Sizemore Capital Management

2011 Year End Investment Outlook and Commentary

noreply@blogger.com (Charles Lewis Sizemore, CFA) — Tue, 17 Jan 2012 00:33:00 +0000

To Our Investors,

2011 was a year for the history books. This was a year that saw an earthquake, tsunami and nuclear disaster cripple Japan, the third-largest economy in the world. It witnessed the “Arab Spring,” the biggest upheaval in Middle Eastern politics in more than three decades. Closer to home, it saw the United States lose its coveted AAA credit rating. And of course, 2011 was the year of the slow-motion European sovereign debt crisis that, at time of writing, is still far from resolved.

Through it all, investors experienced some of the most volatile market moves since the meltdown year of 2008. This was the year of “risk on / risk off.” Virtually all risky asset classes moved in lockstep in response to macro events. When it appeared that Europe might avoid meltdown, stocks, commodities, real estate, non-Treasury bonds, and even alternative investments like fine art soared as risk appetites returned. But at the first whiff of bad news, all of these disparate assets classes crashed together.

Allocating capital under these conditions is a little like walking through a minefield. You’re generally quite satisfied to make it through in one piece. Quite a few investors—including household names like George Soros, John Paulson, and Bill Gross—saw their reputations tarnished in 2011 (see “Even the Greats Make Mistakes” for our write-up on some of these high-profile flameouts). We are pleased to say that all Sizemore Capital strategies saw positive returns in 2011.

Portfolio Review

SCM Tactical ETF Portfolio

For the year ended 12/31/2011, Sizemore Capital’s Tactical ETF Portfolio returned 2.5 percent vs. 1.9 percent for the S&P 500 Total Return Index.

While we were pleased to see that the Tactical ETF Portfolio beat its benchmark, the S&P 500, 2011 was nonetheless a frustrating year. Our decision to build the portfolio around a core of high-quality, dividend-focused stocks was vindicated, as quality dividend payers performed well relative to their lower-quality and non-dividend-paying peers. Our tactical investment in the healthcare sector also performed as expected. Our investments in emerging markets and in Europe did not perform as expected, however, and negatively impacted returns. We continue to see value in these sectors, however, and expect them to do well in 2012.

Perhaps most frustrating was our tactical gold short. We correctly identified that gold was in a bubble and predicted that its price would crash (see “Is the Gold Bubble Reaching its Climax?”). Yet despite being correct about the gold bubble, our implementation of the gold short was ineffective. Rather than being a significant driver of portfolio gains, our two attempts at shorting gold resulted in small portfolio losses. Such was 2011; you could be “right” and still lose money.

Still, we shouldn’t complain. By keeping the core of the portfolio invested in high-quality dividend payers, we prevented small unsuccessful tactical trades from inflicting large losses on the portfolio as a whole.

Looking forward, I am confident that the strategies being employed in the Tactical ETF Portfolio will serve us well in 2012. We added one new tactical position at the end of December, the iShares MSCI Germany ETF (NYSE:EWG), which complements our existing tactical position in Spanish equities. We expect the European bond markets to stabilize in the first half of 2012, and as a result we expect European equities to be among the best performing of all asset classes. The core of the portfolio, however, remains invested in high-quality, dividend-paying stocks. So, should capital market conditions remain volatile longer than we anticipate, the core of our portfolio should remain relatively stable.

SCM Strategic Allocations

In 2011 the SCM Strategic Allocations enjoyed the following returns:

Preservation of Capital	3.83%
Conservative Income	8.20%
Growth and Income	6.62%
Growth	4.13%
Aggressive	2.13%

All Sizemore Capital Strategic Allocations outperformed the S&P 500, which had a total return (capital gains and dividends) of 1.9 percent. The superior returns were largely the result of Sizemore Capital’s focus on income. The S&P 500 was flat for 2011—starting and finishing the year at 1,257—meaning that the 1.9 percent total return is due entirely to dividends. The higher returns enjoyed by Sizemore Capital’s Strategic Allocations relative to the S&P 500 are almost entirely due to the higher yields paid on the Allocations’ portfolio holdings.

Looking forward, we expect to see a greater percentage of the Allocations’ returns coming from stock dividends. With growth options somewhat limited, many companies have opted to increase their dividends in recent years. Dividend payout ratios, however, remain quite low, suggesting that there is plenty of room for additional dividend hikes.

Notably, we do not expect the bond holdings of the Strategic Allocations to be meaningful contributors to portfolio returns in coming years. With bond yields as low as they currently are, it is not realistic to expect future returns to be as high as the returns of recent years. That said, we do believe that bonds continue to play a valuable role as a portfolio “shock absorber” and that, when utilized with an effective rebalancing strategy, reduce portfolio risk.

Looking Ahead

Last quarter, we wrote that “The remarkable thing about the volatility that has dominated the markets for the past several months is that none of the issues driving it are new.” And as this letter is going to press, little has changed. Europe remains the key. When it appears that Europe’s leaders have reached a political solution to alleviate the debt crisis, the capital markets shift into “risk on” mode; when the political solution inevitably falls short of expectations, they shift instead into “risk off” mode.

We expect a workable solution in the first quarter of 2012, but we also expect a lot of volatility in the meantime. In 2011 taught us anything it is to expect the unexpected. And our preferred way to prepare for the unexpected in this environment is to err on the side of quality. Given the attractive pricing and negative sentiment in most world markets, we believe that putting capital at risk makes sense. We view the “risk” in today’s market as that of short-term volatility; but the risk of permanent or long-term loss would seem remote.

Looking forward to a profitable 2012,

Charles Lewis Sizemore, CFA

Chief Investment Officer, Sizemore Capital Management, LLC

Third Quarter 2011 Letter to Investors

noreply@blogger.com (Charles Lewis Sizemore, CFA) — Mon, 03 Oct 2011 14:38:00 +0000

To Our Investors,

The third quarter was a rough one for investors as the Standard & Poor’s downgrade of the United States and persistent fears of a European sovereign debt meltdown wreaked havoc on world financial markets. Investors experienced some of the most volatile market moves since the annus horribilis of 2008. Virtually all asset classes—with the exception of U.S. Treasuries—suffered losses. Even gold, which had been considered a “safe haven” asset for much of the past three years, saw a sharp correction. Though it is too early to say with certainly, it appears that the gold bubble may finally have burst.

Through the third quarter our actively-managed Tactical Portfolio returned (5.2%), losing less than the (8.7%) of the S&P 500 Total Return Index for the period.

Portfolio Review

The SCM Tactical ETF Portfolio was positioned relatively conservatively at the start of the third quarter, but not quite conservatively enough to escape the wave of volatility. Even our conservative positions in dividend-focused stocks, heath care, and international telecom saw significant declines, though less than the broader market. Our positions in emerging markets suffered the greatest losses for the period.

Through the third quarter our actively-managed Tactical Portfolio returned (5.2%), losing less than the (8.7%) of the S&P 500 Total Return Index for the period.

On August 15, midway through the quarter, we made significant changes to the Tactical ETF Portfolio. In a memo distributed to private clients, we wrote:

It has been a rough summer for investors, but the Tactical ETF Portfolio has weathered the storm comparatively well. Our heavy allocation to steady dividend-paying stocks and to defensive sectors such as utilities, telecom, and health care took less damage that the overall market averages. During a panic-fueled rout—such as the one that followed Standard & Poor’s downgrade of the United States from AAA to AA+—you win by not losing.

Though it is always difficult to remain calm when surrounded by hysteria, it is much easier when you understand your portfolio holdings and are comfortable with the prices paid. Investors need not be scared when they are holding quality, conservatively-finance companies at reasonable prices. Volatility—even violent volatility like we saw in August—can be viewed as a buying opportunity…

We have also initiated short sell of gold via the Proshares UltraShort Gold Fund (GLL). The price of gold soared during the run-up to the S&P downgrade announcement, as investors were truly desperate to get into something “safe.” Gold rose from less than $1,500 per ounce to over $1,800 per ounce in a matter of weeks, and the most popular gold ETF, the Gold SPDR (GLD) came within a hair’s breadth of eclipsing the S&P 500 SPRD (SPY) becoming the largest ETF in the world by assets under management.

In a volatile commodity like gold, there are numerous opportunities to make short-term tactical trades, both long and short. We believe this is one of those opportunities.

Now with the markets settling down to something resembling normal, we expect the price of gold to fall, at least in the short term. We have had a negative view of gold for nearly a year now, though we know from experience it can be financial suicide to bet against an asset bubble—whether it be in tech stocks, Miami condos, or gold. For this reason, we are going to keep a close eye on this trade. Should gold rise above its recent all-time highs, we will close out the short position. Gold may be in an irrational bubble, but that doesn’t mean that the bubble has to burst today. On balance, we see downside of less than 10% and upside of 30% or more, making it a trade worth making.

Our optimism proved to be a little premature. After a brief respite, the volatility continued throughout August and much of September. Gold briefly rallied to new highs, prompting us to close our initial short position. We did, however, find a new opportunity to re-enter the short position. On August 26 we wrote,

Following our guidance of our August 15 memo, we closed our short position in gold via the Proshares UltraShort Gold Fund (GLL). On August 15, we wrote,

Should gold rise above its recent all-time highs, we will close out the short position… Should gold rise above its recent all-time highs, we will close out the short position. Gold may be in an irrational bubble, but that doesn’t mean that the bubble has to burst today. On balance, we see downside of less than 10% and upside of 30% or more, making it a trade worth making.

Days after we closed the short position, gold surged to a new all-time high above $1,900 per ounce and then immediately crashed in the biggest two-day sell-off since 1980. We have used this volatility to initiate a new short position. In order to avoid wash sale restrictions, we have opted to use the ETN DZZ rather than GLL. The two funds trade in virtual lockstep, making DZZ an acceptable substitute.

Our trading guidance remains the same. We are willing to put 10-15% of the position at risk, which translates to only 50-75 basis points of the entire portfolio. We believe that gains of 30% or more are likely, making this a trade worth making. Should gold prices again break into new all-time highs, we must simply conclude that this bubble has further to inflate and that this is not an appropriate time to bet against it.

Though it is too early to say, the gold bubble may have finally burst. As we enter the fourth quarter, our gold short position is the only portfolio position that is showing strength.

Looking Ahead

The remarkable thing about the volatility that has dominated the markets for the past several months is that none of the issues driving it are new. The U.S. economy remains sluggish, and its government continues to spend irresponsibly more than it takes in via taxes. Greece, which threatens to start a domino effect that could tear the European Union apart, was a basket case two years ago. It’s still a basket case today. There is little new news here.

It is a mistake to read too deeply into the markets bends and twists because you’re attempting to assign reason to the irrational. John Maynard Keynes, who made a fortune in the stock market, had a colorful way of describing it. In his General Theory of Employment Interest and Money, Keynes compared the stock market to a newspaper beauty contest in which readers are asked to choose the most beautiful girl from a selection of photos. The readers who picked the most popular face would win. Notice I said “popular” and not “beautiful.”

As Keynes noted, “It is not a case of choosing those that, to the best of one’s judgment, are really the prettiest, nor even those that average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practice the fourth, fifth and higher degrees.”

And here we are today. Investors today are not so much afraid of the economy or of a Greek default as they are afraid of how each other will react. No matter what I think the fundamental consequences of a Greek default would be, if I think the investor down the street will panic and sell, I sell first. This creates a cycle of self-fulfilling prophecy and adds significantly to the volatility that has been roiling the market.

This madness cannot last forever. Eventually, the volatility will play itself out. Perhaps Greece will finally default and the months and months of handwringing will finally be over. Or perhaps (less likely) growth picks up significantly in United States and eases the fears that we are returning to recession.

It is impossible to say, of course. But this is the nature of the investment game. Investing is an exercise in making decisions under conditions of uncertainty. And under these conditions, you have to filter out the hysteria and embrace your “Inner Spock.”

Being as objective as we can be, we continue to see value in American and European multinationals with high and rising dividends. There is a core of solid bluechips that will survive and thrive under even the worst-case scenarios being described today. These are the companies that we are using as the core of our investment strategy.

In addition to this solid core, we continue to look for tactical trades as market conditions warrant. Our gold short, for example, has added value for us during a very difficult period in the market. We will continue to look for short-term trading opportunities as we navigate through this volatile period in market history.

Announcements

We would like to build on our announcement from last quarter. Our first two portfolios—tracking the Tactical ETF Portfolio and the Sizemore Investment Letter Portfolio—are now live on the Covestor platform (see http://covestor.com/sizemore-capital). A new portfolio mirroring the Strategic Growth Allocation will be launched early in the fourth quarter. Covestor allows investors will smaller portfolios to mirror the investment strategies of their managers, and this allows Sizemore Capital Management to reach new clients that we would ordinarily not be able to serve. We consider this an exciting new avenue for growth.

Here’s to a strong finish for 2011.

Respectfully,

Charles Lewis Sizemore, CFA

Chief Investment Officer, Sizemore Capital Management, LLC

Sizemore Capital Launches Tactical ETF Portfolio on Covestor

noreply@blogger.com (Charles Lewis Sizemore, CFA) — Thu, 18 Aug 2011 13:00:00 +0000

NEW YORK - (AUGUST 16, 2011) — Sizemore Capital Management LLC has launched a global ETF investment model on Covestor, the mirrored investing platform that enables clients to replicate the trading strategies of proven investors.

The Sizemore Capital Tactical ETF Portfolio, managed by Sizemore Capital Management Chief Investment Officer and Sizemore Investment Letter founder and editor, Charles Lewis Sizemore, CFA, is a Global Macro ETF model with a strong contrarian value focus.

The model utilizes all major asset classes, including U.S. and global equities, emerging market equities, bonds, currencies and commodities, as market conditions warrant. The model attempts to allocate to those asset classes the manager believes to be undervalued while avoiding or selling those asset classes deemed to be overvalued.

Covestor brings the type of investing expertise once reserved for high-net-worth investors to everyday investors. Covestor customers can subscribe to Sizemore’s Tactical ETF Portfolio with a low minimum investment of $5,000.

“We aim to identify the powerful macro trends driving the global economy and make investments that profit from those trends. The Tactical ETF Portfolio is a global, macro model utilizing all major asset classes,” said Sizemore.

“Though the Tactical ETF Portfolio may have concentrated allocations to stock market sectors, countries, currencies or commodities, we will always keep the portfolio prudently diversified. Only under very rare circumstances would the portfolio have more than 10 percent of its assets targeted to any single non-diversified position,” added Sizemore.

“The addition of Sizemore's model furthers Covestor's goal of broadening our selection of globally oriented investment options,” said Eric Esterkin, Director of Client Relations, Covestor.

About Covestor

Covestor allows its clients to automatically mirror the trades of individual and professional investors, managing their own money in their own accounts. All securities are purchased in the client’s name and held in custody at an independent broker-dealer. Covestor uses a combination of proprietary and institutional systems to capture and mirror trades for near-real time execution. The company uses industry standard software to generate its performance results.

Covestor is an investment advisor registered with the US Securities and Exchange Commission under the Investment Advisors Act of 1940. Additional information can be accessed directly from our Form ADV document, available at www.covestor.com.

Tactical ETF Portfolio Reallocation

noreply@blogger.com (Charles Lewis Sizemore, CFA) — Tue, 16 Aug 2011 01:59:00 +0000

The following is a Sizemore Capital Management client memo and is intended for informational purposes only; it should not be viewed as a solicitation to buy or sell securities.

The following changes will be made to the Tactical ETF Portfolio:

Utilities Select SPDR (XLU) -10%

iShares MSCI Spain (EWP) +5%

Proshares UltraShort Gold (GLL) +5%

The Tactical ETF Portfolio allocation is now as follows:

Comments

The decline in stock prices that began in May could be finished—or not. Only time will tell. But the acute crisis phase following the debt ceiling and downgrade fiasco does appear to be over.

We initially moved the portfolio into its current defensive position—high concentrations in large, conservatively-financed, dividend-paying stocks—because we saw the bull market that started in March of 2009 maturing. After hitting bottom in March, virtually all risky assets rose in lockstep—all sizes and sectors of stocks, commodities and, in particular, gold. It was a rally in everything, and the more speculative and junky the better.

We believed that this “snap back” rally from the panic lows of 2009 would be replaced by a mature bull market that favored higher quality issues, and we positioned the portfolio accordingly in late 2010 and early 2011. It was the right thing to do.

Today, however, we believe the time is right to get more aggressive. Our allocation to utilities served us well during the crisis, but we now believe there are more attractive opportunities elsewhere—most notably in Spain, the epicenter of the European sovereign debt crisis. Spain is the cheapest major developed market in the world and is some to several world-class companies—including long-time Sizemore Investment Letter recommendation Telefónica (TEF). We have initiated a 5% position in the iShares MSCI Spain ETF and may increase the allocation if market conditions warrant.

We have also initiated short sell of gold via the Proshares UltraShort Gold Fund (GLL). The price of gold soared during the run-up to the S&P downgrade announcement, as investors were truly desperate to get into something “safe.” Gold rose from less than $1,500 per ounce to over $1,800 per ounce in a matter of weeks, and the most popular gold ETF, the Gold SPDR (GLD) came within a hair’s breadth of eclipsing the S&P 500 SPRD (SPY) becoming the largest ETF in the world by assets under management.

In a volatile commodity like gold, there are numerous opportunities to make short-term tactical trades, both long and short. We believe this is one of those opportunities.

Respectfully,

Charles Lewis Sizemore, CFA

Special Update to Sizemore Capital Management Clients

noreply@blogger.com (Charles Lewis Sizemore, CFA) — Tue, 09 Aug 2011 03:59:00 +0000

To Our Investors,

Congratulations: you have just lived through the sixth-worst day in the history of the U.S. stock market. The Dow Industrials fell 634 points today in response to Standard & Poor’s downgrade of the United States’ credit rating.

After a day like this, it’s important to step back and get a little perspective. When you see the world around you crashing down, it’s natural to panic. But ask yourself the following questions:

If the United States is now a bad credit, then why did bond investors run to Treasuries today as the market was selling off? The yield on the 10-year Treasury note is now near all-time lows. This suggests that bond holders are not the least bit worried about getting their money back. If bond investors aren't worried, then why are you?
Why is it that Warren Buffett—the most successful investor in history—brushed off the S&P debt announcement and considers stocks to be attractively priced?
And how are stocks “risky” when some of the biggest and most widely-held stocks—and nearly all of the ETF positions held in Sizemore Capital portfolio—-now pay out more in dividend yield than the 10-year Treasury does in interest?

When you do your homework and you choose your investments well, you don’t have to worry at times like these. In fact, if you have extra cash at your disposal, you use them as a buying opportunity. That’s what the all-time great investors do.

Long-time readers have no doubt heard me mention the name Albert Meyer. Albert manages the Mirzam Capital Appreciation Fund (MIRZX), and I consider him one of the sharpest accounting minds in the business. I’m also not entirely convinced that Albert is human. I suspect that he is a refugee from planet Vulcan, home of Star Trek’s Spock.

You see, Albert has that certain personality quirk that tends to be prevalent in successful value investors—a total lack of emotion when it comes to the investment process. Albert dissects a company’s financial statements with the detachment of a surgeon in the operating room. When he determines that a company is a bargain, he buys it. And if determines that a company is expensive—or if he finds their accounting practices questionable—he avoids it, no matter how popular it is.

He also has a second personality quirk that is common to virtually all successful value investors—an ability to tune out the constant stream of noise coming from the media. Albert, like myself, reads the Financial Times religiously. But unlike me, who compulsively has to read it every morning with my coffee, Albert reads a weeks’ worth of newspapers at once, usually on a Saturday when the market is closed. Oh, and he doesn't own a TV. ("It's mostly all rubbish, anyway," is his rationale, spoken in his professorial South African accent. He's correct on that count.)

Right now, I’m going to recommend that we play it cool like Albert. If you are comfortable with what you own—and I most certainly am—then don’t let a wave of hysteria over a meaningless credit downgrade cloud your judgment. You sell when your reasons for owning an investment no longer hold true, not because of a volatile fear-based decline. Continue to collect the dividend checks and add to your positions as your funds allow. You’ll sleep better at night. And when the dust settles, you’re likely to walk away from all of this a lot richer.

I am keeping an eye on our portfolio positions, and I am prepared to sell if conditions warrant. But for now, I recommend we sit tight.

Charles Lewis Sizemore, CFA

Sizemore Capital Management 2nd Quarter 2011 Letter to Investors

noreply@blogger.com (Charles Lewis Sizemore, CFA) — Sun, 10 Jul 2011 20:50:00 +0000

To Our Investors,

As we hit the mid-year mark, 2011 is shaping up to be another good year for Sizemore Capital Management and our clients. Through the first half of the year our actively-managed Tactical Portfolio returned 8.2%, outperforming the 5.9% for the S&P 500 Total Return Index and with less volatility.

Investors were apprehensive in the second quarter. Continued instability in the Middle East, recurring fears of a sovereign debt meltdown in Greece and other European countries, and an American economy that appears to be weakening again all conspired to send stocks and other risky assets sharply lower. Sizemore Capital Management’s portfolios were well prepared for this kind of environment, however, and we enjoyed a strong quarter marked by investor rotation into the sectors that we favored.

Portfolio Review

SCM Strategic Portfolio Allocations

Our returns for second quarter 2011 on the passive Strategic Portfolio Allocations were the following:

Preservation of Capital.....1.7%
Conservative Income........5.1%
Growth and Income..........5.6%
Growth..............................5.6%
Aggressive........................6.0%

The Growth and Income, Growth, and Aggressive allocations soundly outperformed the S&P 500 in the second quarter, erasing much of their underperformance in the first quarter. Master limited partnerships, which are an important constituent of all three portfolios, have underperformed thus far in 2011, as have emerging market equities. The relative underperformance of these two sectors has been a drag on the performance of Sizemore Capital Management’s Strategic Portfolios. Real estate investment trusts and high-dividend stocks have been the best performers in 2011, followed by U.S. small cap equities.

The Strategic Portfolio Allocations are long-term allocations, and Sizemore Capital Management does not actively manage them; we simply rebalance them on an annual basis and periodically, as market conditions warrant, do a strategic review. In light of the historically low yields that are currently prevalent in the bond market today, we believe that such a review is now prudent.

An allocation to bonds serves two purposes. Firstly, bonds have an expected return based on the steady stream of coupon payments and the potential for capital gains from falling yields. But secondly, and arguably more importantly, an allocation to bonds serves as a “shock absorber.” When the markets hit a rough patch—as they did in the second quarter—bonds provide stability and lessen the overall volatility of the portfolio.

This latter role, as a portfolio shock absorber, is still an important reason to have exposure to bonds. But unfortunately, given the current low-yield environment, we cannot expect much in the way of returns. The 10-year Treasury note barely yields 3%, which is less than the dividends paid by many of the other holdings of the Strategic Portfolios. Furthermore, it is not realistic to expect significant capital gains in bonds. In order for bond prices to rise, the yield—which is currently near all-time lows—would have to continue falling, and yields can only fall so far.

Unlike many managers, Sizemore Capital Management is not bearish on bonds, per se. Our forecast is that the 10-year Treasury note trades in a range of 3-4 percent for the next 5-7 years, implying flat or slightly positive returns. But while we are not bearish, we most certainly are realistic. And even under the most optimistic assumptions, the current allocation to bonds in the Growth and Income, Growth, and Aggressive portfolios is likely to be a drag on performance going forward. Furthermore, after a long period in which bonds appeared undervalued versus stocks after adjusting for risk, today the precise opposite would appear to be true. Though stocks can be expected to be volatile, at current prices they would appear to be undervalued relative to bonds.

The diversification benefits of bonds and their role as a shock absorber make an allocation to them a necessity. But it is our view that the protection offered by bonds must be weighed against the lackluster returns that we expect going forward. On balance, we believe that a smaller allocation to bonds and a larger allocation to high-dividend stocks, master limited partnerships, and real estate investment trusts is appropriate.

While these changes may slightly increase portfolio volatility in the years ahead, we believe that any mild increase in volatility will be justified by the higher expected return. Importantly, the portfolios keep that all-important “shock absorber” through the continued exposure to bonds and Sizemore Capital Management’s rebalancing strategy.

All clients whose portfolios will be affected by these changes will be consulted before the changes are made to ensure that they are consistent with the client’s objectives.

SCM Tactical ETF Portfolio

The SCM Tactical ETF Portfolio was well positioned for the market conditions we experienced in the second quarter of 2011. We expected investors to shift out of the more speculative and cyclical sectors and into more value-oriented sector such as utilities, telecom, health care, and high-dividend stocks in general. Our portfolio moves proved to be a little too early, and we underperformed in the first quarter. But the volatility of the second quarter vindicated our choices, and the portfolio make significant gains even while the broader market was selling off. Through the first half of 2011, the Tactical ETF Portfolio returned 8.2%, outperforming the S&P 500 total return of 5.9% Sizemore Capital Management made no changes to the Tactical Portfolio during the second quarter of 2011.

Looking Ahead

We believe that our portfolios are well positioned for the market conditions we see for the remainder of 2011. We expect the bull market in stocks to continue, but in the “post-QE2” environment we believe that less speculative, dividend-focused sectors should continue to outperform relative to their more cyclical peers.

Though it is too early to say definitively, it would also appear that the tight correlations between risky assets—and particularly between stocks and commodities—that has persisted since the start of the bull market in 2009 is starting to break down. The Federal Reserve’s quantitative easing programs produced excess liquidity, which had the effect of inflating practically all risky assets. As this excess liquidity continues to drain out of the financial system, correlations should return to something closer to their historic norms.

Sizemore Capital Management expects to see continued weakness in most major commodities as investor interest turns to more attractively-priced asset classes. At the same time, we expect investors to “rediscover” emerging market equities. Due to fears of inflation and “overheating,” emerging market equities have underperformed their developed-world peers in 2011. We expect emerging markets to lead in the next 6-12 months.

Announcements

We do have one exciting announcement to make. Sizemore Capital Management is joining the Covestor platform and subscribers to the http://covestor.com website will be able to invest in the Tactical ETF Portfolio starting at the beginning of August. A second portfolio mirroring The Sizemore Investment Letter Portfolio will follow. Covestor allows investors will smaller portfolios to mirror the investment strategies of their managers, and this allows Sizemore Capital Management to reach new clients that we would ordinarily not be able to serve. We consider this an exciting new avenue for growth.

Here’s to a strong second half of 2011.

Respectfully,

Charles Lewis Sizemore, CFA
Chief Investment Officer, Sizemore Capital Management, LLC

The full quarterly letter can be viewed here.

Live on Fox Business News: Charles Sizemore on Dividend Investing

noreply@blogger.com (Charles Lewis Sizemore, CFA) — Tue, 17 May 2011 18:53:00 +0000

Sizemore Capital Management's Charles Sizemore discusses dividend investing live on Fox Business News:

If you are unable to view the embedded video, please follow this link: http://video.foxbusiness.com/v/4698180/tips-for-investing-in-etfs-/

Charles Sizemore Live on Fox Business News

noreply@blogger.com (Charles Lewis Sizemore, CFA) — Tue, 19 Apr 2011 18:00:00 +0000

Watch Sizemore Capital Managment's Charles Lewis Sizemore, CFA give his thoughts on the market to Lori Rothman of Fox Business News

If you cannot view the embedded video, please follow the link below:
http://video.foxbusiness.com/v/4640284

Sizemore Capital Management 1st Quarter 2011 Letter to Investors

noreply@blogger.com (Charles Lewis Sizemore, CFA) — Mon, 18 Apr 2011 18:34:00 +0000

To Our Investors,

2011 is shaping up to be another good year for Sizemore Capital Management and our clients. Through the first quarter our actively-managed Tactical Portfolio returned 5.5%, marginally underperforming the 5.9% for the S&P 500 Total Return Index but with less volatility.

Portfolio Review

SCM Strategic Portfolio Allocations

Our returns for first quarter 2011 on the passive Strategic Portfolio Allocations were the following:

Preservation of Capital.......0.2%
Conservative Income.........2.5%
Growth and Income...........3.5%
Growth.............................4.1%
Aggressive........................5.0%

All SCM Strategic Portfolios—even the Growth and Aggressive allocations—underperformed the S&P 500 in the first quarter. While disappointing, the results were not particularly surprising. The first quarter favored cyclical, smaller, and more speculative sectors while many of SCM’s growth sectors—such as non-U.S. large caps, dividend-focused equities, and master limited partnerships—lagged. Curiously, given the preference for more speculative issues, emerging market shares also lagged. Sizemore Capital Management expects better relative performance from these sectors in the remainder of 2011.

SCM Tactical Portfolio

Sizemore Capital Management made one significant change to the Tactical Portfolio during the first quarter of 2011. Believing that little upside potential remains, we sold our long-term holdings in high-yield “junk” bonds, realizing equity-like returns with significantly less volatility.

Junk bond yields hit all-time lows during the first quarter, and junk spreads over Treasuries of comparable maturities narrowed significantly. Furthermore, the supply of new junk issues hit record highs as companies flooded the market in an attempt to take advantage of historically-low yields. March beat the previous monthly record for junk new issuance, with $47 billion worth of bonds sold, according to Thomson Reuters.

Under these conditions, we felt the time was right to liquidate our position in the sector. Shortly thereafter, we initiated a new position in emerging market consumer stocks. Emerging markets have significantly underperformed American stocks since the fourth quarter of 2010, and valuations are presently quite attractive. We considered the first quarter an excellent opportunity to rebalance into what will likely prove to be the best performing asset class of the next decade.
We also want to reiterate our bullish view on our three contrarian sector investments in utilities, global telecom, and health care. As the first quarter neared its close, investors appeared to be slowly realizing the attractiveness of global telecom and health care. Utilities continue to lag, due in part to fears stemming from the Japanese earthquake and nuclear crisis. We continue to view all three as highly-attractive contrarian value plays and anticipate no immediate portfolio changes.

For a current summary of Sizemore Capital Management’s investment thesis in these sectors, please see Three ETFs for a Volatile Spring

Looking Ahead

We are off to a great start in 2011, and we only see this accelerating as the year progresses. If, as we expect, investors shift from a growth focus to a value focus, our Tactical Portfolio should soundly bet the market for the year. But, should investors continue the same buying patterns of the past two years—which has favored cyclical and more speculative sectors—then our portfolios will slightly lag the broader market.

We continue to allocate capital where we see the greatest value, with a strong focus on dividends and dividend growth. There are bargains to be found in this market, and we intend to continue exploiting them.

Respectfully,
Charles Lewis Sizemore, CFA
Chief Investment Officer, Sizemore Capital Management, LLC

Sizemore Capital Comments on Japan

noreply@blogger.com (Charles Lewis Sizemore, CFA) — Fri, 18 Mar 2011 21:28:00 +0000

Charles Sizemore, Chief Investment Officer of Sizemore Capital Management LLC, gave his analysis of the developing crisis in Japan to Reuters following the earthquake and tsunami and offered his suggestions of how investors can profit from an improvement in sentiment.

BOSTON, March 15 (Reuters) - Japan's stock market, usually one of the world's dullest, has turned into a gripping 24-hour roller coaster fueled by fear and punctuated by only short moments of relief.

The U.S.-listed iShares MSCI Japan Index exchange-traded fund (EWJ) turned over 400 million shares worth some $4 billion on Tuesday, more than 10 times the fund's average volume over the prior three months. Another 37 million shares traded in the first hour on Wednesday on the New York Stock Exchange.

Why would anyone want to trade amid such uncertainty?

"American investors wanting a short-term play on a Japanese recovery can consider (the fund)," Charles Sizemore, who runs Dallas money manager Sizemore Capital Management, said. While not advocating a long-term bet on Japan, "in the short to medium term, I like Japan as a contrarian value play. Natural disasters tend to have only very short-term effects on the stock market," Sizemore added.

OTHER TRADES INVESTORS ARE MAKING

In any eventual economic recovery, the biggest gainers might be funds that specialize in smaller Japan companies. These companies populate small-cap stock funds like the SPDR Russell/Nomura Small Cap Japan Fund (JSC) or the iShares MSCI Japan Small Cap Fund (SCJ), according to Ron Rowland, chief investment officer at Capital Cities Asset Management in Austin, Texas.

In the past, Rowland has worried about the funds' light trading volume but that has changed since the disaster. "They've been around for four or five years, but now that they've been discovered, perhaps investors will take a continuing interest in them," Rowland said.

Money manager Sizemore agreed that small caps might get a bigger bounce, but warned that Japan has deep, underlying problems that won't go away when the damage is repaired.

"Longer-term, Japan is the short of all shorts," Sizemore said. "The country has debts it can never hope to repay and demographics that are catastrophically bad."

How to Choose the Right Dividend ETF

noreply@blogger.com (Charles Lewis Sizemore, CFA) — Wed, 26 Jan 2011 15:00:00 +0000

The stock market hasn’t returned a single red cent in over twelve years, as measured by the S&P 500. Twelve years is a long time to go without earning a return on your investment, particularly if you are close to retirement.

With the boom years of the 1980s and 1990s now a distant memory, it is not shocking to see investors losing faith in the cult of capital gains and gravitating instead to dividend-paying stocks and ETFs. In a world in which paper gains can be ephemeral, it’s good to be paid in cold, hard cash.

In many ways, this is simply a return to the basics of investing. Historically, before federal capital gains taxes and Modern Portfolio Theory shifted the industry to a focus on growth, dividends were the primary source of investor returns (see Figure 1), and over the past twelve years dividends have been the only source of investor returns.

Today, we have our choice of a host of dividend-focused ETFs—so many, in fact, that it can be daunting to choose. Though all claim dividends as the central piece of their investment mandate, there are significant differences between the strategies that investors should understand. In this article, I’m going to pick apart some of those differences.

Three Strategies

There are already well over a dozen dividend ETFs that focus on the U.S. market, and I included the most popular in Figure 2. Each can be grouped into one of three major categories:

High dividend yield
High dividend growth rate
Dividend weighting

The first category is what most investors immediately think of when they hear “dividend investing.” The primary focus is on high current income with capital gains as a distant secondary objective. This is good, old-fashioned “widows and orphans” investing and is the most conservative of the three strategies.

The iShares Dow Jones U.S. Select Dividend ETF (NYSE: DVY) is the oldest dividend-focused ETF and is the only one to follow a pure high-yield strategy. The fund represents America’s top stocks by dividend yield, selected annually. To weed out those at risk of cutting their dividend, companies must have a positive five-year dividend-per-share growth rate and a dividend payout ratio of no more than 60% of earnings. The stocks that qualify are then ranked by dividend yield and the top 100 are selected.

The result is a solid ETF that currently yields more than the 10-year Treasury with an expense ratio and turnover that are tolerably low.

The second category is based less on dividend yield and more on the growth rate of dividends. The PowerShares Dividend Achievers ETF (NYSE: PFM) and Vanguard Dividend Appreciation ETF (NYSE: VIG) are based on rival (yet nearly identical) versions of the Mergent Dividend Achievers Index. To become eligible for inclusion in the Index, a company must have increased its annual dividend for the last ten or more consecutive years.

The rationale for the criteria is easy to understand. Companies that pay regular—and rising—dividends send a powerful message about their financial health and stability. Maintaining a dividend forces discipline on managements that are prone waste shareholder wealth on nonsensical mergers and “empire building.” Dividends are also honest; there can be no cooking of the books or “creative accounting” when the accounts have to be settled in cash.

Given the similarity of the two ETFs, it is hard to see how PowerShares justifies its higher fee. If you like the Dividend Achievers strategy, go with VIG. You’ll pay almost two thirds less in fees.

As a sort of hybrid between the first high-yielding category and the second high-growth strategy, PowerShares also offers the High Yield Dividend Achievers ETF (NYSE: PEY). This fund is based on the Mergent Dividend Achievers 50 Index, which holds the 50 highest-yielding stocks of the broad Mergent dividend index, on which PFM is based.

Standard & Poor’s has its own competing strategy called the Dividend Aristocrats, which goes even further than the Dividend Achievers. The S&P 500 Dividend Aristocrats Index measures the performance of the companies within the S&P 500 that have increased their dividends every year for the last twenty five or more consecutive years.

In a similar methodology to PEY, the SPDR S&P Dividend ETF (NYSE: SDY) builds a portfolio out of the 50 highest-yielding Aristocrats.

While both PEY and SDY offer very attractive yields, their higher portfolio turnover would make them less attractive than DVY for taxable investors. You’re already being taxed twice on the dividends; why be taxed again with capital gains distributions?

This brings me to the third category: dividend-weighted ETFs.

WisdomTree is a relatively new entrant into the ETF sphere, but the company has carved out a distinct niche with its use of fundamental weighting rather than traditional market-cap weighting. The problem with traditional index funds is that they tend to overweight the companies and sectors that are faddishly overvalued due to the current whims of the market (think of tech stocks in the 1990s or financials in the 2000s). By weighting an index by a fundamental value—such as earnings or dividends—you largely eliminate this bias. This was WisdomTree’s rationale for its Large Cap Dividend (NYSE: DLN) and Total Dividend (NYSE: DTD) ETFs.

Because their weightings are based on the dollar size of the dividend rather than the yield, the WisdomTree funds will tend to be biased more towards mega caps than the other ETFs. This is not necessarily a bad thing, however. In fact, of all of the ETFs in Figure 2, I consider WisdomTree’s DLN to have the best potential for capital gains in the years ahead specifically because of its exposure to quality blue chips. The low fees and low turnover are also quite compelling.

Still, if it is yield that you are looking for in an investment, the WisdomTree ETFs might not be the best choice. The yields are considerably smaller than those of DVY, PEY, and SDY.

Which One is Best?

Let’s now return to our original question: how do we choose the right dividend ETF? The answer is that it really depends on what it is you are trying to accomplish. To keep it simple, I’ll break it down like this:

For the best combination of high current income and tax and fee efficiency, go for DVY.
For the best long-term growth prospects, VIG is your best bet. Though if your objective is growth, make sure that you reinvest your dividends. Compounding is the key.
For the best medium-term (5-7) year allocation, DLN is probably your best option. Large-cap, high-quality companies represent some of the most attractive investments at current prices, and DLN is loaded with them.

With the economy still looking wobbly and many sectors of the stock market looking extended, stocks that pay consistent dividends have never looked more attractive. With this in mind, investors should consider adding a dividend-focused ETF to their portfolios.

Charles Lewis Sizemore, CFA

This article was first published on InvestorPlace

Sizemore Capital Management 4th Quarter 2010 Letter to Investors

noreply@blogger.com (Charles Lewis Sizemore, CFA) — Thu, 06 Jan 2011 23:46:00 +0000

To Our Investors,

I am proud to announce that Sizemore Capital Management has logged another successful year. Our actively-managed Tactical Portfolio returned 15.7% for the year 2010, essentially matching the 15.1% for the S&P 500 Total Return Index but with less volatility.

Portfolio Review

SCM Strategic Portfolio Allocations

Our returns for 2010 on the passive Strategic Portfolio Allocations were the following:

Preservation of Capital..................2.96%
Conservative Income.....................9.36%
Growth and Income.....................12.55%
Growth........................................15.15%
Aggressive...................................17.44%

The SCM Strategic Portfolios posted fair returns in 2010, performing as expected. The Growth and Aggressive Portfolios outperformed the S&P 500.

The largest gains came from the MLP, REIT, and small cap American equities sectors, while non-U.S. large-cap equities underperformed, primarily due to lingering fears over the European sovereign debt crisis. Emerging market and high-dividend equities modestly outperformed the S&P 500. Our bond sectors also posted respectable returns despite the rising interest rates that characterized the fourth quarter.

SCM Tactical Portfolio

We made no major changes to the Tactical Portfolio during the fourth quarter of 2010, maintaining our strong focus on income and our contrarian value positions in the health care, utilities, and global telecom sectors—all of which we see doing exceptionally well in 2011. In the first week of January 2011, we reinvested the 5% of the portfolio that was formerly in cash in the PowerShares International Dividend Achievers ETF (NYSE: PID), raising our allocation to 15%. This brings our total allocation to dividend-focused investments to 35% of the portfolio. Our sector positions in health care, utilities, and telecom make up a combined 30%. The remainder of the portfolio lies in our core position in the S&P 500 (25%) and our tactical position in high-yield bonds (10%).

This is an optimal allocation for the economic environment I see materializing in 2011. Though I do not anticipate a return to the crisis conditions of recent years, I do see risk aversion making a comeback and would expect investors to rotate out of cyclical sectors—which are beginning to look extended—and into value sectors. I view the energy and materials sectors as being particularly at risk. These sectors were among the best performing in 2010 (see Figure 1), while our contrarian investments in health care, utilities, and telecom were laggards. I see this trend reversing in 2011, as investors take profits in the cyclical sectors and look for bargains among the currently out-of-favor sectors. Valuations in our contrarian sector positions—as measured by price/earnings ratio and dividend yield—are highly favorable relative to the broader S&P 500.

Furthermore, I believe that the recent spike in interest rates is already nearing its end. Interest rates may never again fall to the lows seen earlier in the year, but the absence of inflation should guarantee that they stay low by historical standards. This should benefit our dividend-focused investments. (For a more detailed explanation of SCM’s views on interest rates, please see: “Is There a Bubble in Bonds?” and “There is NOT a Bond Bubble—at Least Not Yet.”)

A rising interest rate environment is generally bad for all sectors of the stock market, but sectors that receive a high percentage of their total return in the form of dividends are particularly at risk. After all, investors have no need to accept the volatility of equities if they can get comparable yields in the bond market. Expectations of a continued rise in rates caused the Tactical Portfolio’s positions to underperform in the 4th quarter of 2010, losing some of the relative outperformance from the 3rd quarter.

In a more normal environment, rising rates would also punish cyclical industries such as industrials, basic materials, and energy. Of course, we are not at all living in normal times; we are living through an extended liquidity-driven “reflation” of the capital markets after the worst credit crisis in a hundred years. As the angst that gripped investors during the second and third quarters began to lift, money poured into the most volatile and economically-sensitive sectors and into emerging markets. Commodities and energy have been in a bull market for roughly a decade now, and these sectors are becoming increasingly trendy. It is my belief that the prices of many physical commodities are now firmly in bubble territory and driven almost entirely by speculators in the plethora of new commodity-themed ETFs and mutual funds. While we cannot know with certainty when this bubble will burst, I feel that it is prudent to avoid commodities and to underweight materials and energy equities. It is unrealistic to believe that commodities and energy will continue to rise in an extreme low-inflation environment. Furthermore, a major bust in China—which I consider a question of “when” rather than “if”—would put extreme pressure on commodities and energy prices. (See “More Evidence of a Chinese Investment Bubble” for an expanded analysis of the China bubble).

Betting Against the Herd

In November, I published an article that discussed the extreme negative sentiment toward the utilities sector based on a survey published on November 1 by Barron’s (see “Avoid the Herd: Buy Utilities”)

On December 22, Barron’s published the results of a similar survey. Despite the passing of nearly two months and the selection of a new panel of professionals, the results were nearly identical (See Figure 2).

The utilities and health care sectors are absolutely despised by the “Big Money” interviewed by Barron’s. Fully half of the investors surveyed were bearish on the two. Utilities got not a single bullish vote, and health care got only one. The figures for telecom were little better.

Meanwhile, fully half of those surveyed were bullish on energy (and none bearish), and a whopping two thirds were bullish on technology.

As a contrarian value investor, this is exactly what I like to see. The sectors that have performed the most poorly over the past several years in Figure 1 are the very same sectors that investors are shunning in Figure 2. What this tells us is that these sectors are under-owned and that the selling has largely already been done. While not an exact science, I consider this to be an excellent rule of thumb for evaluating sectors.

At the very least, what this tells us is that the downside should be limited in these sectors relative to the others. If I am right about the coming sector rotation and about inflation being benign, then we should earn market-beating returns in the quarters ahead. But if I am wrong, the cheap valuations and high yields mean that our downside should be limited.

Looking Ahead

2010 was a great year at Sizemore Capital Management. Here’s to making 2011 even better.

Respectfully,

Charles Lewis Sizemore, CFA

For the complete letter, see: Sizemore Capital Management 2010 4th Quarter Letter to Investors

Sizemore Capital Management in the News

noreply@blogger.com (Charles Lewis Sizemore, CFA) — Wed, 05 Jan 2011 02:07:00 +0000

Sizemore Capital Management was recently mentioned in Investment News: "How to 'Backdoor' Emerging Markets."

Excerpt:

There are also some overlooked “back doors” into many of the emerging economies, according to Charles Sizemore, owner of Sizemore Capital Management LLC, a boutique research and investment firm.

While Mr. Sizemore is not a fan of China because of its fuzzy economic data, or Russia “because they tend to throw business executives in jail,” he does believe in tapping some markets from a safe distance.

Telefonica SA (TEF), a telephone services company based in Spain with a price-to-earnings ratio of 7, is deriving 60% of its revenue from European and Latin American emerging markets.

“This is a company that has been left for dead just because it’s based in Spain,” Mr. Sizemore said. “It’s truly absurd; you don’t normally see these kinds of bargains after an emerging-markets rally.”

Another example is Unilever PLC (UL), a 100-year-old blue chip, which is paying a 4% dividend and drawing half its revenue from emerging markets.

In keeping with the emerging-middle-class theme, Mr. Sizemore recommends EGShares Emerging Markets Consumer (ECON), an exchange-traded fund made up of companies that sell to emerging-market consumers.

“That’s an ETF for somebody who wants some real buy-and-hold emerging-markets exposure,” he said.

Charles Lewis Sizemore, CFA
Chief Investment Officer

Sizemore Capital Management LLC
2633 McKinney Avenue, Suite 130-159 Dallas, Texas 75204
Phone: (214) 717-4935 Fax: (214)-572-7865

New Developments at Sizemore Capital Management

noreply@blogger.com (Charles Lewis Sizemore, CFA) — Fri, 19 Nov 2010 03:10:00 +0000

To Our Investors,

I am pleased to announce new developments at Sizemore Capital Management. I'll start with the most visible. The company now has a new website that provides a wealth of information to both existing and potential clients. Feel free to browse it at your leisure: http://www.sizemorecapital.com

Secondly, by the end of the year clients will begin receiving comprehensive statements that consolidate all accounts managed by Sizemore Capital. Previously, clients received a separate statement for each account from the account custodian only.

Finally, we are launching a new managed account option for more aggressive investors. For investors looking to implement the investment ideas expressed in the Sizemore Investment Letter but prefer the convenience of professional management, we now offer the SCM Sizemore Investment Letter Managed Account. For more details, please contact Sizemore Capital Management.

Here's to making 2011 even better than 2010,

Charles Lewis Sizemore, CFA
Chief Investment Officer, Sizemore Capital Management LLC

Sizemore Capital Management LLC
2633 McKinney Avenue │ Suite 130-159 │ Dallas, Texas 75204
Phone: (214) 717-4935 │ Fax: (214)-572-7865 │ Skype: clsizemore

Sizemore Capital Management 3rd Quarter 2010 Letter to Investors

noreply@blogger.com (Charles Lewis Sizemore, CFA) — Mon, 01 Nov 2010 15:13:00 +0000

To Our Investors,

The third quarter of 2010 ended on a high note with the S&P 500 posting its strongest September in 71 years. Against this backdrop, our actively-managed Tactical Portfolio returned 9.0% for the year through the third quarter, compared to 3.9% for the S&P 500 Total Return.

Our returns for 2010 year-to-date on our Strategic Portfolio Allocation models were the following:

Preservation of Capital........3.61%
Conservative Income.......... 7.44%
Growth and Income.............7.81%
Growth...............................8.06%
Aggressive..........................7.86%

Portfolio Review

SCM Strategic Portfolios

Given that the Strategic Portfolios are long term in nature, it is rare for Sizemore Capital to make allocation changes. We rebalance annually, of course, but the core positions do not often change. The only change made prior to the third quarter of 2010 was the replacement of the defunct Bear Stearns MLP ETN (BSR) with a substantially identical security, the JP Morgan Alerian MLP Index ETN (AMJ).

In the third quarter, we decided that another change was appropriate. We replaced our emerging markets position, the iShares MSCI Emerging Markets ETF (EEM) with the EG Shares Emerging Markets Consumer ETF (ECON).

This is a change we would have loved to have made sooner had it been possible. We were never satisfied with EEM as an emerging markets position, but we kept it for lack of better alternative. EEM was never truly an “emerging market” play but instead a “global macro” play, as the fund was comprised almost entirely of banks, oil companies, and export-oriented companies with very little exposure to emerging market consumers themselves.

ECON is the first ETF to specifically target the emerging market consumer sector. This ETF was a long time coming, and kudos to Emerging Global Shares for being the first to bring it to market.

For an expanded explanation of our investment rationale with respect to ECON, see the two articles we penned for Seeking Alpha in September:

ECON: Investing in the Emerging Market the Right Way
Just One ETF: The New Fund Aimed at Local Goods for Emerging Consumers

SCM Tactical Portfolio

We made several significant changes to the Tactical Portfolio during the quarter, selling four long-time holdings in infrastructure, municipal bonds, and luxury goods and replacing them with two new positions that focus of dividend income.

In a July 16, 2010 internal trade memo, we wrote:

Given the recent correction in the equity markets and our belief that high-dividend stocks offer better value than bonds at current prices, we felt the time was right to liquidate our position in municipal bonds (VKQ) and to reallocate the funds to high-dividend stocks via an ETF, the WisdomTree LargeCap Dividend Fund (DLN).

DLN is the ideal position for our current strategy. Many of the companies we have recommended in The Sizemore Investment Letter are among the fund’s top holding, including AT&T (T), Johnson & Johnson (JNJ), Microsoft (MSFT), Philip Morris International (PM) and Procter & Gamble (PG). In DLN we get a cash yield comparable to a ladder of Treasury securities, but unlike bond interest—which does not increase over the life of the bond—the dividends of DLN’s equity holdings should rise in the quarters ahead.

The market’s currently elevated level of volatility shows no sign of abating, and a general market selloff, were it to occur, could send DLN’s price lower in the short term. But given the attractive pricing of DLN, we would consider any such volatility to be little more than short-term noise. We consider this a low-risk and potentially high-return allocation for the Sizemore Capital Management Tactical Portfolio.

On July 26, 2010, we increased the Tactical Portfolio allocation to DLN from 10% to 20%. Reaffirming our investment rationale, we wrote:

Given our view that non-financial, blue-chip equities are currently the most attractive asset subclass, we have increased our allocation to the WisdomTree Large Cap Dividend ETF (NYSE: DLN) to 20% of the SCM Tactical Portfolio. This is not a short-term trade; we consider this a major change in investment strategy with a time horizon of 1-5 years.

Our belief in the attractiveness of non-financial blue-chip equities is multifaceted. Firstly, we want to emphasize how cheaply many of America’s premier companies are currently priced relative to their historical averages. As we outlined in the July issue of The Sizemore Investment Letter, Johnson & Johnson, Procter & Gamble, and Microsoft (among many others) are trading at P/E ratios not seen in multiple decades. According to financial theory, large and stable companies should trade at a premium to the broader market. By buying at higher prices, investors are generally willing to accept lower returns on blue chips in exchange for the perceived safety. But today, the opposite is true. Many blue chips actually trade at a discount to the S&P 500. The 2009 rally was primarily a rally in lower-quality “junk.” And while we do not necessarily forecast that the broader stock indices like the S&P 500 will see poor returns going forward, we do expect higher-quality stocks to outperform given current pricing. So on a valuation basis, a large overweighting in DLN makes sense.

Secondly, the competing investment alternatives are sparse. Bonds represent a remarkably poor investment given current yields. The 10-year Treasury note yields less than 3 percent—and less than the dividend yield of many of the blue-chip stocks in DLN.

There is a fair amount of overlap in our current allocation. For example, Johnson & Johnson is a major component of both DLN and IYH, and AT&T is a major component of both DLN and IXP. Under more normal pricing, we might view this as a risk. But in this situation, we consider the overlap a source of strength.

In order to free up capital for the new allocation, we are having to part with two long-time portfolio holding, FMO and MFD. While we remain bullish on both, neither had a long-term place in the Tactical Portfolio. When we initially purchases FMO, it was one of the few options available for investing in the MLP sector. But today, options are plentiful. Were we to re-enter the MLP asset class in the Tactical Portfolio, we would do so using a different investment vehicle. The same is true of MFD. While we consider infrastructure and utilities to be attractive—and continue to have exposure to the sector via XLU—we no longer see MFD as a potential long-term holding.

We were delighted to see that GMO’s legendary Jeremy Grantham—an investor we respect very much—appears to agree with our assessment of non-financial, blue-chip equities. In his July 2010 letter to investors, Grantham laid out his seven-year forecast for various asset classes. At the top of his list were what Grantham calls “US High Quality Stocks,” defined as those companies with high and stable profitability and low debt.

While Mr. Grantham’s comments would certainly not be sufficient to persuade us to invest in the sector, we do find it encouraging that our favorite asset class is shared by an investor of his stature. We would certainly prefer to bet with Mr. Grantham than against him.

Finally, we regrettably had to close our position in the global luxury goods sector, or rather it was closed for us. In a September 29 internal trade memo we wrote:

This is a trade that we would have unfortunately preferred not to make. We were very satisfied with the investment performance of the Claymore / Robb Report Global Luxury ETF (ROB). It was the only pure play in existence for one of favorite investment themes for the next decade: the rise of the new rich in the developing world. In addition to the long-term growth story, the individual stocks that comprise the ETF remain undervalued in our view. This is an investment we would have liked to have let run for at least another several months, if not longer.

Unfortunately, the fund sponsor had other plans. Given the sheer volume of ETFs on the market, there was simply not enough investor demand for a niche ETF like ROB. The fund was never able to gather enough assets or generate sufficient trading volume to stay viable. So, in late September the fund was liquidated and the cash proceeds were returned to investors. Not wanting to sell into an illiquid market, we opted to hold the shares until the liquidation date.

While we were not ready to let this position go, we do believe we have found a suitable replacement. ROB was a unique way to play a niche sector, and it was one of our favorite ways to get access to emerging market growth without having to take positions in volatile emerging market stocks. Given that no other funds exist that fill that role, we have opted to pursue a different investment theme altogether.

The Powershares International Dividend Achievers ETF (PID) is an ideal position for the Tactical Portfolio. In the current environment of economic uncertainty, we are focusing heavily on quality, as we explained in our investment rationale for the Wisdom Tree Large Cap Dividend Fund (DLN) in July. At current market prices, there is no premium for quality. Some of the world’s finest companies are also among the cheapest. This is a condition that should normally never exist, yet it does today. When the market gives us gifts like these, we gladly take them.

The International Dividend Achievers index is as close to a pure play on non-US quality as we have seen. To become eligible for inclusion, a company must be incorporated outside of the United States. The companies must be have an American Depository Receipt or common stock trading on NYSE or NASDAQ. Most importantly, companies must have paid increasing regular annual dividends for five or more consecutive years.

A company that could raise its dividend over the past five years—years that included the worst credit crisis in 100 years and the worst recession since the Great Depression—is a company that is clearly worth owning at the right price. And in PID, we get an entire portfolio of them trading at a trailing P/E ratio of only 12. As an aside, several companies that have been highlighted in The Sizemore Investment Letter are currently in the index, including AmBev (ABV), Turkcell (TKC) and Telefonica (TEF).

We consider PID to be an excellent position at current prices.

Looking Ahead

With the third quarter finishing as strongly as it did, we expect a more muted finish to 2010. We do not necessarily expect a crash or significant correction, but at the same time we do not expect the strong momentum to continue throughout the fourth quarter.

Given our ambivalent view towards the potential for capital gains, we believe that our current emphasis on high income will be a major plus over the next 3-9 months. 40% of the Tactical Portfolio is allocated to dividend-centric stocks and high-yield bonds, while another 30% is allocated to sectors that have payouts higher than the market averages. We also have zero exposure to the sectors we feel are most at risk of collapse—gold and commodities—and zero exposure to low-yielding US Treasuries.

Here’s looking forward to a strong finish to 2010,

Charles Lewis Sizemore, CFA

Sizemore Capital Increasing Allocation to Non-Financial Blue Chips

noreply@blogger.com (Charles Lewis Sizemore, CFA) — Mon, 02 Aug 2010 16:31:00 +0000

Given our view that non-financial, blue-chip equities are currently the most attractive asset subclass, we have increased our allocation to the WisdomTree Large Cap Dividend ETF (NYSE: DLN) to 20% of the SCM Tactical Portfolio. This is not a short-term trade; we consider this a major change in investment strategy with a time horizon of 1-5 years.

Our belief in the attractiveness of non-financial blue-chip equities is multifaceted. Firstly, we want to emphasize how cheaply many of America’s premier companies are currently priced relative to their historical averages. As we outlined in the July issue of the Sizemore Investment Letter, Johnson & Johnson, Procter & Gamble, and Microsoft (among many others) are trading at P/E ratios not seen in multiple decades. According to financial theory, large and stable companies should trade at a premium to the broader market. By buying at higher prices, investors are generally willing to accept lower returns on blue chips in exchange for the perceived safety. But today, the opposite is true. Many blue chips actually trade at a discount to the S&P 500. The 2009 rally was primarily a rally in lower-quality “junk.” And while we do not necessarily forecast that the broader stock indices like the S&P 500 will see poor returns going forward, we do expect higher-quality stocks to outperform given current pricing. So on a valuation basis, a large overweighting in DLN makes sense.

Secondly, the competing investment alternatives are sparse. Bonds represent a remarkably poor investment given current yields. The 10-year Treasury note yields less than 3 percent—and less than the dividend yield of many of the blue-chip stocks in DLN.

There is a fair amount of overlap in our current allocation. For example, Johnson & Johnson is a major component of both DLN and IYH, and AT&T is a major component of both DLN and IXP. Under more normal pricing, we might view this as a risk. But in this situation, we consider the overlap a source of strength.

A major broad-market sell-off, were one to occur, would punish all stocks, including the high-quality names in DLN. But we consider the risk of any such sell-off to be remote enough to justify our bullish allocation.

In order to free up capital for the new allocation, we are having to part with two long-time portfolio holding, FMO and MFD. While we remain bullish on both, neither had a long-term place in the Tactical Portfolio. When we initially purchases FMO, it was one of the few options available for investing in the MLP sector. But today, options are plentiful. Were we to re-enter the MLP asset class in the Tactical Portfolio, we would do so using a different investment vehicle. The same is true of MFD. While we consider infrastructure and utilities to be attractive—and continue to have exposure to the sector via XLU—we no longer see MFD as a potential long-term holding.

Jeremy Grantham Appears to Share Our View

We were delighted to see that GMO’s legendary Jeremy Grantham—an investor we respect very much—appears to agree with our assessment of non-financial, blue-chip equities. In his July 2010 letter to investors, Grantham laid out his seven-year forecast for various asset classes. At the top of his list were what Grantham calls “US High Quality Stocks,” defined as those companies with high and stable profitability and low debt. (Click on chart to enlarge image)

While Mr. Grantham’s comments would certainly not be sufficient to persuade us to invest in the sector, we do find it encouraging that our favorite asset class is shared by an investor of his stature. We would certainly prefer to bet with Mr. Grantham than against him.

Respectfully,

Charles Lewis Sizemore, CFA

Sizemore Capital Reallocating to High-Dividend Stocks

noreply@blogger.com (Charles Lewis Sizemore, CFA) — Wed, 21 Jul 2010 04:20:00 +0000

Given the recent correction in the equity markets and our belief that high-dividend stocks offer better value than bonds at current prices, we felt the time was right to liquidate our position in municipal bonds and to reallocate the funds to high-dividend stocks via an ETF, the WisdomTree LargeCap Dividend Fund (DLN).

DLN is the ideal position for our current strategy. Many of the companies we have recommended in The Sizemore Investment Letter are among the fund’s top holding, including AT&T, Johnson & Johnson, Microsoft, Philip Morris International and Procter & Gamble. In DLN we get a cash yield comparable to a ladder of Treasury securities, but unlike bond interest—which does not increase over the life of the bond—the dividends of DLN’s equity holdings should rise in the quarters ahead.

The market’s currently elevated level of volatility shows no sign of abating, and a general market selloff, were it to occur, could send DLN’s price lower in the short term. But given the attractive pricing of DLN, we would consider any such volatility to be little more than short-term noise. We consider this a low-risk and potentially high-return allocation for the Sizemore Capital Management Tactical Portfolio.

Respectfully,
Charles Lewis Sizemore, CFA

Sizemore Capital Management Second Quarter 2010 Letter to Investors

noreply@blogger.com (Charles Lewis Sizemore, CFA) — Tue, 13 Jul 2010 04:21:00 +0000

We made several significant changes to the Tactical Portfolio during the second quarter. The first was the closing of our short position in the euro. In a May 14 trade memo, we wrote,

With negative sentiment on the euro bordering on hysteria, we felt the time was right to take profits and close our short position in the common currency via the Market Vectors Double-Short Euro ETN (NYSE: DRR). All Sizemore Capital portfolios have been sold out of their positions in DRR.

As of Friday, May 14, 2010, the euro had fallen to 18-month lows to $1.2359. The euro was trading over $1.50 as recently as November.

Market conditions have now completely reversed since our initial portfolio move. In August 2009 we initiated the trade, believing that negative sentiment toward the U.S. dollar had reached irrational extremes and that the euro was being unjustifiably rewarded. We correctly pointed out that Europe’s financial woes were as serious as those of the United States, if not more so. The euro’s strength vis-à-vis the dollar was irrational, and shorting the euro was the correct thing to do.

Today, the negativity has shifted to the euro. The European Central Bank’s response to the Greek fiscal crisis had the effect of knocking the euro off of its pedestal as the alternative reserve currency to the dollar. European stock markets are in free fall, and it is now fashionable on financial news shows to predict the dissolution of the Eurozone. When comments like this become mainstream, a trend has generally run its course. In our view, closing the short position in the euro is the correct thing to do.

At current levels, we consider the euro mildly overpriced but not enough to warrant initiating another trade. We do not anticipate making any further currency moves for the remainder of 2010.

The next significant move we made was to initiate a 10% dedicated position to the global telecom sector via the S&P Global Telecommunications Fund (NYSE: IXP). We had been following the telecom sector for most of the second quarter with interest and even made four distinct telecom investment recommendations in SFO Magazine and the Sizemore Investment Letter, of which IXP was one. This ETF gives us fair exposure to two of the remaining recommendations—Telefónica and AT&T—and a host of other solid competitors as well. For a more in depth explanation of our reasoning for this trade, please see: “Telecom is Dead. Long Live Telecom.”

On June 21, we closed our short position in gold. It was not an easy decision to make given our view of the fundamentals, but at the same time we must be disciplined and follow the risk management guidelines we set out at the beginning of the trade. On June 21, we wrote,

This is a difficult move for us, but we consider it the right move. We continue to believe that gold is in an irrational speculative bubble driven by a potent combination of fear, angst, and political ideology. But as John Maynard Keynes noted, “The market can stay irrational longer than you can stay solvent.” And as we wrote when we initiated this trade, “The problem with making a contrarian call is that you can be ‘right’ but still lose a lot of money if you are too early. Just ask anyone who tried to short the Nasdaq during the 1990s bubble.”

We continue to see gold’s fundamentals deteriorate. Demand is almost entirely in the hands of new portfolio investors and hedge funds and particularly by exchange-traded funds such as the SPDR Gold Trust (NYSE: GLD). GLD now holds 42.05 million ounces and its holdings are up more than 7% in the past week alone, according to the Financial Times. Traditional demand for gold—such as for jewelry—have been in decline for years, as high prices have discouraged buyers. Even India—traditionally the biggest buyer of gold in the world—has substantially reduced consumption over the past five years.

In 2009, investors purchased more gold than jewelry buyers for the first time since 1980—which happened to be the year that the last gold bubble burst and ushered in nearly three decades of declines for the yellow metal.

Gold is in a speculative bubble, and shorting it is “logical.” But the truth is that bubbles can go much higher than anyone believes, and we cannot put our investors’ capital at risk. Nasdaq stocks were already priced at absurdly high valuations by the mid-1990s—as Greenspan noted in his “irrational exuberance” speech—yet the bubble did not burst until 2000. Sensible investors who attempted to short tech stocks during that period would have been wiped out.

So, as bearish as we remain on gold, we are following our sell discipline and exiting this trade. We will continue to watch the gold market and may decide to re-enter it at a later date.

In the weeks after we closed this position, gold gave up some of its recent gains. Though we have no immediate plans to reenter the short position, this is something we intend to watch intently.

Finally, on June 25, we entered a 10% dedicated allocation to the healthcare sector. On the trade, we wrote,

In doing research for the July 2010 issue of the Sizemore Investment Letter, we reached the conclusion that U.S. Large-Cap Healthcare stocks represent a unique value at current prices. We are particularly impressed with the valuation of Johnson & Johnson, Merck, and Pfizer and see the potential for both steady income and substantial capital appreciation over the next 1-3 years. These three companies represent more than a quarter of IYH’s market cap, and the sector as a whole is attractive to us at current prices. We consider this a low-risk, high-return allocation for the Sizemore Capital Management Tactical Portfolio.

Moving on to our existing positions, our investment in luxury consumption—The Robb Report ETF (NYSE: ROB)—continues to perform as expected. We have no immediate plans to make changes to this position.

Our core holding in the S&P 500 will also remain unchanged for the foreseeable future, as we consider stock valuations to be very favorable at current levels. The same can be said for our positions in the utilities sector.

We have been quite satisfied with our position in the Fiduciary/Claymore MLP Opportunity Fund (NYSE: FMO), though recent developments in the MLP sector have caused us to reconsider the fund itself. Several new mutual funds and exchange-traded notes have recently been released that, like FMO, sidestep the complicated tax issues associated with partnerships (i.e. filing K1s). Unlike FMO, however, these alternatives are not closed-end funds and thus cannot trade at a discount or premium to the underlying book value like FMO can. We have no immediate sense of urgency to make a change on this investment, as it would be senseless to create taxable gains if the rationale for changing positions was only marginal improvement. This is something we intend to watch, however.

Finally, we have been very happy with the performance of our two bond funds, HYG and VKQ. These two funds have provided stable income during a very volatile period in the global capital markets. We may liquidate part or all of these positions in the next quarter, however, as we believe the stock market offers better relative value. This is another issue we intend to review in the weeks ahead.

Looking Ahead

Going forward, we are most enthusiastic on the prospects for the telecom, utilities, and healthcare sectors. These three sectors have vastly underperformed the market since the March 2009 bottom, and now represent real value in our estimation. All three sectors are loaded with high-quality companies that pay solid dividends. We fully expect the S&P 500 to finish the year in positive territory. But even if it doesn’t, we are being paid handsomely to wait by being overweighted in these sectors. We expect all three sectors to outperform the S&P 500 on a total return basis over the next 12 months.

Here’s looking forward to a great 2010,

Charles Lewis Sizemore, CFA

Sizemore Capital Covering Short Position in Gold

noreply@blogger.com (Charles Lewis Sizemore, CFA) — Mon, 21 Jun 2010 16:34:00 +0000

On January 21, 2010 we initiated our short position in gold via the Proshares Ultrashort Gold Fund (NYSE: GLL). We are now closing this position, as GLL hit our pre-specified stop of $37.95 (split adjusted). Our loss on this position was limited to 25%, or 2.5% of the total portfolio.

This is a difficult move for us, but we consider it the right move. We continue to believe that gold is in an irrational speculative bubble driven by a potent combination of fear, angst, and political ideology. But as John Maynard Keynes noted, “The market can stay irrational longer than you can stay solvent.” And as we wrote when we initiated this trade, “The problem with making a contrarian call is that you can be ‘right’ but still lose a lot of money if you are too early. Just ask anyone who tried to short the Nasdaq during the 1990s bubble.”

We continue to see gold’s fundamentals deteriorate. Demand is almost entirely in the hands of new portfolio investors and hedge funds and particularly by exchange-traded funds such as the SPDR Gold Trust (NYSE: GLD). GLD now holds 42.05 million ounces and its holdings are up more than 7% in the past week alone, according to the Financial Times. Traditional demand for gold—such as for jewelry—have been in decline for years, as high prices have discouraged buyers. Even India—traditionally the biggest buyer of gold in the world—has substantially reduced consumption over the past five years.

In 2009, investors purchased more gold than jewelry buyers for the first time since 1980—which happened to be the year that the last gold bubble burst and ushered in nearly three decades of declines for the yellow metal.

Gold is in a speculative bubble, and shorting it is “logical.” But the truth is that bubbles can go much higher than anyone believes, and we cannot put our investors’ capital at risk. Nasdaq stocks were already priced at absurdly high valuations by the mid-1990s—as Greenspan noted in his “irrational exuberance” speech—yet the bubble did not burst until 2000. Sensible investors who attempted to short tech stocks during that period would have been wiped out.

So, as bearish as we remain on gold, we are following our sell discipline and exiting this trade.

Charles Lewis Sizemore, CFA

Sizemore Capital Management Analysis of the Luxury Goods Sector

noreply@blogger.com (Charles Lewis Sizemore, CFA) — Sat, 12 Jun 2010 04:36:00 +0000

EXECUTIVE SUMMARY

Given the host of issues facing the global economy—and the European sovereign debt crisis in particular—we have decided to do a periodic review of Sizemore Capital Management’s allocation to the luxury sector in its actively-managed Tactical Portfolio. We find that at current valuations, the luxury sector remains an attractive holding due primarily to its exposure to the emerging market consumer. Weakness in the euro should translate to higher earnings, as the majority of revenues for the European brands that dominate the industry comes from outside of Europe.

COMMENTS AND ANALYSIS

This report is an analysis of the luxury goods sector with respect to Sizemore Capital Management’s allocation to the Claymore/Robb Report Global Luxury Fund (NYSE: ROB) and its constituent holdings.

As earnings releases for the first quarter come in, the results have generally been quite encouraging. As a whole, the luxury sector is enjoying a continued rebound in sales as luxury shoppers have largely recovered from the 2008 meltdown.

Though we prefer quantifiable facts and statistics when doing an investment analysis, there are times when anecdotes can be far more valuable. As legendary investment writer Dennis Gartman is fond of saying, “All economic information of any value is initially anecdotal.” Compiling comprehensive data is time intensive and generally involves a significant time lag, whereas anecdotal news happens in real time. When time is of the essence—as it always is when making investment decisions—random bits of news can be very instructive. We find this to be particularly true when attempting to judge the spending behavior of the world’s wealthy. So, for the majority of this report, we will rely on anecdotal information that we have collected in recent weeks.

One gauge we use to track the world’s wealthy is the Liv-Ex 100 Wine Index (see Figure 1). Liv-Ex is an online marketplace for merchants trading fine wine, and the company has created an index to serve as a benchmark for wine prices. Per Liv-Ex,

The Liv-ex 100 Fine Wine Index is the industry’s leading benchmark. It represents the price movement of 100 of the most sought-after fine wines for which there is a strong secondary market and is calculated monthly. The majority of the index consists of Bordeaux wines – a reflection of the overall market – although wines from Burgundy, the Rhone, Champagne and Italy are also included… [T]he index is designed to give each wine a weighting that corresponds with its impact on the overall market.

Sizemore Capital Management considers this index to be a useful “rule of thumb” indicator as to the spending behavior of the wealthy.

Figure 1: Liv-ex 100 Index

After falling steeply during the crisis in 2008, the index stabilized and formed a long base throughout the first half of 2009. Since then it has been nearly straight up—implying that the rich are back in the fine wine market and buying with reckless abandon. Much of this demand, however, is not from wealthy Westerners but from the new rich in emerging markets and from China in particular.

We have commented for quite some time that the luxury story was really an emerging markets story. Though emerging markets have significantly lower average incomes than the United States or Europe, their upper middle class and wealthy consume a disproportionate amount of the world’s luxury goods and services. As Asia and Latin America continue to develop, the ranks of luxury consumers should continue to swell.

Consider this headline from the Financial Times: “Asian Demand Drives Winemakers’ Hopes for a Bordeaux Bonanza,” June 5, 2010. The FT writes,

“Wine producers in the Bordeaux are gearing up to reap the harvest of last year’s highly-praised vintage. After three lean years, prices are expected to smash records thanks in part to unprecedented demand from Asian buyers…

“China imported more than 10 million cases of still wine last year—50 per cent up on 2008—with France as the largest supplier…. Wealthy Chinese are investing in expensive wines with Hong Kong auctions of fine wines now becoming more important that those in London.”

Chinese purchases of fine wine soared by 50% in a year in which the global economy was reeling and demand for most consumer goods was tepid at best.

It’s not just wine that the Chinese are consuming. Luxury jeweler Tiffany (NYSE: TIF) is also seeing improvement due in no small part to new demand from Asia. Tiffany saw its sales to Asia, excluding Japan, jump by 50% in the first quarter of 2010, while comparable-store sales rose 21% on a constant currency basis.

Of course, the world is bigger than just Asia. Latin America has also been a source of growth for luxury goods makers. Consider this Financial Times headline from May 27: “Burberry Looks to Emerging Markets for Growth.”

The FT writes,

“Burberry…said it would step up investment in emerging luxury markets like Latin America…. The group plans to open 20-30 wholly-owned stores this year, with most emphasis being placed on the Americas and Asia-Pacific region…. Burberry recently opened its first store in Brasilia and it plans another four stores in Brazil this year.”

Furthermore, with many of the world’s premier luxury brands based in Europe, the recent collapse in the price of the euro should translate to higher profits. This would be particularly true of Chinese sales—because the Chinese yuan is pegged to the U.S. dollar, a stronger dollar means a stronger yuan.

VALUATION

The luxury goods sector is highly concentrated in Europe. Thus it should come as no surprise that luxury stocks have been hit hard by the European sovereign debt crisis. During bear market panics, correlations converge to 1 and virtually all stocks fall together.

Crises often create opportunities, however, and the prices of many luxury goods makers are now quite attractive. Given the conservative financial structure of many luxury companies and the massive (though intangible) value of their brands, these stocks should trade at a premium to the broader stock market.

The ROB ETF currently trades at a trailing P/E ratio of 19. Though expensive compared to the S&P 500 at 15 and the MSCI EAFE at 12, we do not consider this price to be excessive given the improving outlook for forward earnings. Many of the ETF’s constituent companies look quite attractive at current levels.

Sizemore Capital Management is not alone in this opinion. In Vito Racanelli’s May 31 Barron’s article “10 Great Stocks,” Racanelli attempts to find bargains in Europe’s battered stock markets and in its export sectors in particular. He puts together a list of “10 Europe-based global powerhouses that are relatively less exposed to the sovereign debt uncertainties. They have healthy balance sheets and dividend yields, often better than those available from U.S. peers, as well as stable business models with roughly 50% or more of their sales outside Europe.”

Interestingly, four of the ten stocks he recommends are luxury goods makers:

BMW (Germany: BMW), the high-end automaker
Moët Hennessy Louis Vuitton (France: MC), the high fashion and wine and spirits conglomerate
Pernod Ricard (France: RI), the high-end wine and spirits company
Luxottica (NYSE: LUX), the Italian maker of high-end sunglasses such as Ray Ban.

CONCLUSION

The rich are officially back. After a brief lull during the 2008 credit market meltdown and the ensuing recession, consumers of luxury products have returned to stores. Company earnings releases are confirming anecdotal evidence of a recovery in the sector.

Though currently not as attractively priced as they were a year ago, we continue to see value in the luxury goods sector. We see demand in Western markets and Japan stabilizing, while emerging markets should provide healthy revenue and profits growth. At current prices, we continue to view the luxury sector as a way to get exposure to the explosive growth of emerging markets while not accepting the risk inherent in direct investment in emerging market stocks. Sizemore Capital Management will maintain its allocation to the luxury sector.

Respectfully,

Charles Lewis Sizemore, CFA

Sizemore Capital Allocation Update: Close Short Position in the Euro

noreply@blogger.com (Charles Lewis Sizemore, CFA) — Tue, 11 May 2010 16:37:00 +0000

The following is an excerpt from a Sizemore Capital Management internal trade memo:

With negative sentiment on the euro bordering on hysteria, we felt the time was right to take profits and close our short position in the common currency via the Market Vectors Double-Short Euro ETN (NYSE: DRR). All Sizemore Capital portfolios have been sold out of their positions in DRR.

As of Friday, May 14, 2010, the euro had fallen to 18-month lows to $1.2359. The euro was trading over $1.50 as recently as November.

Market conditions have now completely reversed since our initial portfolio move. In August 2009 we initiated the trade, believing that negative sentiment toward the U.S. dollar had reached irrational extremes and that the euro was being unjustifiably rewarded. We correctly pointed out that Europe’s financial woes were as serious as those of the United States, if not more so. The euro’s strength vis-à-vis the dollar was irrational, and shorting the euro was the correct thing to do.

Today, the negativity has shifted to the euro. The European Central Bank’s response to the Greek fiscal crisis had the effect of knocking the euro off of its pedestal as the alternative reserve currency to the dollar. European stock markets are in free fall, and it is now fashionable on financial news shows to predict the dissolution of the Eurozone. When comments like this become mainstream, a trend has generally run its course. In our view, closing the short position in the euro is the correct thing to do.

We were too early entering the trade, and our position in DRR lost money for the first four months. Our patience was rewarded, however, as the euro finally broke down. We may also be exiting the trade too soon and potentially leaving money on the table, but at this stage we believe the risk of staying in the trade outweighs the potential returns.

For historical reference, our original reasoning behind the trade, dated August 10, 2009, was as follows:

In light of the recent strength in the euro – which we view as unwarranted given the recessionary conditions in the Eurozone – we feel that a short position in the euro is appropriate. The dollar index is currently not far from its all-time lows. Given the extreme, almost universal bearishness towards the dollar (trader sentiment on the dollar index reached a low of 3% on August 3, 2009, according to Jake Bernstein) we feel that going long the dollar / short the euro makes sense from a contrarian perspective. Having visited Europe ourselves last month, we simply cannot find any economic justification for the current exchange rate. It is our belief that the dollar weakness / euro strength is primarily a result of the negative comments by China and Russia earlier in 2009 – in which both expressed an interest in ending the dollar’s role as the world’s reserve currency – and investor unease about the record US budget deficit, which is viewed by many as irresponsible. While we understand the bearish case against the dollar and are even somewhat sympathetic to the views, we feel that the market has mispriced the euro in response. Yes, the dollar is “bad,” but is the euro fundamentally better? We would say no. Furthermore, the US current account deficit has been shrinking since the onset of the crisis, partially neutralizing one of the most often cited reasons for the dollar’s weakness.

Other Portfolio Moves

Our short position in gold via the Proshares Ultra-short Gold Fund (NYSE: GLL) is currently close to hitting our stop loss and is under review. Like the euro, we believe that gold’s strength is irrational. That said, we set a hard 25% stop loss when we initiated the trade, and we intend to follow it should gold continue to rise.

At this time we have no immediate plans to reallocate the cash portion of our portfolios.

Charles Lewis Sizemore, CFA

Sizemore Capital First Quarter 2010 Letter to Investors

noreply@blogger.com (Charles Lewis Sizemore, CFA) — Mon, 05 Apr 2010 04:22:00 +0000

The following is an excerpt from Sizemore Capital Management's first quarter letter to investors. This is for informational purposes only; nothing below should be viewed as investment advice or as a solicitation to buy securities.

In the first quarter, we made several significant moves. We sold out of all direct emerging market positions—specifically emerging market infrastructure and Brazil—and initiated a short position in gold. We will explain our rationale below.

On January 8, in an internal investment memo we wrote:

After enjoying gains of nearly 100% in just over one calendar year, we decided that the time was right to sell our position in emerging market infrastructure (PXR). As we wrote in our 4th Quarter 2009 letter to investors, this is a move we have been considering for quite some time. Our growing concern is that China is in the midst of an unsustainable capital spending and infrastructure bubble. While we cannot know when this bubble will burst, we believe the safe and easy money has already been made. Holding this position at this point would constitute chasing returns, which is something we consider dangerous. In our view, it makes sense to take some money “off the table” so that we will be in position to move quickly should new opportunities present themselves.

PXR’s market cap is 15% China, 12% Brazil, 9.1% South Africa, 8.9% Indonesia, and 8.2% Russia. With the exception of Brazil—which we continue to have exposure to via our position in EWZ—we consider all of these countries to be high risk at current levels. Should emerging markets in general come under strain, our position in EWZ will also be under review.

We have been growing skeptical of emerging markets for several months, but our recent caution was triggered by a number of factors:

1. The view is nearly unanimous on the Street that emerging markets are the place to be invested in 2010. The “themes” that have been appearing with increasing frequency are the relative decline of the developed world (US, Europe, Japan) and the rise of emerging market giants like China, India, and Brazil. We actually agree with this macro theme—over the long term.

Technology and globalization have made it possible for poorer and less-developed countries to leapfrog many of the stages of development that today’s rich countries experienced. India doesn’t even have adequate paved roads, but the country’s cities have world-class internet infrastructure. Similarly, many countries are bypassing the expensive step of laying communications wires and are going directly to cheaper wireless infrastructure. We view this as a major positive; it is clearly good for the world economy if living standards rise in the developing world.

Still, it is unclear why this beneficial long-term trend would automatically mean higher stock prices today, particularly when emerging market stocks tend to be geared towards exports to the West, not domestic consumption. Given that all major emerging market indices are dominated by such stocks, we believe the boom in emerging markets is based on false premises.

2. The Pragmatic Capitalist did an excellent job of aggregating the 2010 forecasts from the major Wall Street banks. The overwhelming consensus on the Street was for U.S. stocks to finish the year positive, though not wildly so. This is not something we pay a lot of heed to, as this is fairly standard. In bull markets, Wall Street strategists consistently underestimate the indexes’ performance, while in bear markets they overestimate it. This is not to say that the strategists are ill-informed or unintelligent; they have access to some of the sharpest minds and the most expansive data in the world. But for lack of better forecasting tool (because none exists), they fall into the common forecaster trap of “anchoring and adjustment.”

At any rate, while we do not take market forecasts seriously, we do like to read them for common themes. And it seems that every bank on Wall Street—even those that are bearish—seem to have a positive view on emerging markets. As natural contrarians, we would view this as a signal to bet the other way. When “everyone” is bullish on a given asset class, there is no one left to buy.

3. China is starting to draw the attention of some significant contrarian short-sellers. James Chanos, who made a name for himself by shorting Enron and Tyco before their respective implosions, is actively betting against China. And he is doing so specifically by targeting infrastructure stocks, which he sees as being the most vulnerable. While Chanos’s comments alone would not be sufficient for us to take action, we do believe that it is only prudent to take the views of such a successful contrarian seriously.

4. Pivot Capital Management published an excellent report outlining how truly excessive China’s capital spending boom has been. We will refrain from summarizing the entire report, but these facts warrant repeating.

Investment accounted for 70% of GDP growth in 2008

Investment accounting for 90% of GDP growth in the first half of 2009

China’s investment rates far exceed those of even post-WWII Germany and Japan

China is experiencing declining marginal returns on its investment spending (i.e. getting less “bang for the buck” for every dollar invested in capital spending). Decreasing returns are an indication of overcapacity.

China’s urbanization rate is massively understated due to the definitions that China uses (by China’s definition Houston, Texas is not considered “urban” despite being one of the largest cities in America. Its population density is too low). Pivot estimates that China’s true urbanization rate is 20% higher than the quoted 45%. What this means is that continued urbanization will not be the economic boon that many China bulls believe it will be.

Anecdotal stories abound of China having a real estate bubble, with prices driven to uneconomical levels by speculators. We take these stories with a grain of salt due to the lack of quality data, but evidence is mounting that prices are rising faster than incomes. According to Pivot, price-to-income ratios are higher in China’s major cities than they were in Los Angeles or London at their mid-2000s peaks.

All of these factors indicate to us that the time is right to exit this position. Could China’s investment boom continue for months or even years? Absolutely. The U.S. housing boom certainly proved that overpriced markets can get even more overpriced before they crash. But we feel that prudence dictates we make this reallocation now, while we still have a handsome profit. We will also closely monitor our position in Brazil (EWZ) in the event that weakness in emerging Asia spreads to Latin America.

On January 21, our fear turned out to be true. In response, we wrote:

Brazil and emerging markets in general came under incredible stress over the past two days. EWZ finished today down nearly 5%.

We have grown increasingly skeptical of emerging markets over the past 3-6 months. We maintained our position in EWZ as a way of hedging out bets; just in case we were wrong about emerging markets being at risk, we wanted to have some amount of exposure, and EWZ appeared to us to be a reasonable vehicle to accomplish this. So long as the security continued to rise in value, we were content to hold. Now, it appears that our skepticism was warranted, so we believe it makes sense to liquidate this position while we still have a healthy profit in it. In roughly four months, we earned a 10% return, plus dividends. There is no reason to get greedy here and chase returns.

This brings us to our second portfolio move today, the purchase of the Proshares Ultrashort Gold Fund. If there is anything we were more skeptical of than emerging markets, it would certainly be gold. None of the bullish arguments for the “barbarous relic” made sense to us. Yes, gold has some value as an inflation hedge. But we are currently experiencing deflation, and the experience of Japan shows that deflation can continue even with massive monetary and fiscal stimulus when the private sector is deleveraging. Yes, gold has traditionally been a “crisis hedge” during uncertain times. But when the financial sector collapsed in 2008 and it appeared that the world as we knew it was ending, gold actually fell. Yes, gold offers protection from a falling dollar—if you bought it ten years ago. But how will gold perform in the event of a bull market in the dollar? We firmly believe that a stronger dollar will be the reality over the coming 1-3 years; it is difficult to see gold performing well in this environment.

Finally, for us to believe the gold story we would like to see confirmation from another asset class, such as bonds. The bond market is generally considered to be more sophisticated than the stock and commodities markets because it is dominated by large institutional investors. And right now, the much feared “bond vigilantes” are showing no signs of fear. Yes, yields have risen in recent months. But they are still very low by historical standards and hardly indicative of impending hyper inflation or a dollar collapse.

To us, the bull market in gold is a trend based on false premises. It’s also become a “popular” investment among both retail investors and some money managers. As contrarians, this makes us highly skeptical.

The problem with making a contrarian call is that you can be “right” but still lose a lot of money if you are too early. Just ask anyone who tried to short the Nasdaq during the 1990s bubble. With this in mind, we find it necessary to use strict risk control on this trade. We are implementing a 25% stop loss. On a 10% portfolio position, this limits the total risk to the portfolio to a tolerable 2.5%.

Should gold continue to break down as we expect, we would look to exit this position in roughly six months or after a profit of 30-40%.

The January 16 issue of the Economist attempted to refute many of the China bear arguments made by Pivot and by Chanos (see “Not Just Another Fake”). It’s not to say the Economist is bullish on China; it’s just that they believe it’s “not that bad,” and that the country is actually in better shape than Japan prior to its implosion two decades ago. The Economist does make some valid points:

“Chinese share prices are nowhere near as giddy as Japan’s were in the late 1980s. In 1989 Tokyo’s stockmarket had a price-earnings ratio of almost 70; today’s figure for Shanghai A shares is 28, well below its long-run average of 37.”
Despite the bubble in some markets, “Average home prices nationally…cannot yet be called a bubble. On January 14th the National Development and Reform Commission reported that average prices in 70 cities had climbed by 8% in the year to December, the fastest pace for 18 months; other measures suggest a bigger rise. But this followed a fall in prices in 2008. By most measures average prices have fallen relative to incomes in the past decade.”
“The most cited evidence of a bubble—and hence of impending collapse—is the ratio of average home prices to average annual household incomes. This is almost ten in China; in most developed economies it is only four or five. However, Tao Wang, an economist at UBS, argues that this rich-world yardstick is misleading. Chinese homebuyers do not have average incomes but come largely from the richest 20-30% of the urban population. Using this group’s average income, the ratio falls to rich-world levels. In Japan the price-income ratio hit 18 in 1990, obliging some buyers to take out 100-year mortgages.”

These points may technically be true, but the Economist misses the point. China’s bubble doesn’t have to be as big as Japan’s in order for it to burst. And the fact remains that China has overcapacity in its industrial sector that it continues to add to with new capital spending. The Economist also makes a critical error in comparing China today to the United States 100 years ago. The United States had a booming population in those days due to both immigration and high native birth rates. The United States was building infrastructure for its burgeoning population and for the settlement of the West. Due to the One Child Policy, China’s population growth rate is negligible. China’s migrants also move primarily from the countryside to the already populated coastal regions. Yes, this requires construction on a massive scale. But no, China is not conquering an untamed continent.

We believe that China’s infrastructure building has, at a minimum, gotten ahead of itself. China is currently building roads that may not be utilized for ten or twenty years. At the very least, we would expect the growth rate in China’s commodities usage to moderate in the coming months and years. In any event, we continue to believe that selling PXR and EWZ was the right move to make.

Update on the Luxury Sector

Coach sent the luxury sector into a tailspin when the company released its earnings on January 20. The company’s stock price then proceeded to fall more than 10% in two days. So, is the rebound in the luxury sector over? We don’t think so. We read the earnings release and found nothing objectionable in it. Year over year growth was strong. It just wasn’t quite as strong as Wall Street had hoped, and the stock got punished. We don’t view this as indicative of a larger setback for the industry, and in fact, the stock more than recovered from its fall throughout the rest of the quarter and currently sits near its 52-week high.

The Financial Times appears to agree with us. The day after the Coach release, the FT wrote,

These may still be early days but there are increasing signs of a revival in the luxury goods industry. Tiffany, Richemont and Burberry have all been reporting an encouraging recovery in sales during the second half of last year that appears to have accelerated in December….

Luxury goods groups all expect demand to continue growing strongly in Asia but they are also banking on the recovery of their mature markets compounding the Asia-Pacific region’s double-digit growth.

Well said. The FT essentially made the same points that we have used over the past 18 months. The luxury sector is primarily a play on the rising affluent class in the developing world and secondarily a play on the recovery of America’s wealthy. It’s also a play on the rise of the American Echo Boomer young woman. As America’s enormous population of college students (currently at the highest levels in history) graduate and join the workforce, they will need work-appropriate clothes and accessories. This should be a big boon for Coach and other entry-levels luxury manufacturers and retailers. Every college girl will not run out and buy a new Coach purse upon getting that first job offer. But given the size of the Echo Boomer generation, there should be enough of them to make a noticeable impact on luxury sales going forward.

Still, sentiment toward the sector remains skeptical. We like this. It tells us that the sector most likely has at least a few more months of outperformance left in it.

High-Yield Bonds

The Financial Times published an article on March 29 that summarized many of our thoughts on our position in high-yield bonds (see “Junk Bonds Sell in Record Volumes”). The FT wrote,

Global issuance of bonds with ratings below investment grade, known as high-yield or "junk", totalled $67.8bn (£45.3bn) at the end of the first quarter - an all-time high for the first three months of the year, according to Thomson Reuters…

Persistently low official rates have driven yield-hungry investors out of money market funds into higher yielding investments such as junk bonds.

Meanwhile, economic growth and receptive capital markets have improved the prospects of lower rated companies. Default rates are expected to drop under 5 per cent this year from a peak of 14 per cent globally in 2009, says Moody's Investors Service…

But the sharp gains and the wave of supply over the past year have led to warnings that investors are chasing performance and that the rally may run out of steam soon. The torrid pace of issuance follows $176bn last year, the second highest annual tally, Thomson Reuters says.

So, we have two opposing forces affecting this market. On the bullish side, we have an improving global economy and a decline in risk aversion. All else equal, these factors should point to lower yields and higher bond prices.

But on the bearish side, we have a massive influx of new supply that is outstripping demand, keeping yields relatively high. On balance, we are still mildly bullish on the sector. We concede that rising supply should put a limit on capital gains potential, though we don’t see it depressing prices much further. At present, we believe the high yield we enjoy from this sector to be adequate compensation for the risk. We have no immediate plans to sell, though we will continue to monitor the sector for signs of weakness.

Looking Ahead

Going forward, we are most hopeful on the prospects for our short sales of gold and the euro. The euro trade is performing as expected. While gold has no yet joined the euro in its decline, we believe that it is only a matter of time for the reasons discussed above. Ideally, we would like to close these positions within the next 1-2 quarters, but our decision will be based on the performance of these two positions over that time period. Our biggest disappointment in 2010 has been the performance of the utilities sector. To us, utilities remain the most attractive industrial sector—they enjoy a high yield and conservative pricing relative to the S&P 500, which is increasingly looking extended. Given current pricing levels, we consider ourselves already compensated for any regulatory risk due to new government “green” initiatives or other risks.

Here’s looking forward to a great 2010,

Charles Lewis Sizemore, CFA

Sizemore Capital 2009 Year End Investment Outlook and Commentary

noreply@blogger.com (Charles Lewis Sizemore, CFA) — Sat, 02 Jan 2010 05:26:00 +0000

As we enter 2010, let us take a moment to reflect on the year that just passed. At the beginning of 2009, world capital markets were in the midst of a full-blown meltdown. The global financial system had failed, putting virtually every major bank at risk of insolvency. Most U.S. banks that survived did so only by taking emergency funds from the federal government.

During the crisis—which originated in the U.S. housing market—investors, interestingly, did not flee the U.S. dollar. In fact, they ran to it as a safe haven (this is something we will return to later in this letter).

By the end of the first quarter, stock and credit markets had found a bottom and then proceeded to enjoy one of the biggest rallies in history, posting nine months of virtually uninterrupted gains. The state of crisis had abated, and things slowly returned to “normal,” even if this was a “New Normal” of diminished expectations.

In this most extraordinary of years—one that will no doubt provide mountains of material for future market and economic historians—we are proud to say that Sizemore Capital Management’s portfolios had an excellent year.

Our actively-managed Tactical Portfolio returned 38.9% for the year 2009, beating the S&P 500 Total Return by a full 12.3%. Our high concentrations in select foreign and emerging market stocks, infrastructure, and luxury goods contributed most to our returns, while our positions in bonds and utilities stocks added income and stability.

Our returns for 2009 on our passive Strategic Portfolio Allocation models were the following:

Preservation of Capital	1.7%
Conservative Income	10.1%
Growth and Income	18.3%
Growth	24.9%
Aggressive	29.5%

Portfolio Review

SCM Tactical Portfolio

After a busy third quarter—in which we added exposure to the euro short sale (DRR), the utilities sector (XLU) and Brazil (EWZ) and sold our positions in high-grade corporate bonds (LQD) and Taiwan (EWT)—we made no changes to the Tactical Portfolio allocation in the fourth quarter of 2009. Frankly, the portfolio was working, and we felt no need to “upset the apple cart,” so to speak.

At the end of 2009, every position in the portfolio was performing as expected. Even the euro short sale, after months of disappointment, finally began work for us as the dollar gained significant ground on the euro in December.

This move took a lot of investors by surprise. The dollar is, without question, the most despised asset in the world right now. Market booms and busts tend to create their share of self-styled experts. In the late 1990s, every investor because a technology expert, convinced that their pick—fill-in-the-blank.com—was the next “sure thing” to instant wealth. Then, when this failed spectacularly in the 2000-2002 bear market, attention shifted to the housing market. By the mid 2000s, every average Joe believed that he could become the next Donald Trump buying real estate. No experience or expertise was needed, of course. It was easy. And everyone was doing it!

It goes without saying that amateur (and even quite a few professional) investors that pursued these strategies lost a lot of money in doing so. Unfortunately, these same investors—now convinced that the “dollar is trash” and that the “only true store of value is gold” appear to be making the same mistake again. The extreme bullishness for gold has become synonymous with extreme bearishness for the dollar, and this ties in nicely with our euro short sale. The euro, like gold, was one of the chief beneficiaries of dollar weakness, and both have now become vastly overpriced in our view relative to the greenback.

In mid December, we wrote the following about the dollar/euro trade in our financial blog (available at http://www.sizemorecapital.com):

A funny thing happened on the way to the dollar's imminent destruction: it broke its downtrend and is now looking to finish 2009 strongly.

We've been highly skeptical of the "dollar bear" argument for quite a while now. We wonder if half of the "experts" who joined the anti-dollar bandwagon over the past two years have ever left the United States. Had they been to Europe recently, they would have found that prices there already defy reality for those of us paying in dollars. (My recent visit to Madrid was nearly 50% more expensive that the one I took a few years ago...and this during a period where Spain is suffering a severe deflationary recession in which domestic prices are falling.)…

Yet none of this makes sense.

Is the US federal government spending an irresponsibly large amount of money these days on stimulus...much of it borrowed? Absolutely. But so is virtually every European country, and yet the euro remains strong. The same is true for the Fed's excessively lax monetary policy. As bad as it is, it is only marginally worse than that of most other developed countries. As we wrote in a prior post…some Eurozone members are at significant risk of sovereign default. And what might a default by a member or, in the most extreme case, the exit from the Eurozone of a major regional economic power like Italy, mean for the future of the euro? Let's just say it wouldn't be good.

The dollar was too expensive in 2000. But today, after nearly ten years of grinding bear market, the dollar is cheap and despised. Legendary speculator George Soros is credited with saying that the secret to making money in the financial markets is to find the trend whose premise is false and then bet against it. And we believe that the dollar bear market is one such trend. Soros's old partner, legendary contrarian investor Jim Rogers, agrees.

We remain bullish on the dollar for the next 6-18 months and recommend steering clear of the anti-dollar hysteria.

This brings us to a discussion of the luxury sector. On this front, our thinking is unchanged. In a November edition of SFO Weekly, we wrote:

We first recommended the luxury sector (an ETF, ticker: ROB) in the July 2008 issue of SFO Magazine (“The Contrarian Stock Play: Luxury Sector”). Our timing, as it turned out, left much to be desired. Just three months later, the market entered the infamous 2008 meltdown, and the luxury sector got hit harder than just about any sector excepting financials.

In the midst of such financial turmoil, it appeared that even the rich were not immune. Luxury brands across the board experienced significant contractions in sales volume, and some had to resort to that most cardinal of sins for a high-end retailer: discounting!

But then a funny thing happened. Despite (or perhaps because of) the extreme bearishness towards the consumer sector that still persists at time of writing, retail stocks in general, and high-end luxury stocks in particular, have staged a massive rally. ROB has more than doubled from the March 2009 lows, outpacing the broader retail sector by more than 20 percent and the S&P 500 by more than 40 percent.

So, what happened? Is the U.S. consumer back? The short answer is no…. But here is the good news: While the average [baby boomer] is cutting back, the high-income set is starting to visit the malls again. The Wall Street Journal writes, “Nov. 5 brought news that October retail sales at high-end Nordstrom and Saks rose for the first time since May and June 2008, respectively. Like the swallows flocking back to Capistrano, the Rich have returned” (“Return of the Big Spenders,” Nov. 10, 2009).

So, within the U.S. consumer sphere, we see a bifurcated market in which the mainstream retail sector continues to see tepid demand while the high-end market enjoys at least a moderate recovery. Furthermore, as I wrote in the original July 2008 article, the real growth story for luxury brands is not in the United States but in China and the rest of the developing world.

Looking Ahead

Currently, we believe that our euro short position in DRR has the most potential for substantial gains in the early months of 2010, and we may substantially add to it early in the first quarter. The question then becomes one of what to sell. The most obvious candidate is our position in emerging market infrastructure, PXR. This is a difficult call for us, because we are not at all bearish on PXR’s prospects. It is just that, looking forward, we see PXR’s growth being more moderate as its underlying portfolio companies appear to us to be at or near a fair valuation. Our position in the luxury sector, ROB, is also a candidate for sale or reduction at some point in 2010. We are not at all bearish on ROB, of course. We still believe the case for luxury is quite strong. But going forward, we would expect ROB’s returns to eventually converge with those of the broader S&P 500. We’re not in any hurry to sell ROB. But, should market conditions warrant, we may decide that the time is right to rotate those funds elsewhere.

Currently, we see the most value in utilities and MLPs and to a lesser extent to high-yield and municipal bonds. At this point in time, we intend to continue holding these sectors through at least the first quarter of 2010 and probably significantly longer, though as always we reserve the right to alter course if market conditions warrant. In an environment in which stocks appear to be roughly close to “fair” value, we believe that these income-oriented investments offer the best risk/return trade-off.

Here’s looking forward to a great 2010,

Charles Lewis Sizemore, CFA