The Prudent Speculator: January 2012
Copyright 2012 John Buckingham
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Table of Contents
Editor’s Note
Graphic Detail
Recommended Stock List
Portfolio Builder
Editor's Note
Whether it is The Wall Street Journal reporting, "During the past three years, investors globally have poured nearly $700 billion into bond funds, while pulling nearly $300 billion out of stock funds," or having to turn to Page R6 of that publication’s Year-End Review & Outlook section before finding a 2012 summary of U.S. stocks, investor indifference toward equities remains puzzling.
"Let’s just wait and see what these knuckleheads [Congress] do."
—John Odland,
CFO, MacMillan-Piper
As a contrarian investor, I’m not complaining about the apathy, mind you, but the S&P 500 delivered a total return of 16.0% in 2012 for crying out loud. Perhaps the seeming disinterest stems from the significant underperformance last year of the widely followed Dow Jones Industrial Average, which gained ‘only’ 10.2% on a total return basis. Believe it or not, more than a few media outlets chose to trumpet the Dow’s 7.3% yearly change and the S&P 500’s 13.4% price advance, ignoring the substantial role that dividends play in investment returns. Indeed, Standard & Poor’s reported that companies in the S&P 500 index were on track to pay a record $281 billion in regular dividends to shareholders in 2012, a 17% increase from 2011! And with more than $1 trillion in cash sitting on the balance sheets of those S&P 500 members, one would look for dividends to climb again in 2013.
To be sure, the year just completed was terrific for the equity markets, especially considering the laundry list of obstacles that stocks had to overcome. While every year has its share of headwinds (2011 had unrest in the Middle East, an earthquake and tsunami in Japan and the S&P downgrade of the U.S. credit rating, to name a few), investors in 2012 faced the ‘London Whale’ debacle at JPMorgan Chase (JPM—$44.57), more drama in the long-playing European debt crisis, the Facebook IPO disaster, a ‘trading glitch’ that led to the near-collapse of Knight Capital, a slowdown in Chinese economic growth and a polarizing U.S. election. And I haven’t even mentioned the tragedies in Aurora, Benghazi and Newtown, as well as the devastation of Superstorm Sandy, the sinking of the Costa Concordia and the dysfunction in Washington that sent the country, for a day, over the Fiscal Cliff.
While we drink a toast to Auld Lang Syne, 2013 was rung in with gusto as the first trading day of the new year saw stocks rocket higher. Indeed, the Dow soared 308 points and our benchmark Russell 3000 index jumped more than 2.5% after the House of Representatives late on New Year’s Day passed the Senate’s American Taxpayer Relief Act of 2012. Heck of a name for a piece of legislation that raises taxes on every Tom, Dick & Harry, but the common refrain on Wall Street was that it could have been a whole lot worse! After all, the conventional wisdom had the upper end of the tax code reverting to 39.6% on individuals/couples earning more than $200K/$250K and dividends being taxed at ordinary income rates. Thus, folks could actually cheer an increase in taxes as the upper threshold was set at $400K/$450K and dividends (ignoring the 3.8% Obamacare tax on investment income) rose only to 20% for those in the top bracket.
We can’t underestimate the impact that the uncertainty related to taxes has had on investment decisions, both at the individual and corporate level. We suspect that many folks have been in the same boat as John Odland, CFO of MacMillan-Piper, a freight-transport firm in Seattle, who recently said, "We’re all sitting on the sidelines right now wondering what’s going to happen to us."
Certainly, animal spirits are not about to be unleashed en masse, especially as the debt ceiling and sequestration are major unresolved issues looming on the horizon, while the inevitable cutbacks in government spending (not to mention higher taxes) will not help economic growth this year. However, given an economy that has been remarkably resilient, incredibly low interest rates and strong corporate balance sheets and income statements, we think that stocks are likely to deliver solid returns in 2013.
Graphic Detail
Time once again to detail the current Sector and Industry Group weightings of our four newsletter portfolios as well as how they compare to the broad-based Russell 3000. While we very much remain bottom-up stock pickers focused on the merits of individual companies, we also keep a watchful eye on the composition of our benchmark index in order to ensure that we are comfortable in the over- or under-weighting of a particular Sector or Industry Group. Also, we are able to better focus our subjective reviews on the output of the objective new-idea generation screens that we run every day on areas in which we might desire additional exposure. Illustrative of this process are the first-time recommendations in November of Consumer Discretionary name Kohl’s (KSS—$42.35) and PNC Financial Services (PNC—$59.75), not surprisingly, a resident of the Financial sector.
Obviously, there is a great deal of art accompanying the science of portfolio construction as Sector and Industry Group weightings are always used as a guide and not as the gospel. Over time, the gaps have narrowed, but inevitably there will be dispersion across the newsletter portfolios. Indeed, there is a significant difference in the number of holdings between Millennium Portfolio (60) and PruFolio (90), while Buckingham and TPS Portfolios have been impacted by the timing of cash flows and the usage (in years past) of margin leverage.
The Prudent Speculator: January 2013 Page 1
