Author: Paul Franke, Quantemonics
Covestor model: Relative Value
Disclosure: Long all stocks mentioned below
We have not posted much on Covestor or the Quantemonics Investing website and related blogs the last few months as we are finalizing our second model portfolio research. It has taken up most of my free time since March. We are optimistic this more aggressive portfolio approach will fit the wish list of risk-taking investors, and complement our “conservative” IRA-centric Relative Value portfolio.
The macroeconomic risks remain quite large today, perhaps the scariest in my 26 years of investing. I have joked for years that Fed Chairman Greenspan, followed by Chairman Bernanke, would have the stock market firmly planted at all-time or multi-year highs just days before World War 3 began.
While I was joking, the latest political confrontations in Japan vs. China or Iran vs. Israel (or both at the same time) have the historical hallmarks of previous large, long-lasting wars on the planet involving direct U.S. participation, blood and treasury.
Overlay the timing of such a potentially large war event on top of the need for America to cut government spending in 2013, and a prudent investor might say the odds of real disaster for the U.S. and global economy are better than many experts currently understand or estimate.
While it may be viewed as a “black swan” event in hindsight years from now, in our opinion it is clear that Israel and Iran may clash, with far reaching consequences directly on millions of lives in the Middle East and indirectly on the global economy overall (with billions of lives altered).
Real supply shocks in the crude oil market similar to the 1970s oil embargo by Arab nations, the 1980 Iran-Iraq War, or the 1990 Gulf War, can lead to a quick double or triple in prices. We wrote several articles about the crude oil supply problems coming soon on our Motley Fool blog earlier in the year.
From an entertainment perspective, it has been interesting to watch the battle in crude oil pricing between weakening demand caused by a recessionary global economy and the supply shock we all know is nearly upon us.
I have eaten my share of popcorn the last 12 months listening to a variety of opinions each day. In the end, after a decade of ignoring Iran’s slow push to develop nuclear power, prestige and weaponry, we are being backed into a corner.
While the recent arguments revolve around the false choice between war and peace with Iran (similar to past acts of appeasement in the history books), the actual choice in late-2012 may be between a “conventional” war now, holding far fewer consequences and players, or a “nuclear” war with Iran in 2013-14, including plenty of competing nations having a say and picking sides!
Choose wisely would be my common sense advice. In reality, taking out Iran’s nuclear development program successfully is getting harder to do, day by day, just like the accumulating sovereign debt mess in the western industrialized world.
Weak leadership and short-sighted policy have turned the world upside down the last couple of decades on a variety of fronts. The wise choice would have been the aggressive one to take years ago, especially when oil prices were much lower as a starting point. Having a nuclear armed Iran is akin to giving a terrorist organization a back-pack nuke, in my opinion. If you think the world is in a pickle now regarding Iran, hold off on military strikes another 6-12 months, and see how nutty things can really get!
Consequently, we have been overweight oil and gas, plus gold and silver assets since the beginning of the year. Currently, we own equities like Hess (HES), Devon (DVN), SPDR Oil & Gas (XOP), Phillips 66 (PSX), National Oilwell Varco (NOV), Hecla (HL), Goldcorp (GG), iShares Silver Trust (SLV) and a long-term Energy/Solar play First Solar (FSLR) in various Covestor accounts.
The continuation of Federal Reserve money printing levels (currency devaluation vs. hard assets) is what’s keeping Wall Street excited and stock prices high in 2012, despite the long list of problems that are coming due. The September Federal Reserve announcement of reckless and experimental money printing in unlimited and today undetermined amounts is both highly inflationary for the pricing of goods and services heading into 2013, and a pre-emptive strike against the U.S. fiscal cliff mess due to hit world markets shortly.
Our Relative Value account has been slightly net “short” the stock market for most of 2012, and we have gladly bypassed 10%-15% market gains for the calendar year to make sure our pot of money is whole when the roof caves, as it mathematically seems destined to do in coming months or sooner. The model is down 4.6%* year-to-date as of the end of September.
We are projecting the odds of a 10%+ stock market sell-off in the October-December span at nearly 80%, and a 20%+ decline in stock prices at closer to 50/50 coin flipping territory. What point is there chasing small upside returns in the stock market generally, when the downside “risk” is as great as 40% or 50% the next 3-6 months?
We are patiently waiting for better long-term values to appear, alongside real investor fear of the future, before going substantially net long in the Relative Value model portfolio. Using today’s weightings as an example, a 20% stock market decline with rising oil prices as the trigger for selling could theoretically generate “gains” in the Relative Value portfolio of 10% or greater. That would equate with 30% outperformance of the market indices quickly, versus a simple buy and hold mutual fund or ETF investment.
We have been working hard on real-time testing of the new model portfolio design since early August. Hopefully by November or December we will have our “formula” for the more aggressive account finalized, and we can talk about this option for investors on Covestor.com by year’s end. The new portfolio uses margin, alongside several formulas and systems to pick stocks, including the specific timing of buy and sell trades.
*Performance discussed is net of advisory fees. The index comparisons herein are provided 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.
Some investments discussed are held in client accounts as of September 26, 2012. 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.
Certain of the 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. We believe 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.
