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Lessons from 2012 for profiting in the recent rally

posted on January 4, 2013 at 8:30 am
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So now what?

We’ve had a December sell down on fears that the United States would go off the fiscal cliff—the Dow Jones Industrial Average was off 2.48% in the fourth quarter.

We’ve had a huge pre-New Year’s move—the Standard & Poor’s 500 Stock Index climbed 1.7% on December 31 on hopes that the crisis would get resolved and an even bigger January 2 move on an actual “solution. The total gain comes to 4.3% for the two sessions.

But where does the market go from here? I think you can guess, right? After all we did go through this pattern of sharp rallies and deep retreats in 2012.

So with the benefit of that experience, let me give you my seven steps for the first half of 2013.

Last year, markets went down when high levels of worry about big macro-events such as a hard landing for China’s economy or a Greek exit from the euro led money around the world to slosh toward safety. When that happened, U.S. Treasuries and German Bunds became the asset of choice and stock markets with any hint of risk—such as China or Brazil—sold off.

Last year, markets went up when worries receded and investors collectively let out a sigh of relief. When European Central Bank president Mario Draghi said he would do whatever it took to defend the euro and investors decided they didn’t need to fear a meltdown in Spain, markets rallied in relief. When China’s economy showed evidence that it had bottomed in September without breaking below 7% growth, markets rallied in relief.

When it looked like the U.S. Congress and President would force the country off the fiscal cliff, markets went into a funk. And when the House of Representatives actually voted to approve a deal on Tuesday January 1, the sigh of relief swept financial markets around the world.

But we know from 2012 that relief can all too easily turn back to worry.

That seems all too likely in coming weeks.

It’s not like the fiscal cliff “solution” actually solved anything: The mandatory budget cuts—the Sequester—that were supposed to force Congress to behave like adults (or get spanked like children) have been put off for two months. At the end of that time, Congress will face exactly the same budget fight. (And the suspension of these budget cuts in the current deal will be paid for—according to the fiscal cliff compromise—by some amazing gimmicks such as encouraging people to convert their traditional IRAs to Roth IRAs so they’ll pay taxes early on their retirement withdrawals.)

And it left the whole tax/spending cut battle to be replayed when the U.S. government hits its ceiling for borrowing. Depending on what magic Treasury Secretary Timothy Geithner chooses to pull out of his hat before he leaves office, the U.S. will run out of room to pay its debts in late January or early February. Republicans in Congress say they intend to use the leverage from the debt ceiling to force big spending cuts. President Barack Obama says he has no intention of negotiating anything in exchange for an increase in the debt ceiling. Should be interesting. I think we can be sure that the markets, as in the 2011 battle over the debt ceiling, won’t be amused at the idea that the United States might choose to default on its obligations.

With the lessons of 2012 still fresh in our minds—it was just days ago—here are my suggestions for the early stages of 2013.

  • First, since relief rallies can be incredibly explosive and remarkably short-lived, don’t dither. If you’re going to try to increase the upside potential of your portfolio by adding stocks that look likely to do well, do it within the next week—or play the hand you’ve got. The worst move is to wait and wait and wait, hoping for evidence that will convince you this move up is for real. That almost guarantees that you’ll be buying in just as sentiment starts to turn. You’ll be buying high and will probably wind up selling low.
  • Second, this isn’t a time for regrets and for moves designed to get even or make up for mistakes. I thought raising some cash at the end of 2012 gave me a reasonable shot at buying low if the fiscal cliff deal didn’t happen. Didn’t work out. I sold Costco (COST) and Dollar General (DG) out of my Jubak’s Picks portfolio http://jubakpicks.com/the-jubak-picks/ to raise cash that I didn’t get a chance to put to use. But this isn’t the time to try to fix that sell by re-buying those shares. That decision is past history. Time to move on.
  • Third, if you’re going to buy something in an attempt to profit from this sigh of relief buy the stuff that’s going up most strongly now. The deal has created its own buying logic—go with it.  As I explained in my morning post on January 2 http://jubakpicks.com/2013/01/02/global-markets-breathe-sigh-of-relief-as-u-s-dodges-fiscal-cliff/ the reduction in fear that came with the fiscal cliff deal has enabled traders and investors to focus on the ongoing positive story on accelerating growth out of China and on the increased odds for massive stimulus in Japan. The stocks best positioned to take advantage of those stories are China commodity or financial plays. Since getting in and out of these could well be important if sentiment moves quickly in the other direction, I’d use New York traded ADRs here such as Aluminum Corp. of China (ACH) or China Life Insurance (LFC). Please note that I don’t especially like Aluminum Corp. of China on its fundamentals and prefer Ping An Insurance (2318.HK in Hong Kong) to China Life, but in the context of a short-term trade, liquidity gives the first two stocks a decided edge. For commodity plays I’d suggest Thompson Creek Metals (TC) and Vale (VALE.)
  • Fourth, you don’t have to scramble to do anything just to catch this relief rally. And you certainly shouldn’t buy something at a price that seems uncomfortably high in an effort to catch the rally. Remember 2012: If you miss this rally, there will be another along not too much later. The debt ceiling negotiations. The next round in the euro crisis. I don’t think we’re going to lack for volatility in 2013.
  • Fifth, consider the possibility that the U.S. financial markets aren’t going to be the greatest place to be in the first half of 2013. Wall Street figures that the fiscal cliff uncertainty and then the deal will take economic growth in the first quarter of 2013 down to a 1% rate from the 3.1% growth rate in the third quarter of 2012. The biggest specific dent to growth comes from the expiration of a two-percentage point cut in Social Security payroll taxes. (The rate will go back to 6.2% from 4.2%.) That’s certainly better than sending the U.S. economy into recession, and Wall Street economists do expect growth to pick up in the second half of the year, but the political follies of Washington have hurt the economy.
  • Sixth, in the weeks before the fiscal cliff deal Japan (on potential government stimulus) and China (and other emerging markets linked to China’s economy) showed signs of being able to move up even when the U.S. market had stalled on fear. In the first half of 2013 I think that’s again a good possibility as long as the battle over the U.S. debt ceiling doesn’t threaten global financial meltdown. (A big mess is fine. Armageddon is not.) I think adding to your weighting in China, Brazil, Turkey and Korea makes sense for the first half of 2013. I’d especially look for stocks that will take advantage of domestic growth in those economies.
  • Seventh, the challenge, once you start talking about domestic growth in emerging markets, is that most of the big, well-known, and highly liquid stocks on those markets are exporters or commodity plays. Everybody knows Brazil’s Vale (VALE) and Petrobras (PBR), but few investors know Kroton Educacional (KROT3.BZ) or Natura Cosmeticos (NATU3.BZ) even though in the last year you would have much preferred to own Natura (up 68%) than Vale (up 5.9%.) And it sure doesn’t help that many emerging market, domestic-oriented companies trade only in national markets rather than as ADRs in New York. (Kroton and Natura both trade only in Sao Paulo.) To get domestic emerging market exposure you have to cast a wide net that includes New York traded ADRs such as China’s Home Inns and Hotels Management (HMIN), Argentina and Brazil’s Arcos Dorados (ARCO), and Brazil’s Itau Unibanco (ITUB); relatively liquid (72,420 shares daily volume) New York OTC-traded stocks such as China’s Tencent Holdings (TCEHY) and Japan’s owner of the ubiquitous Asian Seven-Eleven chain Seven & I (SVNDY); or developed economy companies with big emerging market revenue such as Johnson Controls (JCI) or IMAX (IMAX). Yes, that IMAX. About 40% of the company’s order book for new IMAX theaters is in China. (Home Inns & Hotels and Johnson Controls are members of my Jubak’s Picks portfolio http://jubakpicks.com/the-jubak-picks/ )

If you’ve read this and think it sounds like I think 2013 is going to be as volatile as 2012, you’re absolutely right. At least for the first half of the year. After that I wouldn’t mind some good ol’ fashioned boredom. You know the kind where markets grind upward so steadily that you don’t even know you’ve made good money until the end of the year.

But I’m not holding my breath.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. The fund did own shares of Arcos Dorados, Home Inns & Hotels Management, Johnson Controls, Kroton Educacional , Natura Cosmeticos, Seven & I, and Tencent Holdings as of the end of September. For a full list of the stocks in the fund as of the end of September see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/

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  • greedibanks on 4 January 2013

    Kass at thestreet.com has a view similar to point #4 above but he leaves it at that and does not recommend buying anything.
    Nice recovery in: shippers like Navios,
    MLPs like Kinder Morgan (thank goodness for that), and even mReits like Annaly

  • eremmell on 4 January 2013

    So … go all-in now, and focus on Chinese stocks? Meh ;-) Although, I did start tracking IMAX, thanks for that tip.

  • eremmell on 4 January 2013

    Stay far away from the dry bulk shipping sector. It may be experiencing a small relief rally, but the oversupply issue is still there and getting worse. I will not touch it again.

  • eremmell on 7 January 2013

    IMO, CLF is a better iron ore commodity play than VALE, I just bought some.

  • Jim Jubak on 8 January 2013

    eremell, don’t think I suggested going all-in on anything or focusing on Chinese stocks. I do think that I’d look to increase my weighting in Chinese and Asian stocks in 2013. And if you are going to try to make money in the very short-term China stocks like those I mentioned are good trading candidates.

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