Rebalancing July 2018

On 20 July 2018 a couple of our positions reached the point where their share in the overall Optarix US Portfolio became too large for our taste.

We sold some of our position in VF Corp (VFC). We started the position at a share price of USD 53.12 in February 2017. We now sold some of our shares at a price of USD 93.44. This represents a realized gain of 75.9%.

We also reduced our position in S&P Global Inc (SPGI). We bought our shares in February 2017 at USD 126.40 per share. We sold them at a price of USD 212.37, a realized gain of 68.0%.

As a result of these two sells and combined with the accumulated dividends we started a new position in Walgreen Boots Alliance (WBA). We use is picked the company with the lowest P/E ratio from the list of dividend aristocrats that we don't own yet. This was WBA this time. The share price for the buy was USD 64.90. As always when we start a position the intention is to keep it indefinitely.

This post highlights two of the rules we use. The first rule is reducing positions that have appreciated in value to a point that their share becomes too large in relation to the overall portfolio. When that happens, we want to take some of the gains off the table while at the same time reducing the exposure and risk to some degree. At the same time, we keep the majority of the position and participate in potential further increases in value.

The second rule we used in these transactions was to look at the list of all dividend aristocrats in the S&P 500 that we don’t already own. We then picked the one with the lowest P/E ratio to add to our portfolio. In total this added one more position to portfolio, reducing the average risk that any of the existing positions represents.

Note that past performance is no guarantee for future performance. We cannot look into the future. In particular the performance of VFC and SPGI described in this article doesn’t include any major bear markets like the Global Financial Crisis (CFG) so are not representative for the long-term performance of these and other shares.

Happy investing!

Disclosure: We have positions in VFC, SPGI and WBA. We have no intention to change these positions in the next 72 hours.

June 2018 Result: +3.64% Return over SPDAUDP

The past month was a roller coaster. The tariffs on steel and aluminum that the US imposed came into effect. Canada, Mexico and the European Union responded with tariffs of similar quality and quantity. The G7 summit ended without a joint communique.

We use two benchmarks for the Optarix US Portfolio: The first is the S&P 500 and the second benchmark is the S&P 500 Dividend Aristocrats index. With our portfolio selection we aim at matching these indices.

For our portfolio it means that it didn’t beat the S&P 500 in the 12 months ending 30 June 2018. The result was an active return of minus 0.47%. While disappointing it’s not unexpected that occasionally the performance of our portfolio is slightly less than the benchmark. We have allocated a significant percentage to dividend aristocrats which as a group underperformed by about 0.5% compared to the S&P500.

The average active return is still +2.96% which is not a bad number. However, as the graph shows the average return had its high point in Feb and has been in decline since then. With increasing rates and yields, dividend aristocrats – which at times tend to be have a little bond-ish – are out of fashion. This will end at some point, though. Long-term (i.e. last 10 years) dividend aristocrats delivered an average return of about 10.32% per annum, which is higher than the S&P 500 over the same time frame which had a return of about 8.31% per annum.

Since the Optarix US portfolio has a majority allocated to dividend aristocrats our second benchmark might be a bit more useful at this point. The S&P 500 Dividend Aristocrats index (SPDAUDP) tracks all of the dividend aristocrats in the S&P 500. The active return of our portfolio for the 12 months ending 30 June 2018 was +3.64%, so the picture looks better when compared to that second benchmark. On average the active return of the Optarix US portfolio over the SPDAUDP was +5.49% for the 7 months Dec 2017 to Jun 2018.

We believe that the Fed’s rate increases will continue to put downward pressure on dividend aristocrats when compare to the overall market. However, we are in it for the long-run, selling shares only to rebalance the portfolio or when a position took a bad turn.

We believe that the Fed’s rate increases will continue to cause dividend aristocrats to perform worse than the overall market. However, we are in it for the long-run, selling shares only to rebalance the portfolio or when a position took a bad turn. Rates increase will come to an end at some point. And we believe that dividend aristocrats – as a group – will continue to raise their dividends each year like clockwork. Eventually they will perform in line with or better than the market again.

The trade issues will continue for some time, perhaps even years. However, we remain optimistic that reasonable negotiation and solutions will prevail. We do not believe that any country will benefit from long-term protectionism. Where there are tariffs or other trade barriers they should be removed, even if that happens only gradually and may take many years.

We also share interesting news on Twitter about once a day.

Happy investing!

Realizing Gains as Instrument for Portfolio Management: The Example of T. Rowe Price

At Optarix, like everywhere else, we monitor how share prices are doing for all positions that we already own or companies that we might be interested in. And while we enjoy if a positions goes up in price, we are equally aware that prices can come down, too. There always seem to be shares, sectors, industries, geographies, etc. that are in favor or out of favor. As a result companies may be overvalued or undervalued. In almost all cases we don’t know if that is the case. We don’t know if selling or buying will be at a good price. We know that for any given trade we will not get the timing right.

On the other hand, with enough trades over time and following a set of rules, on average we get acceptable prices when we sell or buy. One of the rules that we use is that we sell stocks when their price has increased by a certain percentage. This percentage is not fixed and depends on a number of other factors, e.g. the share of the position in the overall portfolio.

Let’s look at our position in T. Rowe Price (TROW). We bought shares in July 2016 at a price of about USD 74.00. Their share price has developed quite nicely. Along with that the size of their share in our US portfolio increased as well. As that share increases, the risk associated with this single position increases as well. We don’t mind taking risks. However, we aim at taking calculated risks. In this case, we decided to reduce our position to some degree. We sold shares at about USD 125.00 which represents a realized gain of 68.92% since July 2016. This is quite a decent result and it freed up some cash that we then used to start a new position in a company that we believe is a good addition to our portfolio. At the same time we reduced our exposure to TROW.

Another aspect is timing. There is very well the case we got the time wrong. Perhaps we sold too early. In that case we continue to participate in the share price increased with the remainder of our position, admittedly to a somewhat smaller degree. Perhaps we didn’t sell enough and there is some bad news around the corner. We are not aware of any and don’t want to start a rumor either. But there’s always this thing call “black swan” event. How do we know what we don’t know? And in case that should happen and TROW’s price isn’t going anywhere, we have now taken some of our money off the table and put it into a new position that helps us spreading the risks.

We posted about the approach of taking some money off the table previously when we discussed our position in Brown-Forman (BF.B). Looking at that example and now TROW, here is a table with the realized gains of these two examples:

Symbol	Buy	Sell Price	Gain
BF.B	USD 46.00 (Oct 2016)	USD 69.20 (Feb 2018)	+50.43%
TROW	USD 74.00 (Jul 2016)	USD 125.00 (Jun 2018	+68.92%

Please note, that this performance is the past. And while we aim at having an annualized performance similar the S&P 500, we are only interested in the long-term performance. These examples are intended only to demonstrate a technique that helps with the following:

1. Rebalance your portfolio in terms of risk and potential,
2. Decide when to sell some of a position,
3. How to reduce exposure to a given position
4. Free up cash to increase a different position or to start a new position

We’ll also share information where we bought additional shares in a company because we got the timing wrong because the price decreased after the start of the position. Fundamentally we think that most of the time we get the timing wrong, so will use approaches that average out such transactions long term.

Happy investing!

May 2018 Result: 1.35% Active Return TTM

The results for May 2018 again yielded in a return better than the S&P 500 in the trailing 12 months (TTM). The active return of our US portfolio was 1.35%. While this is still a good result – we beat both of our two benchmarks - the active return has been decreasing since February. We believe this is mainly caused by the fact that our US portfolio contains to a large degree of dividend aristocrats. With most investors buying dividend aristocrats for their dividends, when the actual interest rates increase dividend aristocrats tend to under-perform the broader market.

This effect is further amplified with the strong job report on Friday, 01 June 2018 for the US labor market. US businesses created 223,000 new nonfarm jobs and the rate of unemployment decreased to an 18-year low at 3.8%. At the same time pressure to increase wages suggests that businesses increasingly compete to keep existing and attract new employees. This upward pressure may require the Federal Reserve to move faster and more substantially in order to keep inflation at bay.

The increases in interest rates are reflected in different ways. The yield on 10-year treasury notes has increased to about 2.9%, the highest since December 2013. The yield on 3-month treasury bills is at about 1.89%, the highest since the GFC in 2008/2009. We can also see this in the dividend yield of our US portfolio which is at about 2.29%. This, too, is the highest since Dec 2013.

We expect our portfolio to not perform as well as the S&P 500 until the interest rates stops increasing. When that will be and by how much the interest rates will be answered in the future. Regardless of this we believe that the dividend aristocrats in our portfolio will continue to increase their dividends by about 5% to 8% per year. This should put some safety cushion under their market value. The other positions in our portfolio represent companies with very strong positions in their respective markets and a fantastic growth trajectory in each case. In combination, we believe that our US portfolio will continue to do well in the long run.

Happy investing!

April 2018 Result: 2.41% Active Return TTM

April 2018 was yet another month where our US portfolio performed better than the S&P 500 in the trailing twelve month period (TTM). This time it was 2.41% which is noticeable lower than for the 12-month periods ending in Dec 2017 and Jan, Feb and March 2018. With raising interest rates dividend aristocrat behave a little bit more bond-like, that is as the interest rates go up the share prices will have some downward pressure. As a result the dividend yield for the dividend aristocrats tends to move somewhat in parallel with the yield on interest-free investments like for example the 3-months US treasury bills in the secondary market. Our US portfolio has allocated about 80% of its funds to dividend aristocrats at the moment.

We have previously discussed the rising interest rates. We continue to believe that these represent the biggest threat to gains in the share market for the time being. Unless the US Federal Reserve indicates that interest rates have reached the desired level, we believe the rising interest rates will continue to put downward pressure on share prices.

Taking a much longer timeframe such as 10 years or more, history tells us that interest rates fall and rise. After each rise there was a fall in the past. After each fall there was a rise. At the moment we are in a longer period where interest rates are trending up. At some point this will come to a halt. Nobody knows yet when that will be as it would require to predict the future.

If you buy shares with the intention to keep them indefinitely the current share prices doesn’t really matter at all. All that matters is what you think the earnings are doing which in turn feed dividend payments. Companies like Stanley Black & Decker (SWK) have paid dividends for 140 years and have increased their dividend each year for 50 consecutive years. It looks as if at least for SWK the ups and downs of the interest rate over the last 50 years didn’t really matter when it came to increasing the dividend. It just was more each year. We don’t expect this to change any time soon for SWK but also for a few more positions we have in our US portfolio.

Obviously we like a higher active return over a lower. Still, we are happy with 2.41% over the S&P 500 over the last 12 months. We are also prepared that until the interest rates in the US stop rising our portfolio may not return as much as in scenarios where the interest rates are flat or even falling. We’ll see. We cannot predict the future either.

Happy investing!

March 2018 Results: 4.09% Active Return TTM

The US stock markets had a negative quarter with declines of -2.49% for the Dow Jones and -1.22% for the S&P 500. The NASDAQ was hit in February and March as well but was able to hold on to year-to-date gains of +2.32%. The NASDAQ benefitted from a 7.36% gain in January.

How did the Optarix US portfolio do in this time frame? Year-to-date it’s down by -1.17% so did better than Dow Jones and more importantly better than our benchmark the S&P 500. Compared to end of March 2018, the S&P 500 is up +11.77% while the Optarix portfolio is up +15.86% given our portfolio and active return of +4.09% over the trailing twelve months (TTM). The S&P 500 gained about 7.89% per years over the last decade. If our active return would have been 4% of that time period, our portfolio would have made about +11.9% per year, and that would have been after tax.

The graph shows the active returns for the twelve months periods ending in Dec 2017, Jan 2018, Feb 2018 and Mar 2018. On average the active return was +4.36%. Any data we have from periods before Dec 2017 is not meaningful as our investment strategy change from about mid of 2016 to Feb 2017.

Of course, past results are never a guarantee for future results. Perhaps we were just lucky with our particular investment style. On the other hand we believe that our reasoning is plausible and this has so far been confirmed by the data. We typically invest about 80% to 90% in companies that have a track record of delivering increasing earnings per share (EPS) and/or increasing dividends, and combine that with 10% to 20% growth stocks that we believe have a proven business model with substantial growth. Frequently this will be well-established high-tech companies.

Obviously we look at other factors as well. For example we believe that if a company pays dividends, the payout ratio should not be too high. We prefer companies with a payout ratio of less than 50%. We also look at figures like the debt level and free cash flow. Typically we review our position in companies as soon as they become the target of an acquisition. With a buyer in the picture we think this brings with it a lot of speculation around the stock price. Sometimes it is just a rumor that doesn’t materialize. At other times the deal will fall through. We certainly will always do some research about the potential acquirer. Fundamentally, we are more interested in long-term potential than short term trading gains. Generally we follow a buy-and-hold strategy.

We have mentioned in earlier posts that we believe the increasing interest rates in the US represent a risk to the stock market. We continue to believe that the climbing interest rates will put at least a damper on stock prices. Perhaps what happened in the first quarter of 2018 was just an early taste of how much more negative things in the next quarters. We believe that the stock market is still a bit overvalued, so are not holding our breath that we’ll see another 20% or so gain in the S&P 500 in 2018. We are happy to be proven wrong, though.

Happy Investing!

US Labor Market Report February 2018

The US Labor Market Report for February 2018 shows an increase of 313,000 added jobs to the nonfarm payroll employment. The unemployment rate was unchanged at 4.1% (Chart 1). Both numbers were reported by the US Bureau of Labor Statistics on 09 March 2018. This compares quite favorably with economists’ estimates who thought the number would be closer to 200,000. This is the highest increase in a single month since July 2016 (Chart 2). Total employment rose by 785,000. Year-to-year average hourly earnings have increased by 2.6%. This latter number was lower than the 2.8% economists expected.

The markets took this as indications that the economy continues to grow nicely while wages do not grow as fast as anticipated. This was interpreted as allowing the Fed to continue their gradual approach towards raising interest rates. If the wages growth is lower, it is expected to create less of an upward trend on inflation. As a result the markets responded with gains of major indexes of between +1.74% for the S&P 500 and +1.79% for the NASDAQ.

Our take on this is: we believe that although this may take some pressure off the Fed it nevertheless means that interest rates will continue to rise. The rate of unemployment is already low, the participation in the labor market is increasing and therefore employers will have to offer more money. This puts upwards pressure on wages. Growing wages in turn create more demand and that may push prices further up which is what we call inflation. It remains to be seen if the Fed is able to let inflation run to the value they feel comfortable with and then bring it to a stop with the currently planned measures.

We continue to believe that the higher and increasing interest rates are not sufficiently reflected in the valuations of the share markets yet. Some companies have increased their profits and/or their dividends and share buybacks, but some of the profits were windfall profits because of the tax reform and some of the dividends were special dividends that won't repeat. While we remain fully invested with our US portfolio we believe that the overall growth for this year will be more on the more moderate end of the spectrum. We are convinced that the Optarix US Portfolio continues to be well-positioned for the current scenario.

Happy Investing!

Source for images: Bureau of Labor Statistics, U.S. Department of Labor, https://www.bls.gov/news.release/pdf/empsit.pdf (retrieved 10 March 2018)