Alpha Select – June 2014 Update
*Alpha Select – MTD +2.53% YTD +10.04%
**S&P 500 – MTD +1.91% YTD +6.96%
* Net of Fees
** Includes Dividends
By David Nelson, CFA
June was a solid month for markets and marks the half-way point for 2014. Alpha Select finished with another strong showing hitting double digit returns for the year.
The half-way point in navigation is often referred to as “the point of no return;” that imaginary line where it is too late to turn back. We’ve clearly crossed the line with regard to monetary policy. Since this isn’t a sequel there is no one who can tell us with certainty just how the movie ends.
As Fed policy unwinds and asset purchases come to a close, markets will be forced to stand with less support. The Fed’s zero rate policy will still be in effect. Nevertheless, investors are well aware we are closer to the end than the beginning.
Despite an unemployment rate that has declined over the last several years there are few including the Fed that believe the employment picture is bright. Many have left the workforce and most have seen stagnant wages for well over a decade.
I believe the Fed is focused on wage growth looking for signs that the employment picture is improving. They understand the headline employment numbers are giving a distorted view of the economy.
The most likely triggering event for a Fed hike will be an inflation scare. Janet Yellen has called recent CPI (Consumer Price Index) numbers noise. Coming in at 2.1% the CPI certainly caught the attention of investors as it is over the Fed’s own target of 2%. The Fed is quick to point out that they prefer the price index for personal consumption expenditures or (PCE) which was up 1.6%.
While global growth seems to be firming, it will take more to drive inflation expectations higher. An energy shock is just the type of event that could force action.
We currently have three hot beds centered on energy. The Middle East is number one with the world’s attention focused on Iraq and its potential to morph into an all-out civil war. In the Ukraine, Russia is using its energy clout almost as a weapon. Finally, China is moving military hardware into the South China Seas and intends to control the assets and resources in the region. Potentially that noise Janet hears could get much louder.
Half-Time Report
Coming into the start of the year my base case target for the S&P was to track earnings growth and end the year close to 2000. At 1960 we’re almost there. I waffled on that call a few times this year as markets hit a series of speed bumps not the least of which was the deep sell-off in March of growth stocks as investors hit a wall on just how much they were willing to pay for growth.
While growth has regained its footing, the giddy atmosphere that seemed to surround a lot of these high flyers seems absent. Many still sit well below highs established earlier this year.
Sector Performance Tells a Story
My favorite chart each month is an update of the relative performance between sectors. As you can see still in first place is Utilities (XLU) but coming up fast on the outside is Energy (XLE). I believe energy will pass Utilities despite a 10 year yield that sits just above 2.6%.
The strength in energy stocks is signaling at least one of the following. Economic activity is going to pick up or oil is going higher. In either case we are overweight and intend to remain so.
Refiners
Refiners were always a port of our energy strategy but at least for now we have exited taking profits this month in Valero (VLO) and a loss in Holly Frontier (HFC). While the exposure to the booming energy supply here in the U.S. has been a home run the picture has darkened after commerce permitted the export of certain types of oil. The long held ban on crude exports has been in place since the oil embargo.
The administration is limiting it to what they call condensate which is another name for shale oil. However, the handwriting is on the wall. Markets will be quick to discount future margin contraction as refiners will be competing with other bidders for raw materials. For the moment we’ve stepped to the sidelines uncertain as to just how deep the correction will be. We’ll focus our efforts on the explorers and service companies that supply the picks and shovels.
So What Now
Well we’ve already hit the base line projection for the year and of course all predictions are fraught with peril. Predictions should not be looked upon as absolutes but only as a guide to what is driving our thinking and allocation decisions.
Markets act as though they want to grind higher. The pain trade is up as hedge funds have not had a good year with many hoping for a pull back to regain relative performance. To date pull backs have been modest with many standing on the wrong side of the velvet rope hoping the bouncer will wave them inside.
For now the offense is on the field and we are still close to fully invested. 2100 is quite possible this year but a number of things have to go right.
- Energy markets have to remain stable – While the United States has made enormous strides and is well on a path to energy independence we aren’t there yet.
- Economic Data Must Improve – We’re all out of excuses on the economy. The bad weather is behind us.
- CAPEX – Corporations are flush with cash and have already picked the low hanging fruit. With low interest rates the focus has been to buy back stock to drive earnings growth. The next leg of the bull market will be driven by Capital Expenditures as companies put that cash to work to drive revenue and earnings growth.
The Good the Bad and the Ugly
Click Here for P&L on Alpha Select Closed Positions
Realized Gains / Losses
The hands down winner was Trinity (TRN) sold for a +32.4% gain followed by Precision Drilling (PDS) +22%. Qualcomm (QCOM) was sold with a +16% gain. I believe that the 2nd derivative of growth for Qualcomm has slowed and despite its backlog I’ve decided to look elsewhere.
The other energy name sold was Suncor (SU) with an 18% return. I haven’t reduced the energy exposure but have rotated into what I believe are more attracts names.
The only realized loss was Holly Frontier (-6.4%) sold for the reasons I mentioned above.
Unrealized Gains / Losses
Best return last month from positions still in the Alpha Select portfolios was Micron (MU). This is our second time in the name and already is up +15% from its purchase a few weeks ago. Best Buy (BBY) has only been in the portfolio a short time but is up +12.8% since inception. This is of course a turnaround story. Management is doing an excellent job managing its cost structure and continues to shed non-core unprofitable businesses.
The three stocks that were down for the month were Delta (DAL), Lyondell (LYB) and Dow Chemical (DOW) down (-5%), (-2.6%) and (-2%) respectively.
This is a short holiday week but expect some activity as we get the June employment numbers the day before our nation celebrates its 238th birthday. By 11AM Wall Street will be a ghost town as markets and exchanges close at noon.
I’ll be back throughout the month with updates but feel free to call with any questions.
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Regarding Alpha Select Performance: Performance data quoted represents past performance and does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investment, when withdrawn from the strategy, may be worth more or less than a client’s original investment. Referenced performance is from a client’s account (model account. Performance is inclusive of all dividends, costs, commissions and the deduction of a 1.00% annual management fee (deducted quarterly in advance).
No current or prospective client should assume future performance of any specific investment strategy will be profitable or equal to past performance levels. All investment strategies have the potential for profit or loss. Differences in commissions charged or management fee charged can cause performance to vary from one account to another in identical strategies. Changes in investment strategies, contribution or withdrawals may cause the performance results of an investor’s portfolio to differ materially from the reported composite performance. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will either be suitable or profitable for a client’s investment portfolio. Historical performance results for market indices generally (such as a benchmark) do not reflect the deduction of transaction and/or custodial charges or the deduction of an investment management fee, the incurrence of which would have the effect of decreasing historical performance results. Economic factors, market condition and investment strategies will affect the performance of any portfolio and there are no assurances that it will
match or outperform any particular benchmark.
Performance reported is not GIPS compliant and has not been audited by a third party. Policies for valuing portfolios, calculating performance, and preparing compliant presentations are available upon request. Data as of 07/01/2014.
