Macro Trend Investor Comprehensive Portfolio Review

The following is from the final publication of the Macro Trend Investor newsletter.  

Before I get started in today’s update, I want to thank you for being a reader.  It has been a pleasure to write Macro Trend Investor and to share my best investment ideas with you.  But as I explained in yesterday’s letter, I needed to shift my resources to focus on my private wealth management practice.

I’m leaving you in good hands with Richard Band.  Richard has been in the business a long time—he’s been writing Profitable Investing for many years—and he, like myself, takes a balanced approach to investing, taking moderate risk when the odds are in your favor.

If you want to stay in touch, I encourage you to visit my investment blog at charlessizemore.com.  And should you want to reach out to me personally, please feel free to click on the “About” tab on charlessizemore.com for instructions on how to reach me.

Now, on the business of the Macro Trend Investor portfolio.  Richard will have his own ideas, of course, but I wanted to leave you with some parting advice on the current recommendation list.  The past month has been a real beating for non-U.S. equities and for yield-sensitive investments.  I’ll go through the portfolio stock by stock, starting with our position in mortgage REITs.

Mortgage REITs

Mortgage REITs have gotten pounded of late on a toxic combination of a weakening housing market and fears that the Fed might act sooner than expected in raising short-term interest rates.  Remember, mortgage REITs borrow short-term and use the proceeds to buy long-dated mortgage securities.  The “spread” is the profit they use to pay their outsized dividends.  A narrower spread means a smaller dividend, all else equal.

The Market Vectors Mortgage REIT Income ETF (MORT), a basket of some of the largest and most heavily traded mortgage REITs, is down a little over 6% since its highs over the summer, not including dividends.  Our leveraged bet on the sector—the UBS E-TRACS 2X Mortgage REIT ETN (MORL)—is down a gut-wrenching 12% from its summer highs, not including dividends.  Of course, we’ve collected $3.16 in dividends since the start of 2014, representing about 15% of the current stock price.

Let’s take a look under the hood at the largest portfolio holdings:

REIT
Ticker
Weight
Book Value
Market Price
Discount / Premium
Yield
Annaly CapitalNLY17.25%$13.23$10.720.8111.19%
American Capital AgencyAGNC12.73%$26.29$21.300.8112.21%
Starwood Property TrustSTWD7.30%$17.08$21.951.298.75%
Tow Harbors Investment CorpTWO5.63%$11.09$9.680.8710.74%
Northstar Realty FinanceNRF5.01%$10.15$17.671.7411.32%
Colony FinancialCLNY4.86%$22.63$22.470.996.41%
Chimera Investment CorpCIM4.83%$3.35$3.070.9111.73%
MFA Financial MFA4.35%$8.91$7.790.8710.27%
Invesco Mortgage CapitalIVR3.75%$19.83$15.860.8012.61%
New Residential Investment CorpNRZ3.65%$5.31$5.881.1111.90%

The two largest holdings—Annaly Capital (NLY) and American Capital Agency (AGNC)—are both trading for about 81% of their book value.  This means that you’re essentially buying a dollar’s worth of quality mortgage assets for 81 cents.  That is fantastically cheap and gives us a wide margin of safety.

Not all of the portfolio holdings trade at that steep of a discount, of course.  Some actually trade at substantial premiums.  But portfolio-wide, MORL’s underlying REITs are trading at a weighted average of 97 cents on the dollar and a yield of 11%.  (Applying leverage gives MORL a yield of about 22%).

If the Fed raises rates earlier than hoped—or if long-term yields drift lower—could dividends be cut?  Absolutely.  But in buying these REITs below book value, our risk is very tolerable.

Rising long-term bond yields would depress book values, which—all else equal—should lead to a sell-off of mortgage REITs.  But how high are yields likely to go?  And how much of an increase has already been priced in by the past month’s declines in mortgage REIT prices?

I’ve consistently made my case throughout 2014 that bond yields are likely to fluctuate in a fairly tight range over the next several years.  (I see the 10-year Treasury yield bouncing in a range of about 2.2% to 3.2% with an average around 2.6%.)  Fed tightening—to the extent it happens at all—will depend on economic data continuing to come in strongly.  Thus far, the data has been mixed at best, and we should remember that we are now more than five years into the current economic expansion.

I’m not forecasting an imminent recession, but in the entire span of U.S. history since the Great Depression the longest stretch we’ve ever gone without a recession was 10 years—and that was during the 1990s tech boom.  Since the Great Depression, the average time between recessions was four years and nine months.

Again, I’m not necessarily predicting a recession around the corner.  But expansions do not last forever, and we should remember that our current expansion has been aided by record federal deficits and the loosest monetary policy in U.S. history.  I think it’s highly likely that we will indeed see a recession at some point in the next two years.

Why does this matter?  Because bond yields tend to fall in recessions.  We should also remember that, with yields in Japan and Europe hovering near all-time lows, demand for U.S. Treasuries should keep a tight yield on Treasuries for the foreseeable future.

What does this mean for mortgage REITs? It means that the current selloff is a buying opportunity.  I recommend you stay invested in MORL but honor our stop loss.  If the closing price dips below $18.73, take your accumulated dividend profits and move on.

Emerging Market Positions

I predicted that 2014 would be the year that emerging markets seized market leadership.  This has distinctly not happened for a variety of reasons.  First and foremost, fears that Fed tightening would pull investor funds out of emerging markets became something of a self-fulfilling prophecy.  But unrest, political instability, and geopolitical concerns also played their part, particularly in China, Russia and Turkey.  And a hotly-contested presidential election is wreaking havoc on the Brazilian stock market this month.

We’re very close to hitting our stop loss in the iShares MSCI Turkey ETF (TUR).  If TUR closes below $48.33, then I recommend you sell and move on.  I am a big believer in Turkey and expect the market to do fantastically well over the next 10 years.  But a lot can happen between now and then, and we put rules in place to protect ourselves.

Russia is a different story.  I’m actually not bullish on Russia’s prospects over the next 10 years.  In fact, I see the country falling on very hard times due to falling energy prices, demographic collapse, and industrial decay.  But I do, however, see Russia as a fantastic trade over the next 1-3 years based on its cheap valuations and investor negativity towards the country.  As with TUR, I recommend you honor our stop losses in the Market Vectors Russia ETF (RSX). Our stop loss is at $21.

China is somewhere in the middle.  Like Russia, China faces major demographic challenges in the decades ahead due to an aging population. And China’s property and banking sectors represent major long-term risks that are, at this point, almost impossible to quantify based on the information we have.  But at the same time, China remains one of the fastest-growing economies in the world, and its stocks are among the cheapest.  I fully expect Chinese stocks to outperform American stocks by a wide margin over the next five years.  Our position in the iShares China Large Cap ETF (FXI) hasn’t done much over the past year, but I recommend patience here.  I suggest holding on to it for at least another 6-12 months , assuming our stop loss isn’t tripped.  Our current stop loss is set at $34.

Moving on, let’s look at MTN Group (MTNOY), our investment in the rise of the African consumer. MTNOY has gotten dragged down by rotten sentiment towards emerging markets.  MTNOY stock is down about 14% from its September highs due entirely to perceived macro risks; the company has made no announcements over the past month.  At time of writing, we’re still up about 6% for the year, including MTNOY’s impressive 4.6% dividend.

MTNOY’s latest results, for the six months ended June 30, were positive across the board.  MTNOY’s subscriber base increased 3.5% to 215 million users, and overall group revenues rose 4.1% in constant currency terms.   Data revenues rose by a whopping 33.1% in constant currency terms, and profit margins widened; EBITDA margins rose 3.5% to 46.3%.

Revenue shrank slightly in South Africa due to brutal competition in that market.  But MTNOY enjoyed organic, constant-currency growth of 8% in Nigeria, its most important market, and 13.4% on average across its other major African and Middle Eastern markets.

It’s been a while since I’ve made the bull case on MTNOY, so let’s review.  MTNOY is a stock that I believe is uniquely positioned to benefit from the continued rise of Africa’s emerging consumer class. The most critical possession of the new middle class is not the automobile, as it might have been in previous generations, but the mobile phone.  And as the dominant African mobile provider, MTNOY is in prime position to benefit from a long cycle of service upgrades as African consumers switch from prepaid to post-paid monthly plans and from basic plans to data-intensive plans.

After the correction of the past month, MTNOY is on sale again. If you don’t already own shares, this is a good time to buy.  When sentiment turns on emerging markets in general and South Africa in particular, MTNOY should enjoy a nice “double whammy” of a rising stock in South African rand terms and a rise in the value of the rand itself.  For U.S. dollar investors, a return of 50%-100% over the next 12-18 months would seem very reasonable.

Our stop loss is $18.46, and I consider it unlikely that it gets tripped.  But if it does, let’s follow our rules.

Now for Telefonica Brasil (VIV).  As with MTNOY, VIV is more a victim of geography than anything else.  The Brazilian market has gotten absolutely hammered of late as it looks likely that current president Dilma Rousseff—who is no favorite of the markets—will win Brazil’s upcoming presidential election.

I’m not the biggest fan of Dilma.  In fact, I think she’s a pretty terrible president.  But I also believe that the Brazilian market is already discounting the absolute worst.  Bottom line, Telefonica Brasil is a nice way to play what I expect to be a monster rally in Brazilian shares once the drama of the upcoming election passes. And if I’m wrong, no problem.  We take our stop loss at $14.77 and move on.

And finally, we get to the Cambria Global Value ETF (GVAL).  This ETF has not performed well for us since I initially recommended it in May, but this should come as no surprise.  Despite being vastly cheaper than the U.S. markets, international markets—and particularly emerging markets—have struggled in recent months.  With this pick, we had the misfortune of succumbing to what I call the “value investor’s curse.”  We correctly identified a cheap investment…but our timing was a little off, and it has since become even cheaper.

I recommend you keep the faith here.  As I have gone to great pains to emphasize over the past year, Europe and emerging markets are priced to deliver returns vastly larger than the American market over the coming years.  If we hit our stop loss at $21.48, I recommend you sell.  But should that happen, I recommend you keep this one on your watch list and consider re-entering it after 3-6 months.  I think this is a fantastic strategy for the next five years.

On a broader note, emerging market currencies have been in freefall.  Over the past two months, the currencies of Brazil, Turkey and South Africa are down 9.1%, 8.3% and 6.9%, respectively.  Those are absolutely massive moves for currencies during normal, non-crisis times.  So, unless we’re heading for a true emerging market crisis, I would expect these currencies to bottom out soon, if they haven’t already.  By the “back of the envelop” metric of The Economist’s Big Mac Index, Brazil was the only one of the three that could be said to have an “overvalued” currency, and the latest figures were from July.  South Africa, in particular, has one of the cheapest currencies in the world.

Could they get cheaper?  Of course.  Anything is possible.  But from these levels, I wouldn’t expect major new declines.

Foreign REITs

Macro Trend Investor has three foreign REITs in its portfolio, the Singaporean CapitaCommerical Trust (C61U.SI) and Spanish REITs Lar España (LRE:MC) and Hispania (HIS:MC).

I’ve recently covered the Spanish REITs, so I won’t belabor you with the details.  But suffice it to say, we’re buying cheap real estate assets in a beaten-down market, and we’re on the same side of the trade with some very smart people.

Let’s review CapitaCommercial.  When I first recommended CapitaCommercial in September of last year, it paid a nice 5.9% dividend and traded at just 80% of book value.  A year later, it still pays a handsome 5.3% dividend, though it has closed the valuation gap to 93% of book value.

In my view, that is still a bargain.  CapitaCommercial has had a fine year, raising its gross revenues and distributable income by 3.2% and 7.6%, respectively, in the first half of this year.  And the dividend was raised by a cool 5.2%.

It’s hard to argue with paying 93 cents for a dollar’s worth of high-quality office buildings while getting paid 5.3% per year.

Are there risks? Of course.  A hard landing in China could spill over into the rest of Asia, leading to office vacancies and to a general selloff of Asian assets.  But thus far, I’ve seen no indication of this.  The Singapore office market is healthy, demand is modestly outstripping supply, and rents are rising.

Another risk is the Singaporean dollar.  If you believe that the U.S. dollar is “off to the races” from here, then anything not denominated in dollars is at risk.  But the Singapore dollar has traded in a relatively tight range for the past four years.  The Singapore dollar—along with virtually every other currency in the world—has been weak relative to the dollar over the past two months.  But I don’t expect too much more downside from here.

CapitalCommercial isn’t the screaming bargain it was a year ago, but it’s still not a bad place to park cash. As always, keep a stop loss in place, and carry on.

Domestic Income Plays

As I wrote earlier in this update, I expect global bond yields to stay low for the foreseeable future and I expect the American 10-year yield to bounce around in a range of about 2.2% to 3.2% with an average of about 2.6% over the next five years or so.  That is good news for our two domestic REITs, American Realty Capital Properties (ARCP) and Digital Realty Trust (DLR), both of which have been excellent dividend raisers in recent years.

REITs have gotten slammed of late, just as they did this time last year, and for the same reason—fears that the Fed will tighten its monetary policy faster than originally thought.

Follow our stop losses, of course, but otherwise plan to hold on to these for a while.

Next up is DoubleLine Income Solutions (DSL), a closed-end bond fund run by one of the very best managers in the business, Jeff Gundlach, and his team.  My guidance here called for buying DSL so long as it traded at a discount to NAV of at least 5%.  As of Morningstar’s latest estimates, we’re comfortably within that range at a 6.6% discount. If you buy my argument that rates will stay depressed for the foreseeable future, DSL should be a safe place to park cash.  You’re in good hands with Gundlach.

Demographic Investments

I hope that after reading Macro Trend Investor for a while you have a good big-picture understanding of the major demographic trends that will shape the next decade.

I’ll start with the Baby Boomers.  I continue to like DaVita HealthCare Partners (DVA) as a long-term play on the aging of the Boomers.  Kidney disease is an unfortunate reality for many aging Americans, and DaVita is a premier provider of dialysis.  It’s a stable and growing business and a favorite of Warren Buffett’s Berkshire Hathaway.  I recommend holding on to this one for a while.

I would make the same argument for StoneMor Partners (STON).  Death is an uncomfortable business to discuss.  But there is a major boom coming to the death care market over the next 20 years as the Boomers enter their golden years.  And in StoneMor, we get to collect a nice 10% yield while we wait.  I expect that StoneMor will be a company you can hold on to for years, if not decades.

Moving on, we get to the Millennials.  The Millennial-driven housing boom I’ve been expecting has been a little slow out of the gate, with housing data over the past several months a little on the disappointing side.  But Silver Bay Realty (SBY), our investment in single-family houses, has managed to hold up fairly well, and we’re sitting on a modest profit.  SBY is a fantastic value play, it trades at less than its accounting book value and at a 22% discount to net asset value based on company estimates of the market value of its houses.

Danone (DANOY) and Mead Johnson (MJN) are our two plays on the coming baby boom, as two major producers of baby-related dairy products.  I’m going to go ahead and recommend you take your profits in MJN and cut your losses in Danone.  It’s not that I’m necessarily bearish on either, but I believe that at current prices these two stocks are less attractive than some of the other recommendations.

Energy Stocks

Here’s a fun stat: The United States is overtaking Saudi Arabia as the world’s largest producer of liquid petroleum for the first time since 1991, according to the latest data from the International Energy Agency.  Those figures include ethane and propane; in terms of crude oil, Russia and Saudi Arabia are still slightly ahead.  But the trend is clear: America is a major energy power again.

I continue to see great things for our master limited partnership general partners Energy Transfer Equity (ETE), Kinder Morgan (KMI), ONEOK (OKE)  and Williams Companies (WMB).  I expect all to generate annual dividend growth in the 10%-20% range over the next 3-5 years. Frankly, given the weak growth I see elsewhere in the economy, I consider these one of the true bright spots in the American economy.

I’m also still very bullish on our three oil major Statoil (STO) BP (BP) and ConocoPhilips (COP).  Yes, growth has been modest in recent years.  But energy is the cheapest sector outside financials in an otherwise vastly overpriced market, and European oil majors are even cheaper than American.

Finally, we come to our two final plays on America’s energy renaissance, Cummins (CMI) and Tenaris (TS).   If you believe that environmental, economic, and geopolitical concerns will mean a continued emphasis on natural gas over coal or crude oil, then Cummins and Tenaris make all the sense in the world as investments.  Cummins is a leader in natural gas engines, and Tenaris is a major manufacturer of the pipelines that will be carrying all of the new gas supplies that seem to pop up every other day.

European Stocks

Moving on to Europe, I’m going to recommend that you keep the faith in our Spanish stocks BBVA (BBVA), Banco Santander (SAN) and Telefonica (TEF).  Europe—and Spain in particular—is quietly stumbling into recovery, and Spain remains one of the cheapest markets in the world.  I believe a patient investor can outperform the S&P 500 by a wide margin over the next five years by simply holding a good basket of Spanish blue chips.

 Bollore (France:BOL) has cooled off lately, but that’s ok.  We’re up over 140% in a little over two years, and I expect more gains to come.  Bollore is run by “the Warren Buffett of France,” and it is a fine long-term play on African infrastructure.

Siemens (SIEGY)is also a good play on emerging market infrastructure in general, as well as recovering Europe.  Our gains have been more modest–about 33%–but I expect Siemens to perform well as Europe’s governments emerge from their austerity straightjackets of recent years.

Unfortunately, we hit our stop loss in Daimler (DDAIF).  As cheap as Daimler is and as much as I expect it to outperform going forward, we have rules for a reason—to prevent small losses from turning into large ones.  So, I’m going to recommend you take your profits in Daimler.

Special Situations

Finally, we come to Madison Square Garden (MSG), what I would playfully call our play on the vanity of billionaires.  As I wrote in July, Madison Square Garden is worth more dead than alive; its constituent pieces, which include the New York Knicks basketball franchise, are collectively worth at least 50% more than the current stock price.  It’s hard to go broke buying 50 cent dollars, so I recommend you hold on to MSG for a while.  As with all of my recommendations, I recommend you have a good stop loss in place for use as risk management.

Before I sign off, let me say again that it has been a pleasure writing Macro Trend Investor for you and that I hope our paths cross again.   Best wishes, and please feel free to reach out to me personally.

Charles Sizemore

Charles Lewis Sizemore, CFA, is the chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. 

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This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities.