The sense in the never-ending

The desire for resolution runs deep in the human psyche. Events and their consequences require a neat explanation; loose ends tied, explanations proffered, amends made. The brain loves convenient partitions. After a line has been drawn, we can move on. Closure, as the shrinks say.

It’s now almost five years since the explosive events of the Global Financial Crisis. And yet there is, to paraphrase Julian Barnes, no sense of an ending. In fact, there seems to be no sense at all.

If lines have been drawn, they appear to be inscribed in the wrong place. The Germans want to save the euro—and as the major beneficiaries, why not?—but see inflicting mass unemployment and social dislocation on their neighbours as the best way of doing so.

There are bailouts for these countries, of course. But soon enough, the money returns to bolster the balance sheets of French and German banks. It comes to places like Athens and Lisbon but it doesn’t linger.

In the US, the economy falters and the political logjam continues. Third world-like stories are commonplace; of formerly middle class families living in drains; of over 1.6 million homeless children; of bankrupt towns and cities. And still the foreclosures come.

High price

The price of the crisis has been high but has not been paid by the people that caused it. Indeed, they seem to be doing rather well. The answer, at least according to the new wave of Republicans, is smaller government and a balanced budget.

At a time when insufficient aggregate demand is the country’s fundamental problem, and the US government can borrow at a price cheaper than at almost any time in its history, the argument for pump priming is strong. There is a limit to how much a country can borrow but the argument, however, is not being made with any force.

Elsewhere, our long-enunciated view of a China slowdown appears to have gathered some numerical vigour. None of the stats suggest an economy doing anything other than slow, a belief quickly and savagely reflected in falling commodity prices.

No wonder markets haven’t moved on; No wonder Australians are pulling out of the share market and whacking their savings in a term deposit. How can any of us draw a line under the GFC when each market tribulation reminds us that we are still living with its consequences?

And yet here we are, at the other end of a financial year, writing about the same stuff that occupied our minds at the same time last year, saying much the same thing, with a familiar tone: No, it’s not over. Yes, it could go on for years. No, we have no idea for how long. Yes, it will end.

It’s all a bit pointless isn’t it? Why can’t we just bang on about Infigen instead? Or Woolies? Or QBE Insurance or the phone hackers at News Corp? That’s what you’re paying us for, right—those little juicy morsels of opportunity—the well-researched, pleasantly written, sensibly weighted buy recommendation?

Yes, of course. And don’t worry, we’ll get to it.

Do something different

There is, though, a larger point: Weak markets only mean weak performance if you’re doing what everyone else is.

As a member of Intelligent Investor, you’re probably doing something different. That’s good. As American investor Leon Cooperman once said, ‘The market will do whatever it’s got to do to confound the largest group of investors.’ We doubt you’re confounded. But you should be prepared. Let’s count the ways.

First, we’ve shifted the intensity of our focus towards defensive, attractively priced blue chip businesses. Happily, the turmoil over the past year has produced quite a few opportunities. We simply don’t need to take excessive risks right now in order to produce attractive returns. Our picks and performance this year (see below) reflect that fact.

Second, we’ve suggested taking advantage of the strong dollar and cheap stock prices by shifting a portion of your portfolio to many of the tempting opportunities overseas. The special report Ripe for the picking: Eight overseas stocks to buy now makes a few (informal) recommendations (and shows you how to open a very cheap broking account to trade international stocks).

Third, we’ve repeatedly made the case for building cash reserves (and not going to cash entirely). Happily, a few times over the past 12 months we’ve had the chance to deploy some of it in attractive situations. This year’s two Strong Buys in Macquarie Group and QBE Insurance were especially notable.

Avoid poor businesses

Fourth, recognising that what you don’t buy is almost as important as what you do, we’ve spent time keeping you away from poor businesses.

There’s no point having winners like Challenger Infrastructure Fund, Spark Infrastructure, News Corp, CSL, Goodman PLUS and Dexus RENTS if the returns are eaten up by mistaken investments in Bluescope Steel and Qantas. Yesterday’s story, (see Dangerous blue chips (redux)), which shows that the basket of bad businesses selected on 29 Apr 11 is down a collective 35%, suggests a reasonable performance in this regard.

James Greenhalgh’s work on the retail sector and Gaurav Sodhi’s selective approach to resources also deserves mention. It was almost a year ago that James advised members to sell some of the sector’s leading companies (see Ill winds hits JB Hi-Fi, Myer and DJs from 15 Jul 11), well before the mainstream press noticed what was going on.

Gaurav’s brave advice to sell Rio Tinto on 29 Nov 10 when the price was $83.65 signals our overall approach to the sector. Having avoided the rare earths boom and bust, the disastrous uranium sector, the overheated coal sector, and other overpriced companies (Fortescue Metals, for example), capital has been preserved, ready for use in more value-orientated situations like Santos and Origin Energy.

Portfolio performance

The overall effects of this four-pronged strategy can be seen in the performance of our model portfolios. As Jason Prowd wrote on 25 Jun 12 in The five secrets of tough times investing:

‘Since the GFC, the Growth portfolio has been the real star, returning 99% versus 32% from the Index. The Income portfolio has significantly decreased its risk, provided $35,476 of income and still returned a reasonable 23% total return, albeit 9% short of the index. That's exactly what you should expect from a well-chosen Income portfolio. It won't keep up with the index in a bull market, but it should perform much better during a downturn.’

If the next three years are like the last, there really is nothing to fear and plenty to relish. Let’s look at the fruits of the past 12 months to see the potential of the harvest.

On 1 Jul 2011 there were 22 stocks on our buy list from the prior financial year. Some have since been removed due to a change in view, including (thankfully but belatedly) Billabong and Platinum Asset Management, others because we downgraded due to higher prices (see ARB Corporation and CSL) and yet more because they were outright mistakes (see Collins Foods, delivering a 17% loss, and speculative buy Carnarvon Petroleum, down 77%).

The real pickings are in the entirely new stocks added to the buy list this year, and those that we already cover but have been upgraded. There are 25 stocks in this select group, as Table 1 shows, seven of which are entirely new additions.

The list is revealing in a number of respects. First, with names like ASX, Computershare, QBE Insurance, Metcash, Woolworths and Westfield, it shows blue chips at the fore of our endeavours. That’s consistent with our strategy to maintain a high quality focus.

Income opportunities

Second, there’s a proliferation of opportunities for income investors; Safe, high yielding notes like Woolworths Notes II and ALE income notes plus high yield stocks like Spark Infrastructure (recently downgraded to Sell) and ALE Property Group. These are delivering much higher yields than term deposits, without travelling too high up the risk curve.

Third, resources are notable by their absence. Those stocks that do feature—Silver Lake, Azumah, Kingsrose and Alumina, for example—are for that (small) part of your portfolio that you can afford to lose.

As for the bigger miners, there may be a time to buy them but we’re not there yet. More resources exposure is available from the likes of carefully chosen situations like Tap Oil and Origin Energy.

If, over the next 12 months, we uncover 25 more buy recommendations with the potential to produce returns well ahead of the index as our model portfolios have done, it would be a most gratifying performance. With the careful preparations made, there’s every reason to believe that’s achievable.

As the Eurozone nears a dénouement, newspaper headlines may become even more hysterical over the next 12 months. There is no need to engage with the panic. Instead, relish the opportunities it will bring. That’s what we’ve prepared for and this year’s returns prove the sense in our approach. It may not be easy, but we all need to stick with it.