We recently had a chance to ask Covestor manager Chris Rees of TenStocks some questions about his model, his highest conviction holdings, and his outlook for 2012.
Q: Name one investment that exceeded your expectations in 2011, and one you had high hopes for that didn’t pan out.
A: I had a bad 2011 overall, and no investment exceeded my expectation. I had high hopes for Hutchinson Technology (HTCH) as an early 2012 turnaround candidate but a flood at their new production facility in Thailand has set them back.
Q: What single position in your portfolio are you most confident in for 2012?
A: Usually I can easily answer this question. With a concentrated portfolio I can often have a single best idea. This year I have four positions I think have the possibility of making big upward moves in 2012. They are Hutchinson, Aveo Pharmaceuticals (AVEO), Chipmos Technologies (IMOS) and Bank of America (BAC). If all four perform well in 2012, I could have a very good year.
Q: What was the biggest challenge to your investment strategy in 2011? In light of that, are you adjusting your strategy for 2012?
A: The biggest challenge for me in 2011 was trying to keep up with, interpret, understand, and then forecast the future outcomes and potential investment consequences of the global debt crisis. It’s a mess. All the political zigzagging and goalpost moving gave me a headache. Adjusting a proven long term successful strategy to account for the changing whims of politicians and central bankers strikes me as a fool’s game. Macro-economic events are indeed driving markets at the moment, but in my opinion it is almost impossible to forecast future zigzags with any degree of accuracy. Certainly relying on ones reading of the macro environment tealeaves, when they are changing every day, to make assumed high probability investments seems unwise. I won’t be doing it. I will stick to my knitting and concentrate on managing a diversified portfolio of company level value. This strategy has served me well for over two decades. I expect it will continue to do so.
Q: Do you believe gold is a genuine hedge in uncertain markets?
A: I’m the wrong guy to ask. I think of it as fool’s gold. It works if enough people believe in it. It’s performed well over recent years so the market has proved me wrong. Pet rocks were popular once. So were cabbage patch dolls. Nobody believed in gold back in the late nineties when I was buying it at less than $300 an ounce and it was trading below its cost of production. You were considered an idiot if you bought gold back then. At today’s premium to production cost I wouldn’t touch it with a bargepole.
Q: If you don’t like gold where are you turning for potential downside diversification?
A: To supply some protection in the event of a serious market selloff I have added Proshares Ultrashort Russell 2000 (TWM) to the portfolio. It’s an inverse ETF that basically moves at twice the rate of the market in the opposite direction. It’s not a perfect hedge, but it’s a clean hedge if you want something to go up when the market goes down. I expect continued market volatility in 2012 and putting some TWM in the portfolio adds a volatility ‘collar’. If the market moves up a lot I should be able to sell something and raise cash. If it goes down a lot, I should be able to sell my TWM insurance policy which will give me cash to deploy on the long side at lower, better and safer values. On the negative side, there is some friction cost to owning TWM and if the market rallies strong and consistent through 2012 and beyond without a major break, TWM could become a permanent loss. Obviously, in a strong market, it will also act as a drag on the long side of the portfolio.
Q: As you noted, global macro considerations dominated the headlines in 2011. Do you see 2012 unfolding differently? If so, how?
A: In 2011 the focus was mainly on the debt crisis in Europe, but this is a global problem. There are economic storm winds blowing in China, Japan and the USA that will likely affect everyone on the planet. So far the political medicine for these growing problems has been to ‘kick the can’, in effect to try to solve or delay the debt problem by creating even more debt. The real honest hard answer to the debt problem is to deal with it now. It’s not a matter of ‘kick the can’. It should be ‘can the kick’.
Q: Where do you see the real growth stories overseas right now?
A: I have an interest in the growth and natural resource potential of Africa. It’s a hard part of the world to invest in and I haven’t found an investment that meets my criteria. But I do think it’s interesting.
I also think there may be ground floor opportunities in Myanmar, but again I do not have an investment there. Asia in general should do better than the west over the next few years. I almost view Asia as a play on the economic importance of education. South Korean and Chinese school kids are studying while American kids tweet about Britney Spears, Justin Bieber and Kim Kardashian.
Q: How much exposure to emerging markets do you have?
A: Hutchinson is in Thailand. Chipmos is in Taiwan and China. Bank of America owns a chunk of China Construction Bank and recently received a commercial banking license to expand in Brazil. Archer Daniels Midland (ADM), another portfolio holding, is involved in agriculture and food processing in more than 75 countries, many of them emerging. They also own a 16% share of Wilmar, a leading agribusiness in Asia. My international and emerging market exposure is actually bigger than it appears on the surface. When investing overseas, I tend to favor doing it via US companies or ADRs listed on US exchanges. I think this gives me a language, informational and rule of law advantage.
Q: Is China, India or other major emerging markets better positioned to withstand a serious global economic downturn than the U.S.?
A: I think everyone will get hurt. Some countries will fair better than others but there will be no immunity from a global downturn.
Q: It’s an election year. Will this be good or bad for markets?
A: I don’t think it will have a big enough effect to warrant spending any time trying to figure it out.
Q: Inflation or deflation? Growth or recession?
A: I’m in the deflation camp. I see slow to no growth everywhere. A global recession looks likely. At some point inflation will probably be something to worry about but I don’t see it in the short term.
Q: Which way is the U.S. economy headed and how will you be positioning in light of that?
A: Things have to get tougher over the next few years in the U.S. It’s going to be hard to make money anywhere and there will be plenty of risk to punish the reckless. You can’t invest in this kind of environment without paying careful attention to the downside. I’m talking my own book, but investing in a diversified portfolio of undervalued companies backed by tangible assets will offer upside potential while giving some downside protection. Many companies are better risk/reward propositions than countries nowadays. Despite the dismal outlook, I still believe the stock market is the best place to be long term for capital preservation and accumulation. But it will be a bumpy ride. Away from the equity markets there’s some good value in residential real estate. Apart from that, the bargain bin is pretty much empty right now. For those old enough, it might be wise to remember what the cop said in Hill Street Blues: “Let’s be careful out there.”
