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Europe Reaching the Boiling Point: How to Invest

For a year that started with one of the best first quarters in history, the second quarter has proven to be something of a disappointment.

On the first trading day of June, the U.S. averages had their worst performance of 2012, pushing the Dow Industrials into negative territory for the year. The S&P 500 is still positive for the year…albeit barely.

Interestingly, Spanish stocks—which have been at the center of the European financial crisis that has been roiling the markets—finished the day roughly flat. Sizemore Capital continues to allocate funds to select Spanish stocks, and the relative calm in the Spanish market gives us hope that much of the selling there has already been done. Spain is home to some of the world’s finest multi-national companies, and the state of crisis has created absolute steals that we may not see again in our lifetimes.

The Sizemore Investment Letter Portfolio holds positions in Telefonica (NYSE:$TEF) and Banco Santander (NYSE:$STD) and has additionally sold out-of-the-money puts on both. (See “How to Keep Your Cool While Investing in Europe” for more details on our put strategy.) Additionally, the Tactical ETF Portfolio holds a position in the iShares MSCI Spain Index ETF (NYSE:$EWP).

More than even bad news, markets hate uncertainty. And the uncertainly about the Eurozone’s future has wreaked absolute havoc on Spanish and European shares.

Spain’s effective nationalization of the ailing Bankia—the country’s third largest bank by deposits—had precisely the opposite effect of what you might have expected. Rather than cheer the fact that the Spanish government is taking the crisis seriously, it simply raised new questions about the Spanish state’s ability to afford the bailout of its banking sector.

The way forward is becoming increasingly obvious. As The Economist wrote this week, “Spain’s problem is one of misdiagnosis.”

The focus of the Spanish government and of the broader European Union (and particularly Germany) has been austerity. The thinking is that budget deficits must be slashed in order to restore investor confidence. The case of the United States—where both debts and deficits are higher than in many of the EU’s problem states—proves that this is not entirely true. After all, the yield on the 10-year Treasury note recently hit levels not seen since World War II.

As The Economist continues,

“This fiscal focus gets things exactly backwards. Spain’s poor public finances, unlike those of Greece, are a symptom rather than the cause of the country’s economic woes. Before the crisis Spain was well within the euro zone’s fiscal rules. Even now its government debt, at around 70% of GDP, is lower than Germany’s.”

In Spain, it is all about the banks. Outside of Santandar and Banco Bilbao Vizcaya Argentaria (NYSE:$BBVA), Spain’s banks are by and large insolvent and in need of recapitalization.

Again, using The Economist’s figures, a recapitalization of €100 billion would be roughly 10% of Spain’s GDP. Borrowing this amount would still leave Spain safely below the debt-to-GDP levels of the United States, but the country would have to pay punishingly high rates of interest given current market conditions.

On a side note, the Financial Times estimates the cost of a banking bailout to be much smaller. The FT points out that roughly 11% of Spanish bank loans are non-performing, which is less than half the level of Ireland, the country whose predicament most closely matches that of Spain. At 350% of GDP, Spain’s banking assets are large by world standards, but again, less than half the levels of Ireland.

What is the most likely solution? The budding consensus would seem to be using EU rescue funds to inject capital into the banks directly, which Spain is now advocating.

Currently, this is not legal under EU rules. But as the last year and half of on-again / off-again crisis has proven, EU rules are a bit of a work in process.

In any event, the next week promises to be anything if not interesting. Mariano Rajoy, Spain’s prime minister, publicly announced support for EU oversight of national budgets, apparently in an attempt to sweet talk German chancellor Angela Merkel. Separately, the European Central Bank indicated over the weekend that it was “prepared” to intervene with bond purchases or additional bank assistance if needed. And encouragingly, late last week, the EU announced that it would be lenient in allowing Spain another year to get its budget deficits under control.

What does all of this mean to us as investors? In investing, as in many of life’s endeavors, it is always darkest just before the light. And it would appear that we’re starting to see a sunrise in Europe. Sizemore Capital will look for opportunities in the weeks ahead to profit from the resolution of Europe’s crisis.

 This article was originally published as Sizemore Capital’s monthly market commentary for Covestor.

Disclaimer: 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 nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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Telefonica: Latin American Growth, Crisis Prices

“Buy low and sell high” is the standard advice of any value investor. It can also be remarkably hard to put into practice.

You see, we humans are herd animals, and we tend to think and act as groups, particularly during times of stress. Call it the primal human instinct to seek strength in numbers.

Unfortunately, while this instinct may ensure our survival during times of war or natural disaster, it handicaps us as investors. When we see others panicking we too sell in fear or stand paralyzed in indecision at exactly the time we should be buying with both fists.

All of this is a lengthy introduction to the subject of this article, Spanish telecom giant Telefonica (NYSE:TEF).

Telefonica has had a rough year. The price of its U.S.-listed ADR are down nearly 70% from their pre-2008 highs. The domestically-traded shares have fared slightly better do to the lack of currency movements, but results have been dismal nonetheless.

Spain’s crisis has become Telefonica’s crisis. As the most liquid stock in the Spanish stock market, Telefonica has become a proverbial punching bag and an outlet for traders wanting to short the embattled Eurozone country.

This article was published on GuruFocus.  To read the full article, please see The Case for Telefonica.

Disclaimer: 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 nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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Summer Trading: Utilities

Utilities are the proverbial red-headed stepchild of stock market sectors. During bull markets (so the thinking goes), utilities tend to underperform more aggressive sectors like technology or industrials. But during a good market rout, utilities take a beating along with the rest.

How unloved are utilities?

As I wrote in a recent article, they were by far the most shunned sector by the large money managers interviewed by Barron’s (see chart). Fully 30% of the “big money” managers picked utilities as the worst performer of 2012, and barely 3% thought it would be the best. (On the flip side, more than 30% of the managers chose financials and technology to be the best-performing sectors, and technology had not a single manager who voted it worst).

As a contrarian trade alone, utilities would be interesting. After all, the sector has been known to take investors by surprise; during the 2003-07 bull market, utilities were one of top-performing sectors on a price basis, and this did not include the high and rising dividends enjoyed by investors during the period.

And this brings me to my primary rationale for liking the sector: In a world where 2% is a “good” yield on a 10-year bond, the 3.9% paid by the Select Sector Utilities SPDR (NYSE:$XLU) is attractive. It’s roughly double the dividend yield paid by the S&P 500. And unlike the interest paid by a bond, the dividends of XLU constituent companies have a history of rising over time (more on that in a moment).

While portfolio growth is essential to meeting your retirement needs, growth ultimately doesn’t pay the bills; but income does. Yes, you can sell off appreciated shares to meet current expenses, but that doesn’t work particularly well when the market is trading flat or down. Just ask investors who needed to sell their shares during the pits of the 2007-09 bear market and panic.

The problem for most investors is that their traditional sources of stable income — bonds and CDs — simply do not pay enough in this interest rate environment. This means finding a respectable current income often means accepting stock market risk.

Frankly, I’m OK with that. An investor who is comfortable holding a 30-year bond to maturity should be equally comfortable holding a solid dividend-paying stock. If income is your objective, the bends and twists of the stock market can be safely ignored — so long as you are reasonably sure that the dividend is safe.

Let’s take a look at some of XLU’s largest holdings, starting with Southern Company (NYSE:$SO). Southern, as its name might imply, serves electricity to much of the Old South. It is a diversified power company that generates electricity through coal, nuclear, oil and gas, and hydroelectric assets.

Southern also is a prolific dividend raiser. The company recently raised its quarterly dividend to 49 cents per share, up from 40.3 cents at the onset of the crisis in 2008 — an increase of more than 21%. That’s not bad, given that many companies were forced to slash their dividends in those volatile years. Southern currently yields 4.3%, which is substantially higher than what you will find in the bond market outside of junk. And whether or not we have a eurozone meltdown, that dividend is unlikely to be affected.

Another of XLU’s holdings worth noting is Duke Energy (NYSE:$DUK). Like Southern, Duke is based in the American South. And also like Southern, Duke was able to continue growing its dividend throughout the crisis years of 2008 and 2009 and beyond. Duke currently yields 4.6%.

If we managed to get a breakthrough in the ongoing European debt crisis, I would expect more speculative sectors to outperform. It will be “risk-on” season again, and defensive sectors like utilities will lag behind. But if the European crisis continues to drag on, you can bet investors will flock to conservative income-producing sectors, and utilities could easily be the best-performing sector for the next quarter and beyond.

This article was originally published on InvestorPlace as part of the “My Favorite Sector for the Summer” series.   Charles Lewis Sizemore, CFA, is the editor of the Sizemore Investment Letter, and the chief investment officer of investments firm Sizemore Capital Management. As of this writing, he did not hold a position in any of the aforementioned securities. Sign up for a FREE copy of his new special report: “Top 3 ETFs for Dividend-Hungry Investors.”

Disclaimer: 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 nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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Christmas May Come Early This Year

It’s a little early for Christmas in July, but now is the time for investors to be putting together their “Christmas lists” of sorts.

Recently, I wrote a piece that described an old investment strategy of Sir John Templeton (see “An Anniversary We’d Prefer to Forget”).  Sir John would make a list of companies he’d love to own “if only” they fell to a more attractive price.  He would then place limit orders to buy those companies at prices substantially below the current market price.  In the event of a sharp selloff, the limit ordered would be executed, and Sir John would have his shares at the prices he always wanted.

His rationale for the strategy was simple enough: we humans are instinctively herd animals, and we tend to panic when we see others around us panicking.  We lose our independent judgment and we freeze in fear at exactly the moment we should be buying aggressively.  Templeton’s move was designed to take his own emotions out of the equation; Sir John understood his own human shortcomings, and essentially gamed himself.

Today, with Europe teetering on the edge of a potential meltdown,  I’m going to recommend that investors take a similar approach, though mine has the added bonus of adding a little extra income.

I recommend that you make a list of strong multinational companies based in Europe that you are confident can survive Armageddon with their businesses intact.  Ideally, these companies would have significant percentages of their revenues coming from outside of the Eurozone.

Once you have your list of stocks, consider selling deep out-of-the-money puts on them.  If prices remain relatively stable or rise, the options expire worthless and you pocket the premium.  And if the share prices take a nosedive, the options will be exercised and you will be obligated to buy the shares at the prevailing market price—which was your objective all along.  And you still get to pocket the premium.

Here a little explanation is needed.   When you buy an option, whether it be a call or put, your risk is limited to the price you paid for the options.  You are buying the right to buy or sell shares at a given price, not the obligation.

Selling, however, is a much trickier business.  Your upside is limited to the premium at the time you sell the option.  But your downside is much, much bigger.  In fact, when selling a naked call option, your risk is theoretically infinite.  For example, if you sell the right to buy Facebook (Nasdaq:$FB) at $38 to another investor and the stock rises to $100 the next day, you’re on the hook to buy at the prevailing market rate of $100 and sell at $38.  Not an appealing prospect.

Likewise, when you sell a put, you are giving an investor the right to sell you shares at a price that might be far higher than the prevailing market price.  So, when selling put options on your list of European stocks you’d like to own, make sure that you have the cash on hand to handle the trade if it is exercised.  Don’t get greedy and sell contracts for more shares than you can afford to buy or that you would ideally like to own.

I’m not going to recommend specific put option contracts for you to sell because the entire point of this article was for you to create a list of stocks you like at prices you want to pay.  I also want the advice in this article to be general and something that you can use months or years from now; recommending a specific contract would make this article too short-term for my liking.

I will, however, toss out a few company names for you to consider.  Last week, I recommended Spanish bluechips Telefonica (NYSE: $TEF), Iberdrola (Pink:$IBDRY)and Banco Santander (NYSE:$STD) (see “Bargain Hunting in Spain”).

I continue to like all three, and to this list I would add French oil major Total (NYSE:$TOT) and British telecom giant Vodafone (NYSE:$VOD).  While Vodafone is not a Eurozone stock, it has significant operations in the Eurozone and I would expect its share price to take a tumble in a general market rout.

If you’re not comfortable with options, that’s ok.  You can accomplish essentially the same thing by placing limit orders like Templeton.

Disclosures: Sizemore Capital has positions in TEF.

This article first appeared on MarketWatch.

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Disclaimer: 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 nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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Bargain Hunting in Spain

The first time I set foot on Spanish soil was the spring of 2000, and what a fantastic time it was to visit.  The dollar was near its all-time high versus the Euro, and an American could live like a king on a pauper’s budget.

My, how times have changed.  I most recently visited Spain in the summer of 2009, and a cup of my beloved café con leche in Madrid’s Plaza Mayor had more than doubled in price when translated into dollars.

Of course, I gladly paid it.  Even at an inflated price, there are few pleasures in life like enjoying a hot café con leche in a Madrid café.

Two years and a sovereign debt crisis later, prices in Madrid’s cafes are a little more reasonable.  But prices in Madrid’s stock market are downright extraordinary.

Consider the broad Ibex 35 Index, which tracks Spain’s blue chip companies.  At time of writing, it trades below the crisis levels of 2008; in fact, the index now sits at levels last seen in 2003.

The index sells for just 9.8 times earnings and yields and eye-popping 8.3 percent in dividends.  Remarkably, this is even cheaper than Greece—despite the now almost certain ejection of Greece from the Eurozone and the havoc that that will wreak.

Value investors have a nasty habit of jumping into investments too early, and I am certainly no exception.  I turned bullish on Spain in the first quarter, buying shares of the iShares MSCI Spain ETF (NYSE: $EWP) in my Tactical ETF Model—and taking substantial losses for it in the months that followed.

Value investors also tend to concentrate too heavily on the fundamentals and valuation of a company while ignoring the larger macro picture.  More often than not, macro concerns prove to be noise.  But during times of extreme stress, they have a way of overpowering company fundamentals.  For example, Spanish telecom giant Telefonica’s (NYSE: $TEF) decision to reduce its 2012 dividend had more to do with conserving capital in a tight credit market than it did the company’s financial health.

Still, today most investors would appear to making the opposite mistake: focusing entirely on macro concerns while completely ignoring the incredible value in front of them.

I’ve recommended Telefonica in recent articles, and I’ll spare readers a lengthy rehash of my reasoning.   I’ll reduce it to five  words: big dividend, emerging market exposure.

The same reasoning applies to banking giant Banco Santander (NYSE:$STD), the largest bank in the Eurozone by market cap.   Santander gets roughly half its profits from the emerging markets of Latin America and another quarter split between the United States and United Kingdom.  Only 13 percent comes from the bank’s home market of Spain.

Santander trades for just 60 percent of book value and its dividend is over 13 percent at current prices.  Could that dividend come under pressure in another wave of capital market volatility?  Of course.  But at current prices, it is worth the risk.

Moving on, investors should consider electric utility Iberdrola SA (Pink:$IBDRY).  Like the other Spanish stocks mentioned, Iberdrola gets only about half of its revenues from Spain.  Roughly a quarter comes from Latin America, and the remainder comes from the United States, United Kingdom, and the rest of Europe.  For a globally-diversified utility, Iberdrola is a steal.  It trades for just 0.62 times book value and 0.64 times sales and yields  6.0 percent.

Disclosures: EWP and TEF are holdings of the Sizemore Capital Tactical ETF Portfolio and Sizemore Investment Letter Portfolio.    

Disclaimer: 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 nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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