This is the 21st piece in our Positioning for 2012
series. Readers can find the entire Positioning For 2012
Jeffrey A. Miller, PhD, is CEO and President of
New Arc Investments
. Also a fund manager at the firm, he has guided the Sector
Rotation Fund throughout its exceptional history. Before
beginning his financial career in October 1987, Jeff was a
college professor who worked extensively with quantitative
modeling of sophisticated state and local tax issues. He is the
author of the
A Dash of Insight
Seeking Alpha's Jonathan Liss recently spoke with Jeff to
find out how he planned to position clients in 2012 in light of
his understanding of how a range of macro-economic and
geopolitical trends were likely to unfold in the coming
Seeking Alpha ((
Jeff, how would you generally describe your investing
Jeff Miller ((
Hi Jonathan. Thanks for inviting me to participate again this year.
The Seeking Alpha year-end program brings out a nice range of
expert opinion. You have sharp questions and a good format. I enjoy
reading the interviews, and I am sure that many others do as
Our investment style emphasizes active management, a focus on
risk, and attention to each client. That has been especially
challenging over the past year. Many people do not want to worry
about 350-point swings in the Dow. They need yield with less
volatility. The Fed policy has taken away those choices, so we need
to be a little more creative.
Rather than emphasizing a specific investment style, I interview
each potential client and then create a blend of our five programs
- something that meets the risk/reward needs of each.
With that background in mind, I would say that I am focused on
data and objective indicators. I am resistant to hype and
headlines. I am contrarian - finding opportunity where others see
none. On a long-term basis I am optimistic about the US, the
economy, and stocks. On a short-term basis I am cautious.
Within equities, are there any particular sectors or themes you are
currently overweight or underweight? If so, why?
I am overweight technology and cyclical stocks. The economic
indicators that have passed my stringent tests are more optimistic
than the general sentiment. Many media commentaries still highlight
people who "called 2008" no matter how early. At some point these
pundits will be "one hit wonders" in the same way traders view
Elaine Garzarelli and her forecast of the 1987 crash. Meanwhile,
many of these sources have been dour and wrong since 2008.
Economic growth has been modest, but it has been just fine for
the profitability of the major industrial firms. The trend is
favorable. I like Caterpillar (
) and Illinois Tool Works (
) among others.
The technology play is excellent with economic expansion, but
still works if economic growth proves to be more moderate. Many
technology names are at historic low valuations on a P/E basis.
Why? The story has not worked recently, and
investors are like jilted lovers.
) is an obvious example, but I also like Intel (INTC), Oracle
(ORCL), and Apple (AAPL).
Do you ever buy funds to gain access to asset classes or themes, or
do you stick to single stocks exclusively? What are the advantages
of your approach?
We do not use mutual funds, but we are very active in ETFs. Two of
our five programs trade via ETFs, and we have a free weekly
newsletter with ETF ratings. The trading method asks the following
question: What ETF will be best over the next three weeks? We have
two "experts" on this subject - Oscar and Felix. You can guess
their risk/reward outlook!
We also have a Dynamic Asset Allocation approach ((DAA)). For
this model we ask: What ETF will be the best over the next
Please note that we
have a holding period of three weeks in the first case nor 12
months in the second. Nonetheless, we
ask these questions every day.
This gives us 20 or so trades in DAA every year and many more
for Felix and Oscar.
Right now, the DAA approach is very conservative. By the nature
of the method it will be slow in capturing a rebound. Essentially,
it reduces volatility and gets you on the right side of big
Felix and Oscar were fully invested for the year-end rally.
(This could easily change by the time of publication).
To summarize, ETFs are a very important part of our trading and
we have major positions for clients. It all depends on which of our
programs is right for them.
Speaking of ETFs, which asset classes are you overweight? Which are
you underweight? Why?
We have to start with the definition of an "asset class." There is
a dangerous pitch out there, reflected in current advertising. The
idea is that all of the traditional asset classes - stocks, bonds,
and real estate - are over-valued. The refuge first was gold. Now I
see ads encouraging people to speculate in foreign exchange.
Encouraging people to do active trading based upon their "market
feel" is a prescription for disaster.
My scientific, model-driven approaches sometimes recommend oil
and gold, but I do not have a good method to evaluate these choices
on the fundamentals. The average investor should not confuse
trading with investing.
Can you elaborate on what you mean by "scientific, model-driven
approaches" to allow readers a better understanding of what we're
talking about here exactly?
Good question! I engage several model developers with different
approaches. I test these carefully. You might think of it as my own
version of a "stress test."
The DAA model follows principles that have been accepted in the
finance literature for decades. It is a yearly momentum model, but
including some helpful tweaks. When it is applied to our universe
we minimize the chance of excessive correlation. This method gets
you on the right side of long-term trends. In 2008, for example,
the DAA approach would have led you first to gold and bonds and
later to the inverse index ETFs. This cushioned the downside, but
it would have been very slow in capturing the rebound.
Felix combines momentum, a sense of the cycle, and the element
of uncertainty. Felix does not call tops and bottoms, but he does
get on the right side of fresh moves. If there is a big trend,
Felix will participate. If the market is declining, Felix will get
into the inverse ETFs --- essentially going short.
No system is perfect, and our methods do not call tops and
bottoms. There is always a delay for recognition of a new trend. It
depends on the time frame.
Name one investment that exceeded your expectations in 2011, and
one you had high hopes for that didn't pan out. Do you see any
particular investment surprising investors over the next year?
Our biggest winners were Apple and some of the energy and
healthcare names. We are very good at forecasting economic and
earnings fundamentals, but we do not try to time market
That was the wild card. Beginning with the Japanese earthquake,
then moving to the silly debate over the debt limit, and finally
fixating on the European saga, there has been a continuing reason
to ignore data about what is actually taking place. This meant that
the most important story of the year - fantastic earnings growth -
has been given short shrift.
While we had some nice winners, we expect much better next
The negative side included two groups:
- Anything in the financial sector was bad. Even though we were
underweight and sticking to the top names, there was no correct
time to buy. I still like JP Morgan (JPM), the best of the breed
(U.S. major financial). The market seems to think they have
European exposure, despite explanations to the contrary. It is a
favorite scare ploy to use nominal derivative totals instead of
net. In the case of JPM, they also do not define "net" using
different institutions. It is a "pure" version of determining net
exposure. It is a favorite stock for a rebound this year.
- The other negative was the medical device makers. I really
got this one wrong. (Our health insurance holdings did fine). We
have chosen two device stocks (ResMed (RMD) and Stryker (SYK))
that actually save money by reducing related costs. The earnings
growth has been solid. Despite this, the stocks moved lower. The
political uncertainty over ObamaCare has had a big impact.
Some describe the current era as "The Great Deleveraging." Do you
agree/disagree, and does this macro consideration affect your
investment planning process?
One of the worst things that happened in 2011 was the excessive
focus on debt. The argument is seductive for most. We all try to
equate government problems with our personal family experience.
When the economy is bad, deficits rise. There is a "debate" about
this in a highly-charged political environment.
I have simple advice for the average investor:
- First, ignore the politics unless you are in the voting
- Second, understand that every macro-economic model sees
short-term stimulus as favorable. Put aside your ideology. It is
- Third, every leader of whatever party has supported stimulus
when they are in office.
If we get better economic performance, deficits will be lower.
There will still be a structural deficit. But it will be more
2010-11 saw a notable rush for the exits from equities and equity
vehicles. Is this a cyclical, or secular shift? What would it take
to bring them back?
The individual investor will return to equities far too late - long
after most of the obvious problems have been solved. That would be
when the Dow is at 20K, possibly overvalued, and risk is high. The
story has been repeated many times.
Understanding this recurring phenomenon offers both the biggest
reward and the biggest challenge for the average investor.
I have tried to meet this challenge by providing a blend of
programs that provides participation in the upside while limiting
risk. It is not easy.
Do you believe gold is a genuine hedge in uncertain markets? If so,
how much exposure to it or other precious metals do you have? If
not, where are you turning for potential downside
Gold has a strange character. There is no way to determine a
fundamental value. It is a safe haven in a time of disaster
(deflation, depression, riots….) and it will have value if there is
Our programs have invested in gold and gold miners during the
past year, and probably will do so again next year. We have been
out of gold for a month or so for all accounts.
Since I expect neither disaster nor hyperinflation next year, I
do not recommend gold for long-term individual investors. It has
been approved as a 5% (or so) holding for many years - but not
Global Macro considerations dominated the headlines in 2011. Do you
see 2012 unfolding differently? If so, how?
This is definitely the key question. The selection of individual
sectors and stocks has been secondary for three years. I expect the
European story to be resolved in a few months. Meanwhile, if the US
economy improves enough, that will also change the focus.
Will Eurozone contagion continue to drive the market's direction,
and how are you protecting client assets from potential fallout
I'll go out on a limb. I think that by mid-year in 2012 we will no
longer have the Europe fixation. I have
a series of articles
explaining my reasoning.
I think that the market reflects a high degree of pessimism. You
can protect assets by reducing position sizes, which I have done.
Buying puts is too expensive. You could do some more complicated
put strategies, but something like a "put diagonal" is not suitable
for most investors.
Do you buy into the argument that European equities are actually
undervalued right now?
One of my pet peeves is people who answer questions when they
basically do not know. I have an honest answer. While I study the
European situation carefully, I am not considering specific stocks
there. There are many US companies that are undervalued because of
Europe. I can get plenty of octane with much less risk buying JPM
How much exposure to emerging markets do you have both in terms of
stocks and bonds? Are China, India or other major EMs better
positioned to withstand a serious global economic downturn than the
Most people are surprised to learn that the US has actually fared
better in recent years. It is possible to get a solid amount of
foreign exposure via big US firms like CAT, MSFT, and ORCL (a
recent disappointment, but still a great growth story).
Let's move on to another potential event on investor minds: The
Iran nuke situation and a potential Israeli, U.S. or global attack.
How serious would such an event be to oil prices and subsequently,
the global economy/exchanges? Is this something you're positioning
for and if so, how?
Great question! This is one of the big wild cards for 2012. Most
people are bearish on energy because it fits the pessimistic view
of the world. Many energy companies are extremely cheap on a P/E or
cash flow basis. Owning some energy stocks will help if oil prices
spike. I like Noble Energy (NE) among the drillers and Chevron
(CVX) among the large integrated plays. There are many good choices
in this sector.
We are coming up on an election year. Will this be good or bad for
markets? Are you positioning for different potential outcomes?
Elections, political events, and the impact on stocks really hit my
sweet spot. As a former public policy professor at a top
university, I have studied the political side for decades. Since
1987, I have been a player on the financial side. It is so
I would love to make a prediction, but it is too soon. My team
is working on a generic Obama portfolio as well as a generic GOP
portfolio. I will expand on this as soon as we learn more.
This is a typical area where people try to stake out positions
too soon, with little information.
Is the U.S. housing market still an issue, or not so much anymore?
Will prices continue to fall? Do you have exposure to either REITs
or residential real estate in client portfolios?
I have no position at the moment, although our short-term models
have been indicating good trades (three-week horizon) in these
sectors. When the time comes, this will be one of our major profit
sources. I am willing to miss the first part of the rebound in
favor of more certainty.
Where do you see Treasury yields in 12 months? Are Treasuries worth
buying at current (low) yields? For clients requiring income, where
have you been turning in this low yield environment?
This has been a great success story, but the end is near. I have
two approaches for yield.
First, for clients that only need to preserve wealth
(Congratulations!), I construct bond ladders. These include only
investment grade bonds with a limit of seven years on maturity. If
rates rise, we'll be able to take advantage.
If you have already achieved what you need, keep risk at a
For most clients I am using enhanced yield - a good dividend
stock plus the sale of a call option. I do this with Abbot Labs
(ABT), Johnson and Johnson (JNJ), as well as solid tech stocks like
Intel (INTC) and Microsoft (
). The combination of yield plus call premium is almost 10% per
year after fees. This is working because of low stock prices and
high volatility. It might not work in another year, but for the
moment, let us
take what the market is giving us!
This is a great method as long as you pick stocks that will hold
value and monitor them carefully.
What is the ideal asset allocation for someone with a long-term
horizon (greater than a decade) and no need to touch their
investments? Can investors continue to rely on stocks after the
'lost decade' we just experienced?
I appreciate your desire to quantify this, but I am struggling
since it is so far from my individual approach.
Let me try it a different way.
The single biggest mistake of the individual investor - right
now - is underweighting stocks.
This happens for several reasons:
Fear sells - in politics, advertising, and page views.
Individual investors always react to highly-publicized events
because they do not understand how to determine what is already "in
It is a mistake to be "all-in" or "all-out." This is not poker.
Most people will never attain their investment goals if they do not
have a rational strategy for when and how to buy stocks.
People underestimate the upside.
We have just experienced a year with tremendous earnings growth and
no movement in stock prices. The price/earnings ratio is back where
it was at the market lows of 2009. If and when some of the worries
are relieved, stocks can move to a more normal P/E multiple.
If the European concerns are addressed, people must understand
the stocks could move much, much higher.
My advice? Based upon what I see in many interviews, most people
should be nudging stock exposure a bit higher. It is possible to
participate in the upside potential while keeping a rein on
NewArc's five different programs are currently invested in
all of the stocks and ETFs mentioned. The specific
characteristics vary according to the investor.
Here is a good illustration. New investors do not go all-in
on the first day - we look for good entry points. An investor in
Great Stocks would own Apple tomorrow, since I think it is
massively under-valued. An investor in the enhanced yield program
would never own Apple.
To summarize, every stock mentioned is right for one of our
programs. The individual investor must be cautious when reviewing
market commentary like this. Everyone is different!
3 Heavily Traded Stocks To Buy, 2 To Avoid