The economy is growing at a respectable 5%. Unemployment is down to 5.8% — a level that used to be called full-employment -- and the price of oil has dropped to 5 year lows. A lot of people don’t believe it, but it looks to me that we are in the third inning of a good old fashioned recovery. Nevertheless, there are three changes that occurred in the last quarter that may requirea course correction.
1. The U.S. Government
For the next 2 years, President Obama will have to deal with a Republican controlled House and Senate. Odds are good that the President and Congress will be unable to agree on much of anything. This bodes well for economic policy, which in my view had been going in the direction of top down command and control solutions that have inhibited our recovery by increasing uncertainty and regulatory risk for everyone. The Republican controlled Congress is not going to reverse this trend, but I think they will be able to slow it down, which is a win for investors.
Three Changes In the Market That Need Attention (Photo credit: bigstockphoto.com)
2.The Price of Oil
Today’s low price of oil is another big win for investors. The U.S. consumes nearly 19 million barrels a day of oil. Having the price drop below $60 a barrel saves consumers $416 billion per year. There is virtually no chance that the President and Congress will be able to pass a tax cut/stimulus package anywhere close to this size. This $416 billion stimulus package is brought to us by market forces. In fact, I think it will have a greater impact than a tax cut of the same size, because tax cuts tend to disproportionately benefit the wealthy, for the simple reason that they are the ones who pay most of the taxes. Lowering the price of a basic commodity that everyone buys, will have a much broader impact. In addition, these savings are much more likely to be spent in the U.S., thereby having a bigger multiplier effect on the economy than an equivalent amount of tax cuts.
3.Interest Rates
The Federal Reserve has already ended its Quantitative Easing program, which was a way for them to tighten last year without raising interest rates. Now, with the U.S. approachingfull employment, it is time for them to actually raise interest rates. In my view, it is way past time forsavers toget paid a better interest rate than zero. Higher interest rates will be a godsend to those with savings, but it will be bad for those who hold long-term bonds.
Report card for 2014
The falling price of oil has been a negative for 2 stocks I wrote about in 2014, Petrobas (NYSE:PBR) and Solazyme (NASDAQ:SZYM). But, at the same time, lower oil prices have been a big help for American Airlines (NASDAQ:AAL), Gilead (NASDAQ:GILD), Whole Foods (NYSE:WFM), Blackberry (NASDAQ:BBRY), Tesla (NASDAQ:TSLA), Triquint (NASDAQ:TQNT), AIG (NYSE: AIG), and Apple (NASDAQ:AAPL) all made money for us, while Orbitz (NYSE:OWW) was essentially flat. Out of 11 stocks, only 2 lost money giving a winning percentage of 82%, which in my view is pretty good.
Of the two losers, I recommended sellingSolazyme after their Q3 report. Since then SZYM has lost another 1/3 of its value. When we sold this stock, my thought was that there was no way the company could fix what was wrong in the near term, so it made sense to sell and capture the tax losses to offset gains from other positions. To avoid a “wash-sale” we had to stay out of the stock for at least 30 days. Now that the 30 days have elapsed, we can buy the stock back if we want and still get the benefit of the realized tax loss. However, with the price of oil even farther below Solazyme’s production cost than when we sold, I don’t feel any need to rush back into the stock.
Not all of the winners worked out for the reasons we outlined when we bought them. For example, we were counting on John Chen at Blackberry to stabilize the company’s cash flow, which he has done. But we did not count on the North Koreans hacking Sony thereby shining a spotlight onthe value of Blackberry’s security features for professionals.
Tesla, while still up from when we first wrote about it, has given back a good portion of this year's gain. While the company has executed on their plan as we discussed, we did not expect the price of gasoline to fall as it has. Someinvestors believe that lower gas prices will affect Tesla's sales, because more price sensitive buyers will stick with gasoline powered cars. In my view, however, Tesla's customers are not buying the car to save gas money, so the recent weakness in TSLA is more a buying opportunity than a reason to sell.
Gilead is another stock that has recently given back a portion of this year's gains. Two weeks ago, AbbVie, Inc. received FDA approval for a competing drug for Hepatitis C. We had been tracking the progress of this drug, but did not feel it threatened Gilead because AbbVie's drug co*cktail requires taking four to six pills once or twicea day to get the same results as Gilead acheives with one pill per day. More pills means more side effects to manage and a more difficult time making sure patients actually take all the pills they need when they need them. What really triggered Gilead's recent drop was when Express Scripts madeAbbViethe exclusive treatment available to patients in healthcare plans that useExpress Scripts to manage their pharmacies, in exchange for a price discount estimated to be about 30%. This means that a lot of patients will be unable to use Gilead's drug, even if it is abetter choice for them, purely because AbbVie's drug is cheaper. The patients who Express Scripts wants torequire to take AbbVie's drug have not yet been heard from, but I suspect that many will be willing to go to the matwith their health insurers to get the drug that is best for them.
We thought that Apple's iPhone 6 and the new watch gave the stock a 25% upside. Since then, the stock is up about 15%. We did not foresee the difficulty Applewould have with the supplier they were counting on for the sapphire material they wanted to use to replace gorilla glass in their high end products. Thishighlights the importance of investing instocksthat have a significant upside. In this case, the upside was large enough so that even with the supplier problem,the stock still movedup.
As I’ve said in the past, no matter how much data you have, you can never be 100% certain at the point at which you have to make an investment decision that it will work out. The last 20% of an investment decision is a judgement call that requires a leap of faith. Some people have shown me that over timetheir judgement calls work out most of the time. These are the Masters whose investment strategies and best stock ideas I’ve been writing about, and whose portfolios our SMA clients invest in.
Strategy for 2015
There are many good things happening right now, but the benefits will not be evenly spread out among all companies. Some companies will do exceptionally well in this environment, while others will find that they cannot continue with oil at such low prices or without debt financing available at next to zero interest rates. If you own long-term bonds that you cannot hold until maturity, this is a good time to think about selling.
My thoughts about what to do with your stock portfolio changes, depending on your investment horizon.
If your investment horizon is 5 or more years, I think it's a pretty good bet that 5 years from now, the price of oil will be higher than it is today. By buying oil-sensitive stocks now when the price of oil is low, you are buying into stocks that pay good dividends, while you wait for oil prices to recover. If you are the kind of investor who feels comfortable buying stocks when everyone else is selling, take a look at the top 5 positions of Tim Siegel, Tony Mitchell, Nate Pile, and Mike Koza. If, however, you would rather wait until a stock starts to show some upside movement, then take a look at Justin Uyehara and Marcus Eder.
If your investment horizon is less than 5 years, you don’t have time to wait for the stocks that are out of favor now to come back into favor. I suggest you take a look at an unemotional quantitative investor’s top 5 holdings like Wayne Himelsein, Kai Petainen or Jim Van Meerten.
Whether you have a long or short investment horizon, you probably do not want to be aggressive with 100% of your stock portfolio. For the more conservative portion of your portfolio, consider Eugene Groysman and Thomas Pound.
Visit us at Marketocracy.com to select the Masters you wish to trackby clicking on “Contact Us”. Each month, I’ll email you a report about how they did, so you can compare their returns to the index funds and your own stock picks.
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Disclosure: I am the portfolio manager for mutual and hedge funds advised byMarketocracy Capital Management, an SEC registered investment advisor. Before relying on the opinions expressed in this article, you should assume that Marketocracy, its affiliates, clients, and I have material financial interests in these stocks and may hold or trade them contrary to these opinions when, in our view, market conditions change.
