SINLetter - October 2008

Welcome to edition 38 of Suria Investment Newsletter (SINLetter), a free monthly investment newsletter. The objective of this newsletter is to provide you with unbiased initial research and basic facts about individual stocks and other financial instruments so that you can research them further before deciding to add them to your portfolio or not. If you are reading this and are not a subscriber, you can subscribe by going to www.sinletter.com/subscribe.aspx and you will start receiving this newsletter from next month. I have provided relevant links throughout this newsletter, but if you have any questions or comments, feel free to write to me.


September Blog Entries:

Breaking out of blogging hibernation, I started writing again to address some of the turmoil we experienced during one of the worst months we have seen in years. If you do not subscribe to blog entries by email or in case you missed them, here are the blog entries for September.

If you do not receive blog entries by email, you can still subscribe to receive blog entries by email here.


Portfolio Performance:

We posted the worst monthly performance since the inception of this newsletter with a drop of 9.92% in September, worse than the drops in the Dow and S&P 500 but a little better than the 12.05% drop the Nasdaq experienced as you can see from the table below. The first week of October has lead to further drops and all three major indices are in negative territory since the inception of this newsletter in August 2005, while we are still holding on to a gain of 67.25% in the SINLetter model portfolio. Watching the sea of red in my personal portfolios has been painful and it is little consolation that as of mid-September only 5 out of the 9,100 US mutual funds had positive returns this year. I still believe we are yet to see the bottom and it will take years for this global bubble to deflate but have confidence that our portfolio which represents a broad range of sectors from consumer staples to pharmaceuticals, is positioned well for a recovery if and when it occurs. A 13% cash position gives us some ammunition to either hedge the long portfolio against further declines or add positions that look like bargains.

Performance Metric Dow S&P 500 Nasdaq SINLetter
September 2008 -6% -9.08% -12.05% -9.92%
Third Quarter 2008 -4.4% -9% -13.7% -7.06%
Since Inception (Aug 2005) 2.14% -5.58% -5.15% 82.87%



The much anticipated, hated and perplexing bailout bill, which ballooned from the original $700 billion to $850 billion was approved by the House of Representatives and signed by President Bush (who incidentally happened to call Wall Street drunk just a couple of months ago in this amusing video). Wall Street reacted by sending the Dow down another 157 points or 1.5%, probably on concerns about the 159,000 jobs lost in September. Warren Buffett decided to pour some of his billions into GE (a very sweet deal that pays him a 10% dividend and 5 year call options to buy GE at $22.25) and the market rewarded GE with a 12% drop over the next two trading sessions. GE's decision to dilute existing shareholders by raising $12 billion caused investors to lop off $29 billion from GE's market cap. These are treacherous times for investors and the following cartoon from the 1997 cover of The Economist perfectly captures the mood swings of Mr. Market from manic depressive at one instant to euphoric the next.

Rather than focus on developments related to individual stocks in the portfolio like I usually do (everything took a hit on little or no company specific news) in this section, I am going to focus on the broad theme of asset allocation in this newsletter.

Gold continued to maintain its inversely correlated relationship with stocks by rising $40.1 or 4.83%, closing the month of September at $870 per troy ounce.

Portfolio Readjustment:

I am making no changes to the model portfolio at this time. As discussed below, I am adding Intel (INTC) to our watchlist.


Asset Allocation:

The importance of asset allocation is sometimes not as obvious as it would seem to many retail investors who often mistake investing as picking a bunch of stocks or funds and periodically rebalancing this portfolio. While I was aware of the role asset allocation plays in portfolio performance, I was taken aback by the following paragraph from the book Unconventional Success by Yale University's Chief Investment Officer David Swensen.

A number of well-regarded studies of institutional portfolios conclude that approximately 90 percent of the variability of returns stems from asset allocation, leaving approximately 10 percent of the variability to be determined by security selection and market timing. Another important piece of research on performance of institutional investors suggests that 100 percent of investor returns derive from asset allocation, relegating security selection and market timing to an inconsequential role.

As an investor who does not believe in the efficient-market hypothesis and feels that individual stock selection can help you outperform the market in the long-term, the research that David mentioned in his book was shocking to me. When I read the sentences again I realized the key words in the paragraph were "institutional portfolios" and if the same study were done on retail portfolios, the results may be different but probably not by a whole lot. Studies done of the performance of mutual fund investors have shown that not only do most mutual funds underperform the market, investors in these funds tend to do even worse than the numbers posted by these funds.

Asset allocation if done properly can reduce the volatility of your portfolio and reduce the impact of a bear market. A class of funds commonly referred to as lifecycle funds, can take all the guesswork out for you and automatically adjust asset allocations (primarily between stocks and bonds) as you approach your retirement date. For example, if you plan to retire in 21 years from now, you could pick the Fidelity Freedom Fund 2030 (FFFEX) or the lower cost Vanguard Target Retirement 2030 Fund (VTHRX). The Fidelity fund is down 27.29% since the start of this year, while the Vanguard fund has lost 24.85% when compared to a 24.95% YTD drop in the Dow.

However if you are like me and prefer coming up with your own asset allocations and selecting stocks/instruments within the asset classes, it may be well worth the effort it takes to get a few points of extra performance (alpha). Even do-it-yourself investors have multiple tools at their disposal. The website Financial Engines founded by Nobel Prize winning economist and creator of the Sharpe Ratio, William Sharpe, offers low cost retirement solutions. Another monte carlo simulation tool that lets you play with asset allocations is the Quantext Portfolio Planner by Dr. Geoff Considine.

With the availability of exchange traded funds (ETFs) that not only cover almost every imaginable sector and country but also let you slice and dice within a sector, creating a sophisticated asset allocation model is no longer out of the reach of informed retail investors. Understanding the tax consequences and correlation between asset classes (gold is usually inversely correlated with stocks) is probably as important as picking the right securities and percentages. Based on my current convictions about the macro economic environment, given below is the asset allocation I came up with for my family's tax-deferred (retirement) portfolio.

Asset Allocation

In case the above diagram is not clear, I have also broken out the various components in the following table.

Asset Class Allocation Instruments
REITS (International and Apartment) 10% AIV, AVB, DRW?
Alternative Energy 10% PBW, STP, ALTI, HOKU?
Cash 15%  
Domestic Stocks 20% INTC, GE, SBUX, CTXS, UMPQ, BAC, BCS, ATVI, TWER, ALVR, LGF, MCS?
Commodities      
  Metals 5% SCHN, SID, SLT?
  Gold 5% GLD, NEW, ABX?
  Water 5% PHO, CGW, PICO?
  Timber 5% PCL, RYN, WY?
International Stocks 25% EPI or IFN (India), EWM (Malaysia), EWS (Singapore), EWZ (Brazil), EFV (Europe Value), PGJ (China)?

 

The absence of bonds from this asset allocation is intentional due to personal preferences and has nothing to do with my future expectations related to bonds. I have also decided to break out alternative energy into a separate asset class because I think the sector holds a lot of potential irrespective of who wins the elections come November. Within each asset class my goal is to allocate no more than 5% to individual ETFs and preferably less than 2% to individual stocks.

Please note that this allocation may only make sense for my age and financial conditions and has not been tested or refined using a simulation tool. I will probably tweak the individual security/instrument selections, run some simulations and post the results on the blog at a later date. This article should not be construed as personal investment advice and I am only sharing this to foster discussion and obtaining constructive feedback.


Intel (INTC) $16.93

It has been well over two years since we featured Intel in the July 2006 edition of SINLetter and sold it roughly a year later for $23.23 to book a gain of 22.26%. The stock has dropped significantly since then and is currently off more than 40% from its December 2007 peak. Unless you believe in financial armageddon, troubling times such as these are the perfect time to pick up financially strong companies that are leaders in their sector. Given the financial problems competitor AMD is facing, Intel at this point is not just the leader in its sector but pretty much is the only game in town. Opportunities to pick up virtual monopolies at less than 12 times 2009 earnings, while collecting a 3.2% dividend yield rarely present themselves.

The company currently has nearly $12 billion in cash and short-term investments on its balance sheet as well as $5.29 billion in long-term investments when compared to just $2.83 billion in both short-term and long-term debt. Intel generated nearly $1.6 billion in net income just last quarter and while no one expects jaw dropping growth rates form Intel, expectations of nearly 15% growth are still respectable and may even be aggressive.

As companies like Intel kept packing more and more transistors into chips that kept getting smaller, electricity leakage and heat became a big problem. Intel lost market share to AMD in the server segment primarily because AMD's chips were running cooler and consuming less energy. Intel's answer to this was its new "high-k" material, which in Gordon Moore's own words is "the biggest change in transistor technology since the introduction of polysilicon-gate MOS transistors in the late 1960s." This new material has helped reduce "gate leakage" more than 100-fold and the chips based on this high-k material were picked by Time magazine as one of the best inventions of 2007.

The risks of earnings expectations getting revised downwards and this recession lasting longer than most people originally expected certainly exist but most of those risks already appear to be factored into the stock price. Consider the fact that even during the dot com bear market of 2000-2002 that took a severe toll on most technology stocks, the lowest Intel dropped to was $13.22 in October 2002. Intel had a much stronger competitor in AMD at that time than it does now.

I am going to add Intel to our watchlist and will post an update on the blog if I decided to start a position for the SINLetter model portfolio. I currently hold Intel in my personal portfolio and am planning on adding to my position.


Every month we add featured stocks into a model portfolio started with a cash position of $100,000 on August 2, 2005. To keep calculations simple, trading costs and regular dividends are not included.

Model Portfolio - October 3, 2008

Long Stocks

Stock Symbol Number of Shares* Cost Current Value Diff ($) Diff (%) Date Added
Activision ATVI 600@$16.41 $9,846 $7,524 $-2,322 -23.58% 8/29/2008
Towerstream TWER 10,000@$1.27 $12,700 $10,100 $-2,600 -20.47% 6/0/2008
Textron TXT 150@62.55/share $9,382.5 $3,783 $-5,600 -59.68% 5/31/2008
Companhia Siderurgica Nacional SID 200@43.15/share $8,630 $3,468 -$5,162 -59.81% 4/30/2008
Lionsgate Entertainment LGF 1,000@9.41/share $9,410 $8,650 $-760 -8.08% 2/29/2008
Tata Motors TTM 500@17.52/share $8,760 $3,565 $-5,195 -59.3% 2/29/2008
Barclays PLC BCS 400@32.435/share $12,974 $9,884 $-3,090 -23.82% 11/20/2007
Powershares Water Resources PHO 400@22.10/share $8,840 $6,450 $-2,390 -27.04% 10/31/2007
Marcus MCS 500@19.94/share $9,970 $7,125 $-2,845 -28.54% 9/14/2007
Blockbuster BBI 3,000@3.925/share $11,775 $5,940 $-5,835 -49.44% 7/9/2007
Unilever Plc UL 200@32.53/share $6,506 $5,542 $-964 -14.82% 5/11/2007
EMC Corp EMC 600@13.85/share $8,310 $6,948 $-1,362 -16.39% 3/31/2007
ICON Plc ICLR 300@18.65/share $5,595 $11,181 $5,586 99.84% 1/31/2007
Diamond Offshore Drilling DO 80@76.65/share $6,132 $7,498 $1,366 22.28% 1/3/2007
Alvarion ALVR 1000@6.87/share $6,870 $5,070 $-1,800 -26.2% 1/3/2007
WisdomTree Investments WSDT.PK 1000@7.40/share $7,400 $1,450 $-5,950 -80.41% 11/30/2006
Teva Pharmaceutical TEVA 300@35.05/share $10,515 $13,824 $3,309 31.47% 9/1/2006
Suntech Power STP 250@25.93/share $6,483 $8,368 $1,885 29.08% 7/31/2006
Procter & Gamble PG 180@55.60/share $10,008 $12,784 $2,776 27.73% 6/30/2006
Johnson & Johnson JNJ 200@57.65/share $11,530 $13,232 $1,702 14.76% 2/28/2006
  Cash     $22,752      
  Total     $175,137 $75,137 75.14%  

 

* Price and number of shares adjusted for Activision Blizzard (ATVI) and ICON plc (ICLR) to reflect splits on September 8, 2008 and August 13, 2008 respectively.

Voluntary Disclosure: From the stocks that are currently in the model portfolio, I own shares of Activision Blizzard (ATVI), Towerstream (TWER), Lionsgate Entertainment (LGF), Tata Motors (TTM), PowerShares Water Resources (PHO), Barclays (BCS), Suntech Power (STP), Teva (TEVA), Alvarion (ALVR), WisdomTree (WSDT.PK), Unilever (UL), BlockBuster (BBI) and Marcus (MCS).

 


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