perfect type of stock to wait on buying until there is a healthy stock market correction. You’ll see how we have it beating all others in its region and then finally losing to COP from the Large Cap region. There are some recent indications that are quite bullish, such as an announcement of a major stock buyback going through 2019. One of the factors that can dampen prospects for a company like SMG is rough weather and commodity costs (diesel fuel etc). Buying a stock like SMG is a solid way to play the mid cap space as its large enough to handle economic slowdowns and has healthy enough financials to be acquisitive while managing debt obligations.

Small & Mid Cap Summary:

Towards the end of a bull market cycle you’ll want to stay with companies that are larger in capitalization and lean towards sectors that are historically a bit more resilient to economic slow downs. The stock market party is not necessarily over but it’s hard to argue that we’re not towards the late expansion stages. Some growth names will still prevail, at least in the short-term, but over the next year you can expect to see sectors like consumer staples and even utilities outperform.

Without intending to rain on anyone’s stock market parade, if there is one region in our bracket that we would ditch if we had to it’s the small and mid cap area. Your skill as a stock picker will have to be at its finest and even if you succeed, you may still end the year down in this asset class. The other three “regions” of our 2015 investing bracket will likely outperform this one.

International

Through the first few months of 2015 it appears that there has been a change in leadership is developing. Investors have been rushing to gain exposure to U.S. domestic stocks (primarily Large Cap) while the international space is actually outperforming by a substantial margin. The S&P 500 is up about 1% year to date while several International Indices are up as much as 8% or more!   All too often investors assume it is the mighty USA leading and the rest of the world simply following behind. Over half of the world’s market capitalization currently resides outside the United States, so to ignore it in 2015 might be awfully shortsighted.

Key match-ups and seeds:

#5 GlaxoSmithKline (GSK) vs. # 11 WisdomTree India ETF (EPI)

GlaxoSmithKline (GSK) was founded in 1935 and is headquartered in Brentford, United Kingdom. The company creates, manufactures and markets pharmaceutical products, vaccines, medicines and health related consumer products worldwide. The stock has been on a solid run so far in 2015 (+9%) after having a disappointing 2014 with returns at -15%. The company has a large presence in respiratory medications and treatments, with this unit experienced a drop in U.S. sales of 12% last year. New management is now in place for this division; it will most likely struggle this year but the outlook is bright in 2016 with the approval of several new products. Last September GSK paid a record breaking fine for a foreign company in China. A $490 million fine was levied for allegedly paying doctors to prescribe their medications. The pharmaceutical industry can be a fickle one as drug approval, research and regulations play vital roles with any company in this industry.

WisdomTree India ETF (EPI) focuses on companies incorporated and traded in India. It wasn’t that long ago that investors clamored to gain exposure to the BRIC (Brazil, Russia, India and China) countries. The novelty of investing in these various economies has certainly run its course for a variety of reasons, however, India is once again attracting investors attention. Earlier this month the Reserve Bank of India (RBI) cut rates for the second time within two months. Inflation remains in check due to falling oil prices and reduced food prices. The country imports 75% of its oil making it highly susceptible to oil prices. We expect to see a bullish trend with India (no pun intended) due to the new pro-growth government that took office last May, modest decline in inflation, currency stabilization and substantial foreign capital inflows.

This match between an individual stock and an exchange-traded fund is one that investors often struggle with. Do you take the volatility (both upside and downside) with an individual equity or the diversification of the ETF? GSK is much like a team in the NCAA tournament that lives and dies by the three-point shot … in this case they struggle to find the basket and come up with a loss. EPI is positioned to deliver positive returns for the next 12 – 18 months and appears to be a much more well rounded ‘team’ with many positives in their favor. This represents a big upset with a low seed taking out higher seed that appeared positioned to make a run in this tournament but that is why the games are played!

#2 Vanguard Emerging Markets Index (VWO) vs. #3 Market Vector Russia ETF (RSX)

Vanguard’s Emerging Markets Index has been a rising star in 2015, up nearly 9% year to date. The fund employs an indexing approach by investing approximately 95% of its assets in equities included in the FTSE (Financial Times and London Stock Exchange) Emerging Index with over 900 different companies. This ETF truly offers risk diversification due to the number of positions and focuses on large and mid-sized companies. The performance of emerging markets has caught plenty of attention with over $18 billion flowing into funds similar to VWO through the first two months of the year. Economists will often refer to a theory called ‘reversion to the mean’. Over a period of time asset prices may vary but they will always revert to the mean. Moving forward this theory is essentially saying that emerging markets will outperform the domestic U.S. market and even things out.

Russia has dominated world news for the last several years. The Markets Vector Russia ETF (RSX) consists of companies that are incorporated in Russia or those that generate at least 50% of their revenue there. Just last week (3/13/2015) Russia cut their interest rates by a full percentage point to bring it down to 14%, this is after a 2% cut in January. Over the last year the ruble has seen its valuation decrease by 70% against the U.S. dollar.   The Russian economy has been hit hard by economic sanctions following its annexation of Crimea, its role surrounding Ukraine, and the massive decline in oil prices. 50% of the country’s revenue is derived from oil and natural gas and 25% of Russia’s GDP is driven from the energy sector. The ‘Russian Bear’ has been beaten down but how long will this hibernation last? While there is still downside risk with an economy like Russia it is the classic contrarian play offering those that dare to invest significant upside potential.

These two names have certainly been catching investor’s attention recently. Just last Friday RSX had over 18,000 put option contracts purchased, that represents an increase of 113%! VWO was a ‘Cinderella story’ earlier this year but it appears that investors are moving towards RSX viewing it as a position beat up by world news and geopolitical headlines. We have RSX claiming the victory in this match-up.

International Summary:

The underlying theme when it comes to the International region is … value. Investors need to approach these investments with the mindset that there could be more volatility and lower prices before breaking out to positive results. With pockets of strength and weakness spread across the globe patience will be rewarded and nerves will be tested! Any investment in foreign securities involves unique risks – currency fluctuations, economic and political uncertainties. The investment that we have emerging as the winner out of this region exemplifies all these risks! RSX cuts down the nets from this region and marches on to the Final Four.

Bonds & Alternatives

Key match-ups and seeds:

#7 SPDR Gold Trust (GLD) vs. #4 Vanguard REIT Index Fund (VNQ)

This match-up features two “alternative” investments that have had vastly different “seasons”. Over the past year the Vanguard REIT Index Funds (VNQ) has been up about 18% while the SPDR Gold Trust (GLD) has been pounded and is down –17%. In the near term our thesis may not pan out but over the course of 2015 and going into 2016 we believe you will see a reversal for each of these two investments.

The irony behind both of these investment choices is that they aren’t your typical stock or bond type portfolio holding. While many investors own either Gold or Real Estate it may not necessarily make up part of their portfolio in the way we suggest it could. These are two very tangible assets; you can physically own actual gold and of course buy real property. They each should also have a place in your portfolio for the simple reason that when things aren’t going well with stocks (or bonds) you have something in place that can mitigate that damage. We’ll touch more on this topic in the other match-up with our #6 seed, which actually takes the entire field by surprise to win this whole tournament!

In the above match-up however, we have Gold upsetting REITs. Not many people will agree with this based on the current results. Gold has been absolutely pounded due to fears of interest rate hikes and by a strong dollar. Potential rate increases can adversely affect REITs too but this investment outpaced all other asset classes last year and many believe that they still have room to run. Rate worries seem to have been mitigated in the case of REITs due to a stronger economy and healthy M&A activity. VNQ has also attracted investment dollars due to a robust yield of 3.51%, which in a rate environment like what we have now is very appealing.

Owners of REITs have clearly been rewarded and although they could still go higher eventually there will be a reversion to the mean. For now they’ve done well due to interest rate fears still being held at bay. Once 10-year interest rates rise towards 3% things will change. REITs are close to being fully valued overall and you can expect them to trade correct towards the back half of this year.

GLD on the other hand has been very oversold and although it could dip further in the near term we see a reversal on the horizon. Several technical indicators (relative strength and its moving averages) are showing GLD as being very oversold which in times past has triggered a sharp bounce back. From a fundamental standpoint the massive drop in oil prices has kept inflation in check and for this reason we actually believe the Fed won’t raise interest rates in the near future as many are predicting. Oil possibly going even lower will ultimately help gold bounce, especially if the stock market eventually corrects. If oil recovers by 20% in the near-term the world will think that’s back on par. If it dips another 20% (which we think it could easily do!) you’ll likely see GLD bounce and the Fed would be even more likely to leave rates alone.

#6 Powershares Currency Harvest Fund (DBV) vs. #2 “Active Fixed Income”

The investment that ultimately knocks out #7 seeded GLD is #6 Powershares Currency Harvest Fund (DBV). Our bracket actually has DBV going all the way to win this tournament but early on DBV upsets #2 seeded “Active Fixed Income”.

It should be noted that each of these investments offers numerous ways to play them. In other words, we purposely describe “Active Fixed Income” in a rather nebulous way. For our clients we have a specific bond strategy and instruments that are not along the lines of a passively managed ETF. For this asset class, and considering the potential rate movements that the future will bring, we believe the one asset class you can really make a case for active management in is with Fixed Income. Almost all other funds or managers are basically fleecing investors in fees and underperformance so we simply avoid that mistake with other asset classes.

So, why Currencies and does it have to be done via DBV?

If you read this far you’re either a huge fan of ours or at least an investor who is interested in learning what and why we’re talking about these investment themes. We can also assume that you’re more than fully aware that the stock market has basically tripled over the past six years and hasn’t had a meaningful correction in quite some time. The writing is on the wall…a stock market correction of -10% or more will occur before we put out the 2016 edition of this article. That being said, your portfolio needs something that is historically uncorrelated to the stock and bond markets.

While you don’t necessarily need to use DBV to gain currency exposure you should explore the rationale on what currencies can do for your portfolio. DBV is made up of currency futures contracts designed to exploit the trend that currencies with high interest rates rise relative to those with relatively low ones.

Most people are completely unaware that currencies are the least volatile asset class when compared to stocks and bonds. If you think that the bull market may soon be tested in the next 12 to 18 months you would be very wise to gain exposure to an asset class that has the very least amount of correlated returns to equities.

Currency markets are the most liquid in the world and they operate every day of the year. Unlike the stock market, with pure currency exposure you avoid historic crashes by the principle of one currency being hammered is offset by a gain in another.

Bonds & Alternatives Summary:

Our rationale for having DBV, or basically any solid currency related instrument, win the Bonds & Alternative Investments “region” is based on a massive shift in asset class leadership. Everything comes to an end and the equity run we’ve experienced is getting very long in the tooth. As mentioned above, adding currency exposure will increase your diversification levels but also give your portfolio the opportunity for much greater risk-adjusted returns with lower volatility. If we had a crystal ball our bets are on the fact that one-year from now the average portfolio will have wished it had something that hedged itself from what everyone else owns. Don’t set yourself up for another 2008 where you had two choices (1) ride it out and get decimated (2) panic sell.

Final Four Summary:

This years Final Four Investing Bracket leaves us with a variety of different seeds. We have a #2 with SMG, a #3 in RSX, the #6 seed out of Fixed Income/Alternatives with DBV, and a true “Cinderella” team with the #12 seed COP. While every year should ideally bring us a new champion, we notice similar themes from years past. There is always a team that barely makes it into the tournament with a low seed but then things start to line up and they get hot. The perfect example this year is ConocoPhillips; a stock that has been beat up for the last six months but they find a way to survive and ultimately deliver positive returns for investors. In other words, never count out a great name because it’s been beat up; today’s loser is very likely a deep value and could perform very well later on.

Another important aspect to keep in mind is that not many people actually pick the overall winner. How often have you been involved in an ‘office bracket’ and the winner didn’t pick the champion correctly? It happens quite often, remember that you can miss picking the overall winner but still do well by having a solid “Sweet 16” or “Elite 8” finish.

Our overall belief is that in most years the historical data shows that most investors who passively manage their portfolios by using indexes will beat actively managed funds and individual stock pickers. If you have read many of our other articles you will know that we frequently remind our readers that investing in individual stocks is often a losing proposition. Although it can be fun and exhilarating it is actually more like gambling.

Most folks are better served by building a well-diversified portfolio that lowers the idiosyncratic risks of choosing an Apple (AAPL) over a Microsoft (MSFT) or a Wal-Mart (WMT) over Target (TGT). Over 90% of a portfolio’s performance is driven by the asset allocation, not the individual equities that you rolled the dice on.

March MadnessEnjoy the tournament and check in with us if you have questions on any one of these investments! We’ll also update the bracket in a few months to let our readers see how these picks performed over the remainder of 2015.

 

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