By Roger Nusbaum :
This is the first piece in our Positioning for 2012 series. Readers can find all of Seeking Alpha's 2012 outlook articles here .
Seeking Alpha's Jonathan Liss recently spoke with Mr. Nusbaum 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 year.
Seeking Alpha (( SA )): Thanks for agreeing to kick off our series again this year Roger. Before we dive into specifics, how would you generally describe your investing style/philosophy?
Roger Nusbaum ((RN)): I am a 'top down' portfolio manager which means first and foremost focusing on the bigger picture as to whether the environment to own stocks is currently healthy or unhealthy. In an effort to keep things simple, the market is generally healthy when it (it being the S&P 500 which we benchmark to) is above its 200 day moving average ((DMA)) and it is unhealthy when it is below its 200 DMA. When it is below that key average, we take defensive action in the portfolio.
We have a lot of foreign exposure, currently close to 50%, and expect that will increase over time. We are fairly product agnostic. Whatever we think is the best way to capture an exposure is what we will use. Mostly we use individual stocks, some ETFs and occasionally we have used a traditional mutual fund for some narrow purpose.
SA: Within equities, are there any particular sectors or themes you are currently overweight or underweight? If so, why?
RN: Themes and countries play a huge role in how we build the portfolio and manage it. The idea here is simple; if there is some event where trillions of dollars are going to have to be spent, then it stands to reason that stocks in that theme (or country) will benefit. It creates an easily understood tailwind.
The most significant overweights or underweights we have had have been our underweights to US financials and Europe (EMU countries) and our zero weight to Japan. Readers of my blog will know that we have been underweight (or zero in the case of Japan) for a very long time but more importantly these will continue to be "avoids" for a long time to come in my opinion.
A big theme in the portfolio is countries where there is a middle class ascendance underway. This means exposure to Colombia with Ecoptetrol ( EC ), Brazil with Vale ( VALE ) (also part of the theme of owning countries with stuff in the ground that the rest of the world must have), Chile with Santander de Chile ( SAN ) and China by virtue of a couple of thematic ETFs, namely iShares Emerging Market Infrastructure ( EMIF ) and Market Vectors Coal (KOL). Also part of this view is water and infrastructure.
SA: Which asset classes are you currently overweight or underweight?
RN: We are underweight our target equity allocation (meaning the given client's target weight for equities) consistent with defensive action because the S&P 500 [SPX] is currently below its 200 DMA.
SA: 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?
RN: Gold was probably the biggest [surprise in 2011]. We got back from a trip to Yellowstone late on the night that gold went above $1900. I had flipped on Squawk Box Europe, saw the print, and knew I would lighten up first thing in the morning. That was just a 'right place, right time' type of thing.
ABB Ltd. (ABB) is one stock [we own] that stands out as being a disappointment thus far. It is down meaningfully, but not catastrophically. The fundamental story is intact but it behaves very cyclically.
I am no Byron Wein in the surprise department but I am working on the idea that after slogging through for a while there could be a meaningful lift for US equities sometime in 2012. This is not a bullish call as there is no fundamental argument for a big lift for US equities and I would expect that if there actually was a big, fast lift, it should be sold aggressively.
SA: To which index or fund - if any - do you benchmark your performance? Has this changed recently, and if so, why?
RN: We benchmark to the S&P 500 with dividends for the simple reason that clients know the index and can learn more about it, if they so choose, very easily.
SA: Some describe the current era as "The Great Deleveraging". Do you agree/disagree, and does this macro consideration affect your investment planning process?
RN: The idea of labels is not appealing in terms of actual analysis and portfolio decisions but they do make it easier for clients to understand the magnitude of the event. Clearly the way people have done things needs to change in terms of not saving enough and not using debt wisely and I hope they do.
The investment implications are pretty easy I think: avoid the countries, sectors and stocks that would seem to be directly in the crosshairs of a deleveraging.
SA: 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?
RN: The idea behind this question contributes to the above thesis that there could be a big lift in 2012 (fair warning: it may not fit neatly into a calendar year). If we have collectively not learned much, then investors will come back after the lift. There is clearly a secular aspect to this in that "stocks haven't worked" in so many years. Of course, there have been countries that have had normal or better than normal returns while the US has taken a bumpy round trip to nowhere.
SA: Gold has been such a big story this year. Do you believe gold is a genuine hedge in uncertain markets? How much exposure to it or other precious metals do you have?
RN: If something horrible happens today, I expect gold to go up tomorrow, which is why we own it. Looking over a longer period of time I would say it continues to have a low correlation to equities (for six or 12 months, anything goes) and so we will stay with it. Other precious metals are more tied to economic cycles in ways that gold is not as a result of their industrial uses.
SA: What is your preferred method of playing gold? Do you generally view it as more of a trade position, or a buy and hold position? How do you deal with the tax implications of holding it in non-tax deferred accounts?
RN: We own the SPDR Gold Trust (GLD). We view gold as insurance and so it is a long term hold. We did sell a portion in the day or two that it was above $1900 (as disclosed on my blog at the time of the trade) and would be willing to shave off more on a big move up, or add to [our position] if it craters. Where a client has both a taxable and qualified account we will try to put it in the qualified account but for clients that don't, the exposure to gold is more important, in our opinion, than the tax complications.
SA: Global Macro considerations dominated the headlines in 2011. Do you see 2012 unfolding differently? If so, how?
RN: More often than not I think global macro will drive the bus. As mentioned above, I do believe that at some point there will be a violent lurch upward in US equities (not sure yet if I think European equities will ride those coattails) that will then mostly retrace and we go back to the same type of environment but maybe occurring in a higher range than we have today.
SA: Speaking of the situation in the Eurozone, will it continue to drive the market's direction? How are you protecting client assets from potential fallout there?
RN: We will continue to avoid Europe. It seems like too many people spend a lot of time trying to figure out how to own Europe through the crisis when simply avoiding it makes far more sense, at least to me.
SA: International equities proved volatile for both developed and developing markets over the past 2 years. Do you see a clear winner going forward?
RN: I think the terms 'developed' and 'emerging' have lost almost all meaning. An individual country has its own attributes. In building a portfolio at the country level I think you want to own countries with different attributes to create some diversification. Owning [a group of] countries with the same attributes does not offer much in the way of diversification. An Aussie based investor doesn't gain much diversification by owning New Zealand too.
We choose countries that have some sort of obvious and simple tailwind and we make sure the mix does indeed deliver different attributes to the portfolio.
SA: Are you saying that buying broad 'emerging market' or global funds is basically pointless in terms of adding necessary diversification to client portfolios? Are you sticking to single country funds exclusively at this point when you go the foreign equity fund route?
RN: For accounts large enough where there is no commission drag from 30-40 positions, we do not use broad based funds. We feel these funds are overly 'blunt' instruments versus doing the work to look at countries and themes. This allows us to build in narrower exposures.
We pick countries and then pick what we think are the best ways to capture exposure to a given country. Usually that is an individual stock but if we feel a narrow ETF is a better option, we would [go that route]. As a made up example, if we wanted China exposure and thought energy was the best way in, we would probably consider one of the big oil producers like [[SNP]], [[CEO]] or [[PTR]] or maybe the big coal company Shenhua (CSUAY.PK) and compare that to the Global X China Energy ETF (CHIE) to see which was preferable.
SA: Where are the real growth stories overseas right now?
RN: I would turn this one around a little bit based on the current reality of the investment world. Before figuring out the "growth stories overseas", it is crucial to understand which countries are facing systemic threats that far exceed the threats posed by normal economic and stock market cycles.
For example, the [Brazilian] Bovespa is down 15% YTD as of this writing, up from what was a 25% decline [at one point]. In looking at the totality of the story it is clear that the country is not wading through different forms of desperate and unprecedented action to try to restore something (growth, jobs, housing market etc). Brazil has had ups and downs and of course that will continue but the nature of the threats are nowhere near what they are in the US, Europe and Japan - not even remotely similar.
We look out longer than one year in building an investment thesis. Part of the country selection process we prefer is, among other things, owning countries where there is a middle class ascendance. The idea here is that the demand for access to (relative) middle class lifestyles is very consistent. This means electricity, potable water, cable TV, telephones (probably wireless), better roads, cars, higher quality personal goods and so on - in short, their perception of an American lifestyle.
This [growth in] demand is a one way trade. Of course the stocks [used to play this theme] will not be a one way trade but the demand does create a long term tailwind that is a valid investment thesis. Although not the only form of country selection, we like to use this method. Countries we like and own in this context are Brazil, Chile, Colombia and China (by virtue of China's weight in the two thematic ETFs we mentioned earlier).
The process for possibly adding more countries in this context is ongoing. I've written many times on my blog about learning about countries and following them for quite a while before buying in. This was the case with Colombia and will be the case with other countries we add in to the portfolio in the future.
SA: 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 U.S.?
RN: For equities we have 12% in emerging (14% if you include Israel). For fixed income we have about 5% (of the fixed income portion) in 'emerging markets' with thePowerShares Emerging Markets Sovereign Debt Portfolio ETF (PCY).
In the face of a short-term panic no one should expect emerging markets to decouple. However over the course of a decade, the last decade shows us that many countries can get along and grow just fine without the US.
SA: Let's move on to 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?
RN: Conflict in the region, although always evolving, has obviously been going on for a couple thousand years. Something horrible that has not happened before would clearly be disruptive in terms of initial reaction. Longer-term meaningfully higher oil prices would create an economic drag for consumers. We are overweight the energy sector, own countries that would benefit from higher oil and are overweight volatility in the sector (that last one means that our holdings are collectively more volatile than if we just owned [[XLE]]).
SA: Care to elaborate on how specifically you're overweight volatility in the global energy sector?
RN: Our energy exposure consists of the Market Vectors Coal ETF (KOL), Suncor (SU), Statoil (STO) and Ecopetrol ( EC ).
SA: We are coming up on an election year. Will this be good or bad for markets? Are you positioning for different potential outcomes?
RN: I mentioned above about a big lift for US equities followed by a retracing lower and if correct, I think it would occur with no regard for the election. I think America is so disgusted with both parties and all candidates that the importance of the outcome will matter less than it has in a very long time. The fundamentals for select foreign markets are far more attractive and so more of the portfolio will be headed in that direction, away from the US.
SA: Inflation or deflation? Growth or recession? Which way is the U.S. economy headed and how will you be positioning clients?
RN: For years my opinion on this has been that price inflation will be higher than what we've become accustomed to but [will] not [develop into] hyper-inflation. In terms of CPI, this has not been correct, but in terms of things like healthcare, food costs and education, I think it has been generally correct. Not impossibly difficult inflation, just somewhat uncomfortable.
Growth or recession: there will still be economic cycles but I think the growth will be a little less than what we have gotten used to. This is not a dire outcome, just a somewhat anemic one.
SA: Is the housing market in U.S. still an issue with a strong pull on the market, or not so much anymore? Will prices continue to fall? Do you have exposure to either REITs or residential real estate in client portfolios?
RN: We have been out of REITs for a long time. We sold our one REIT right after Sam Zell sold EOP. If it was a good time for him to sell, that was good enough for me.
I think the real estate market is very unhealthy and will remain so for many years. Prices may not crater from here but there is no reason they have to go up either and I think there are still things we don't yet know. There have been - and will continue to be - good trades along the way. For now, we still have no interest.
SA: 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?
RN: For a long time I have thought that the fundamentals equate to yields going higher, which of course has not been correct. My thinking about Treasuries has been the same for a while: yields may not go up (even if the fundies say otherwise) but buying high is buying high and that is not something we want to do.
Our general mix has been the same for awhile. We own individual foreign sovereign issues from Norway, Australia and Denmark across the board (with more limited exposure to NZ and Canada), we have one closed end fund that, relative to closed end funds, is not particularly volatile, [[PCY]], as mentioned above, two preferred stocks, Vanguard GNMA MAE ((VFIIX)), some TIPS exposure and several individual investment grade corporate issues. For the individual issues, the maturities are all short.
Yields are low. If your fixed income portfolio yields 8% in a zero percent world, then you are taking a lot of risks, risks we would rather underweight. We have different types of exposure to hopefully minimize the consequence of one segment doing poorly.
SA: Have you changed your allocation to muni bonds in client accounts? Do you view them as riskier than they have been in the past given state and local budget challenges?
RN: The only muni exposure we have is for clients who specifically request it. I've never been in the Meredith Whitney camp of magnitude on this but I think municipalities face risks they have not faced before and I don't think yields adequately compensate for this heightened risk. Yes, revenues have been improving some, but I don't want clients getting caught in case something does go wrong.
SA: 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?
RN: The ideal allocation allows you to both sleep at night and gives a reasonable shot of having enough money when you need it. Many countries did not have lost decades, and in fact actually did quite well while the US was going nowhere.
The following chart has been designed generically with caveats and disclaimers up the wazoo…
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Disclosure: Roger Nusbaum is long (in either client accounts, personal accounts, or both) EC, VALE, SAN, EMIF, KOL, GLD, ABB, PCY, SU, STO and VFIIX.
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