After adding insurance stocks to the investment model in mid-February, the model eliminated computer hardware investments after the industry fundamentals deteriorated. The sale was made just as the U.S. market started weakening. At the time of this post, no replacement fund has been selected, so the model portfolio has built up roughly a 10 percent cash weighting which has helped cushion the portfolio in the post Japanese tsunami sell-off.
We were surprised by the discipline’s move out of Asia. Although many countries are represented by the model’s investment in gold companies, other holdings have more than a few international stocks as well. A portfolio “X-Ray” still shows a notable international company presence in the portfolio, but the model owns no “international” funds at this point in time.
The insurance sector investments were added, but they are “on a short lease.” Essentially, the holdings have to perform well immediately, or they likely won’t be held for long. Individual stock work on companies in the insurance sector appear to show many companies with very reasonable valuations, and there have been very few asset classes that have been able to keep up with the U.S. equity market in 2011. To maximize the U.S. exposure, but still maintain a reasonable degree of diversification, financials (via the insurance sector) were added to the portfolio a bit early, this time. If they can’t continue to outperform, we won’t be able to justify holding them very long.
A few weeks later, in early March, investments in the computer hardware sector were taken out of the model portfolio. Research showing that new hardware orders are declining, and hardware inventories are growing, is the main culprit. The hardware industry can be a cutthroat environment when inventories get out of hand and price cutting spreads. Profit margins can crumble in a hurry, so the model portfolio’s investment in that sector was eliminated even though the tech sector has been one of the better places to invest in 2011.
Coincidentally, the market had started showing signs that it had finally moved a bit ahead of itself by the end of February. During the preceeding 6-month period, U.S. stocks had shot up over 20 percent. Although corporate profits have been strong, the market has been stronger. Investor fears seem to be evaporating and we’re not at all sure that the market was prepared for anything but continued ebullience.
Since markets rarely remain problem-free for long, and in fact seemed to be weakening, we have decided against immediate reinvestment of the proceeds from the sale of the computer hardware investments. The cash may not remain for long. At this point, we’re not certain. However, even going into the Japanese tsunami crisis, the markets didn’t seem to be priced for disappointment.
Interestingly, we’re not focusing on risk reduction because of some top-down strategy. In fact, U.S. economic news has been very positive. May-Investments forecast a healthy economy in 2011, and news continues to support that prediction. Just like “good companies” and “good stocks” may be two different things, strong economic news does not always and consistently translate into making money in the stock market. We’re hoping that the market just got a bit ahead of itself. But we’re “listening” to the market as it rotates, in this case out of international while some sectors are beginning to face some new hurdles.
The market seems to have narrow leadership. Only a few sectors are doing better than average, and generally those sectors are pretty volatile. Commodities, technology, and financials are doing well – but money can be lost quickly in all of those areas. It might not hurt to be selective, even though money sitting on the sidelines is getting virtually no return, for the near-term while we take some time to evaluate where to allocate capital next.
Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies .
Posts
