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Q2 2020 Portfolio Management Summary

Q2 2020 Portfolio Management Summary

While the upcoming election will add to the uncertainty and volatility of a market already beleaguered by Covid, opportunities for capital redeployment may arise.

Stocks typically outperform bonds during the recovery phase. I am favoring equities over bonds because I think the economy is no longer in recession, but has moved into its recovery phase. The trade is still TINA (There Is No Alternative) to stocks, given monetary stimulus, low inflation and ultra-low interest rates. I prefer buying higher quality dividend growing stocks that offer better total return potential than bonds in an economic recovery. Over seventy-five percent of S&P 500 stocks have yields higher than the 10-Year Treasury, current yield 0.64%. In order to produce single digit returns in the next twelve months, investment portfolios must own equities, preferably ones that pay bankable dividends above two percent.

I am overweight stocks, but will take some profits in July that I will redeploy on a pullback or correction. Based on the strength of equity returns from their low in March, equity valuations trading at their higher range, the slower progress on opening the U.S. economy, and an election looming, the market is challenged going in the third quarter. The upcoming election will add to the uncertainty and volatility of a market already beleaguered by Covid, but this will present a few buying opportunities as the market fluctuates. The game changer to this strategy is an FDA approved CV vaccine would clear the way for the stock market to reach an all-time-high.

I think diversifying among growth stocks and value stocks is prudent. I am significantly overweight in large-cap stocks versus small-cap stocks. Large-cap stocks are more defensive than small-cap stocks. I don’t want to only own large-cap growth stocks because value stocks could very well generate higher returns in 2021and because growth typically beats value surrounding market declines and until economic growth ratchets up. The all-clear signal for the market to rotate from growth into value comes on a CV vaccine announcement.

I am using a barbell strategy of buying quality secular growth stocks such as Amazon, Microsoft, Google, Apple, and on the other end a mix of CV stocks and recovery stocks. The CV stocks will become secular growers in the new economy, well worth the current premiums, while the oversold recovery stocks consist of quality cyclical value stocks that would outperform when economy grows faster.

By and large I am buying high quality companies that are profitable, with free cash flow, and healthy fundamentals. It is important to own the types of companies that will survive the recession and come out as winners in the “new” economy. I am ignoring premium valuations of technology stocks because their cash flows and sustainable earnings make them defensive stocks worth paying up for future cash flows. In addition, upon faster economic growth, technology stock earnings would benefit from higher CAPEX spending as economy exits CV crisis.

I am tilting towards cyclical stocks versus defensive stocks in portfolios. Cyclical stocks outperform defensive sectors from about three months prior to the start of an economic expansion to about four months into expansion according to Ned Davis Research. Through all this I favor the following sectors: Technology, Consumer Discretion, Healthcare, and Communication Services. Technology and Healthcare have long term secular growth tailwinds. Whereas Consumer Discretionary and Communication Services led us into recession and will lead us out of a recession.

Bond yields imply recovery will be slower and longer. Low bond yields make dividend-paying stocks more attractive than most bond sectors. Bond yields, after rising from March lows, have now backed down as some states have halted their reopening plans. I am holding Investment Grade Bonds, Treasuries, and Gold as a hedge strategy in the third quarter and until CV fears ebb. The bond component has been adjusted to a laddered mix of bond maturities that is skewed toward intermediate bonds. Long bonds have become more attractive, for the moment, with inflation indicators signaling a whiff of deflation, low interest rate risks environment, and the Fed bond buying program propping up prices of even investment grade corporate bonds. I am sticking with investment grade only bonds in the fixed income area of portfolios. I’m still concerned default and bankruptcy risks in specific industries impacted by CV. Rising yields would signal a time to buy leveraged bank loans and trim treasury position.

I continue to buy preferred stocks that yield more than double long-term treasury yields. Preferred stocks are mostly major U.S. Banks that are extremely well capitalized. Preferred stocks are not overbought like many areas of the bond market such as long-term treasuries.

I’m investing in cash-equivalent investments for the third quarter over treasuries and investment grade bonds. The cash-equivalent investment utilized has a higher yield than long-term treasuries, has no interest rate risk, has a AAA credit rating, and will preserve capital in a correction.
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