back to blog homepage

2006-09-21 :: Strategy Update

Sorry for not posting anything for the past week, but we’ve had bank examiners and I’ve been tied up with them and with re-assessing our investment strategy.  Below is the strategy that I began to implement over the past few days.   It is always a major undertaking to make a shift when there are changes in the macro-investment environment.  I have been hoping to reduce our energy exposure to the moderately overweight level discussed below, but with three energy hedge funds collapsing and dumping their stocks in recent weeks, it has severely hammered the energy sector.  As rallies ensue in the aftermath of the hedge fund disasters, we will use that as our selling points.

Anywany, here is the revised strategy:

·        The United States economy has entered a period of sustained economic growth, with fewer and milder economic recessions, which allows the companies that benefit from economic growth to flourish and their stockholders to enjoy above average investment returns.  Cyclical industrial companies, energy and mining stocks are the winners here.

·        The economies of China, India, Brazil and Russia, along with the smaller Far East economies, are the engines of growth in the world and will become increasingly important as their citizens move from third world living standards to western living standards.  Energy, mining, and heavy equipment stocks will benefit from this.

·        The deficits we are experiencing in the United States will ultimately lead to a devaluation in the dollar compared to other currencies against whom we compete.  Having an emphasis of Canadian, Japanese, Australian, and European stocks in portfolios will protect against adverse consequences of the devaluation and will provide additional returns as well.

·        The demographic trends in the developed world, whereby the baby boomers in the US and Western Europe are beginning to reach retirement age mean that an ever-growing amount of money will be spent on health care.  Drug stocks, generic drug stocks, medical device makers, and related companies will be the big winners in this trend.

·        In the long-term, the supply/demand imbalance in the energy market will continue to lead to ever-higher energy prices, and a move into coal and other alternative fuels. Energy stocks, coal producers, and alternative energy producers will benefit from this imbalance.

·        The geographical location of energy reserves will have a particularly important impact on investment returns.  Companies that have reserves of oil and natural gas in the United States and Canada will ultimately be valued higher than companies with supplies subject to political or philosophical events, in countries like Iran, Nigeria or Russia.

·        In the near-term, likely through much of 2007, energy companies will be in a flat trading range, with occasional bounces up.  The exception to this will likely be the deep-water drillers and their suppliers.  We will use rallies in these stocks to pare back our exposure to a moderately overweight position, and re-deploy those assets into large-cap growth stocks and financials.  We will also continue to re-allocate energy exposure to the deep-water drillers and their suppliers.

·        Near-term, through the end of the year, we will be concentrating on technology (non-semiconductor), financials, and building positions in large-cap growth stocks.

·        The economic conditions of 2007 will likely benefit large-cap growth stocks, given their relatively consistent (albeit it low) earnings growth.  Financials should also benefit from the anticipation and ultimate implementation of a Federal Reserve interest rate cut. 

·        It is currently not predicted that we will see a recession in 2007, but the only caveat to that is the fact that every time we have had a real estate bear market nationally (despite what might be happening at the local level of individual communities) the US has had a recession.  In a market that goes through a recession, bonds and bond-equivalents will also benefit from a lowering of interest rates that the Fed implements to combat the economic slowdown.

·        As the economy begins to strengthen in 2007, we will see a return to the energy bull market and the return of the cyclical stocks that provide the outsized returns stocks can provide.  We are simply in one of those transition markets that provide low returns because the types of stocks that lead the market do not have the earnings growth on average to support significant investment returns.  There are specific case where a particular company will rocket ahead higher, but that will be the exception and not the rule.

·        Our revised equity sector targets for client portfolios based upon this strategy revision:

Basic Materials – 7.5%

Consumer Discretionary – 2%

Consumer Staples – 5%

Energy – 15%

Financials – 17.5%

Health Care – 15%

Industrials – 15%

Information Technology – 15%

Telecommunications – 3%

                                                Utilities – 5%