Portfolio Performance

My very unaudited portfolio performance in the second quarter of 2010 is approximately +0.3%, so rounding this off it is 0%. For the 6 months to June 30, 2010, my performance is approximately +9%. Most of the positive portfolio performance could be attributed to the CAD-USD exchange rate – indeed, if exchange rates were unchanged, my performance for the quarter would have been around negative 2%.

You can read the Q1-2010 report here. I also keep the links in the upper-right hand sidebar.

Portfolio Commentary

This has been a relatively boring quarter in terms of performance, but boring is better than the alternative, which is dealing with capital losses. An index investor in the S&P 500 would be down 8% for the year. As the general intention of the portfolio is geared toward risk aversion, while taking some snipes at various issues, I believe my financial intentions are being realized. Nobody said portfolio management has to be exciting.

I did make use of the “flash crash” to add to my existing positions in two names, but the dollar volume amounted to approximately a percentage of my portfolio. I also unloaded a slight amount of one of my debenture positions because there was some guy/computer putting up a rather high price on the bid that I couldn’t resist nibbling at.

Because of the end-of-quarter volatility, there was some trades that I engaged in less than liquid issues, amounting to a few percent of the portfolio. Looking at the ticker tape, it looks like that computer traders were randomly liquidating some of their shares. Although I am not too confident in the state of the economy in general, there are nuggets of value to be picked up here and there (on the equity side) which my research flagged and recent valuations have triggered some price alerts. I will continue examining these short-listed prospects and likely allocate some cash to them if they continue their downward trajectory.

Economic Ramblings

My issue with the economy is that stimulus spending has not translated into private sector investment, especially in the USA. Not helping the US picture is their pending tax increase in 2011 (specifically an expiration of the Bush-era tax cuts). There was a significant drop in inventories in 2009, but now that inventories have been built up in 2010, it is unlikely that we will see any sort of extra investment from the private or government sector that should lead the broad markets into a premium valuation multiple. It is seemingly likely that the rest of this year and a good part of this decade will represent a Japan-type scenario where you have a deflationary environment and a liquidity-trap situation. The only way to cure this is to liquidate bad debts, get the losses on the income statement, take the hit, and move on with life. This is not going to happen.

I have been closely examining the BP incident (as well as a lot of other financial, political and media analysts on this planet) and have some mental orders put in for the various drillers, but nothing has hit yet. Given the market action of the past month, I doubt those transactions will come to fruition unless if the US government decides to launch a frontal legal assault against them in addition to throwing BP under the bus and shaking them down for more money.

I will make a bold call and state that I believe Q3, at least the months of July and August, will be relatively boring, and fraught with conflicting stories on whether the economy is really recovering or whether the “double dip recession” scenario occurs. All one really has to do is look at the commodity and import/export markets to see the best leading indicators of economic activity. I continue to be long-term positive on crude oil, although there might be demand shocks (in the form of economic retardation, especially as the financial markets reverberate) and supply shocks (in the form of conflict arising in the Iran-Israel theater) that will result in price volatility.

It is a simple thesis that watching the world around me that I see planes, trains and automobiles continuing to function. They all require gasoline to run and as long as this is the case, the only thing that will prevent usage of gasoline are higher prices. We will get them eventually, along with $200 oil. It is just a matter of time. The only story that ends the inevitable climb up for crude is demand destruction due to high prices.

Minority governments and the Bloc Quebecois aside, Canada remains one of the most politically stable jurisdictions on the planet to do petroleum business with; as such, we should remain very attractive to international investors, especially considering that Canadian corporations have a huge incentive to doing business here compared to the USA in terms of the corporate income tax regime the Harper government smartly enacted in their late 2007 fiscal update. This is going to pay off massive dividends for Canada and it will pay off massive dividends for Canadians that choose to invest in their own corporations. Still, Canada is very dependent on trade, and our biggest partner (the USA) continues to be the overwhelming majority of our export market. When America gets sick, we will sneeze.

Portfolio percentages

I am going to introduce a new term, mainly the concept of “income equity”. Now that income trusts are converting into corporations, there will be quite a few Canadian corporations that will have relatively high dividend payout ratios. For those companies that have payout ratios that consist a “substantial majority” of their earnings, I will be classifying them as income equity. All other common shares will be considered plain “equity”.

Currently, equity consists of about 1% of my portfolio, income equity 40%, short term debt (maturing between December 2011 to June 30, 2012) is 23%, long term corporate debt (maturing between 2028 and 2033) is 28%, and cash is 8%. Blended together, the current yield on the portfolio is 8.2%. Excluding cash, it is 8.8%.

Assuming I twiddle my thumbs and security prices in my portfolio do not change for the rest of the year, my portfolio will have a 12% cash balance. The short term debt also includes debt that I consider to be a 99% guarantee for maturity at par, so those could be readily liquidated in the event I need to raise some cash. However, for tax reasons and also for the reasons that those securities still give off a fairly high single digit yield, I am not touching them unless if I find significantly better opportunities elsewhere.

Outlook

The investment outlook has changed little – while I am looking for places to deploy cash, I am finding little opportunity out there although May and June’s dip gives a little inspiration. As such, I am keeping a dry powder keg (of cash) ready in the event that investment opportunities arise. My research time (and effectiveness) has been somewhat compromised lately with the arrival of a newborn child, but one of the reasons why I have a low maintenance portfolio was just for this reason. Given what I do see out there, I would lean much more toward the equity side than the fixed income side, but I will not chase yield (or total return). Except for special situations (e.g. picking winners out of the BP fallout) I would also avoid large cap issues.

As such, I continue to wait and be patient. Rule one of investing is: don’t lose money. You lose money by forcing trades in sub-optimal situations. Right now is “sub-optimal”. If we saw more panic like we did in the month of May, I would start to get a little more optimistic. There’s a lot of doom and gloom out there – this generally bodes well for the markets.

However, in the meantime, caution is the name of the game. There is very little chance of any good performance (e.g. double digit returns) in the next quarter without taking more risk (which means selling debt and going for equities). I do not think this risk is warranted at this time.