In a period of historical volatility and uncertainty, focusing on positive returns instead of maximizing returns allows investors to sleep better at night without sacrificing appreciation. In fact, by diligently owning stocks that are undervalued and selling stocks that are overvalued, returns can be spectacular.
For example, as of the end of the second quarter, an equal weighting of longs and shorts based on my Top Stocks for 2009 and Top Stocks to Avoid in 2009 has beaten the market by a significant margin. The aggregate return on the longs is plus 7.58% while the aggregate return on the shorts is minus 13.48%. The S&P 500 generated a paltry 1.78% as of June 30.Like any portfolio, there are deeper subplots that go beyond the headline of the total performance.
There have been some stocks on the Stocks to Buy list that have done very well and a few that haven’t. The same is true of the Stocks to Avoid list. Beyond absolute returns then is the tried-and-true principle of diversification. It’s simply not enough to cherry-pick stocks on one side or the other. Instead, a balanced selection of stocks from various sectors can help generate positive returns with less risk. As such, it’s important to keep track of the goings-on with each of our selections.
Here then is an update on the ten stocks on the long side of the list as of the halfway point in the year.
Top Stock #1 – Jacobs Engineering (JEC)
The economy is healing, but not because of so-called shovel-ready stimulus from the government. In fact, the amount of money that’s flowing has been greatly disappointing. And there certainly has been no boost to those companies expecting to benefit from the program. One of the investment themes for the long side of the Top Stocks portfolio was to buy companies likely to see increased revenue from government spending. At the top of that list was Jacobs Engineering (JEC).
Without the stimulus, JEC is left to struggle in a weak global economy. Shares are down more than 12% so far this year. Supposedly, stimulus projects will accelerate in the second half of 2009. I’m still supportive of the investment theme, but the clock is ticking. I’ll give it until the end of the year to see how things shake out. With gains elsewhere, we can wait for a turnaround in Jacobs.
Top Stock #2 – Pulte Homes (PHM)
How many times will investors be cheated by calling a bottom in housing too early? After years of false starts, I was certain 2009 would be the year to ring the bell for home construction. It hasn’t worked out that way, at least not yet. Pulte Homes (PHM) is down more than 19% due to continued weakness in the sector. Competition from foreclosures, short sales and saturated construction continues to haunt new construction. There is simply too much inventory. About the only good news is that the homebuilders, including Pulte, have strong balance sheets to withstand the weakness. More importantly, they are using the low volume as an opportunity to become lean and mean.
With lower costs, margins should be quite strong if there is a rebound in demand. We are already seeing improvements in the numbers since the second quarter ended, and Pulte shares have rebounded strongly. Homebuilders, including Pulte, represent some of the best value in the market today.
Top Stock #3 – Chicago Bridge & Iron (CBI)
Unlike fellow infrastructure player Jacobs Engineering, Chicago Bridge & Iron (CBI) has benefited from the rally in oil and natural gas prices. Its focus on liquefied natural gas has helped the company withstand a recession in other parts of the infrastructure market. Shares of CBI are up more than 23% so far this year, and with the economy regaining traction, there will surely be more gains for CBI.
We will never quit fossil fuels cold turkey. Instead, the more likely scenario will be increased use of clean-burning natural gas. If so, investment in the natural gas space could propel CBI to higher heights. The experience with CBI again shows the importance of diversification. Even within sectors, it makes sense to broaden your exposure. Gains here with CBI have helped to offset losses from JEC.
Top Stock #4 – General Electric (GE)
Another big loser on the long list of Stocks to Buy has been General Electric (GE). The company has been knee-deep in the credit crisis and has yet to regain its footing. The stock is down nearly 27% as of June 30. One would expect that eventually the company will put the loan crisis behind it and return to growth and profitability. Putting GE on this list was a purely contrarian play. A company with such a reputation for quality and innovation in manufacturing will not be down permanently. The idea is that the pendulum has swung too far against GE.
Unfortunately, the company is having trouble finding the leverage to push the pendulum in the other direction. It truly is facing a stiff wind from the credit crisis and its GE capital division. But there may be a light at the end of the tunnel as financial entities are indeed repairing themselves. GE is one of those entities. I would still own this stock.
Top Stock #5 – Chesapeake Energy (CHK)
I loved Chesapeake Energy (CHK) at the start of the year, and that devotion has paid big dividends. The stock is up more than 22% for the first half of 2009. Not bad considering the market is flat for the year. Speculating on a recovery in oil was a no-brainer given the efforts to stabilize the economy. With crude having fallen below $40 per barrel, it was easy to assume that any sort of economic recovery would push oil higher. The oil trade continues to work, and I see no reason to bet against it despite efforts to derail speculation in the oil markets.
The bottom line is that oil is in short supply and that any growth in global demand will be difficult to meet. The price is really locked and loaded for gains. Add in the potential effect of inflation and a weak dollar, and the oil trade should be solid for at least the remainder of the year. I expect CHK to continue its ascent.
Top Stock #6 – Tesoro Petroleum (TSO)
My appreciation for the oil patch is strong, but so, too, is the need for diversification. And I found just that with oil refiner Tesoro Petroleum (TSO). I have a long history with TSO starting with an initial recommendation of the stock back in 2002 when shares traded for about a buck. The stock
lost a significant amount of value culminating with the collapse in oil prices in late 2008. That loss of value was too great to pass up from an investment perspective. Though margins in refining are small, my view was that the price of TSO reflected huge volatility in crude price. That volatility has only moderated some in 2009.
TSO has traded flat for the first half of the year finishing the second quarter with a loss of just over 3%. Look for oil prices to finally stabilize in the last half of the year. If so, TSO should outperform the market for the remainder of 2009.
Top Stock #7 – Transocean (RIG)
The biggest winner so far on the Stocks to Buy list is Transocean (RIG). Shares are up an impressive 57% through the end of June. RIG follows an easy formula: The higher the price of oil, the higher the price of RIG. If you believe oil prices will keep on rising, then owning this stock makes sense. Though tempting to lock in a profit on RIG, I would let the stock run here. Oil prices have already dropped since peaking earlier this summer. An economic recovery slated to begin in earnest in 2010 is likely to be preceded by another boost in oil prices.
It’s not out of the question to speculate on $100 oil from here. If so, I see RIG breaking through $100 per share. In other words, there are more gains to be had with this oil driller.
Top Stock #8 – Mosaic (MOS)
As demand for fertilizer declined, the potash trade took a hit late in the second quarter, and potash companies gave up what had been impressive gains. After trading above $57 per share in early June, sellers attacked Mosaic (MOS) and pushed shares to the low $40s. But despite the roller-coaster ride, MOS closed the quarter with a year-to-date gain of 28%. Not bad considering where the market is, but disappointing since gains had been much higher.
The underlying basis for the potash trade is still intact for the long term. Farmers demanding higher yields will bid up prices of fertilizer. Global population growth will demand more and more from less acreage. It’s a trade for the ages if you ask me. Indeed, MOS has recovered thus far in the third quarter on speculation of a possible sale. Clearly the market views the assets of MOS attractively. If a sale does occur, it will be at a higher price than we see today. I would stay long and strong on MOS for the foreseeable future.
Top Stock #9 – Fluor Corporation (FLR)
Not all construction firms are created equally, providing more ammunition for diversification. Even on a list with only 10 selections, I have three names here that are in the business of monster construction. Despite a global growth slowdown and a lack of major stimulus for infrastructure in the U.S., Fluor Corporation (FLR) keeps humming along.
Shares are up more than 14% since the start of the year, defying the trend in the industry. Helping Fluor, like Chicago Bridge and Iron, is a focus on oil and gas projects. That segment of the large construction space has benefited from higher oil prices and activity coming as a result of the global demand for oil and gas.
With that segment doing well, investors should benefit from growth in the government contract space, especially where stimulus dollars are likely to flow. As such, owning FLR is still a good idea, at least for the remainder of this year.
Top Stock #10 – Archer Daniels Midland (ADM)
In some ways owning agriculture stocks was a defensive play on the long side, but it was also a growth play. There are more and more people to feed each and every year, and with a limited amount of acreage available, the potential for price appreciation is quite real as demand grows. So far that assumption has been a bit of a dud for Archer Daniels Midland (ADM). The stock is down some 7% for the first half of the year. No defense here and certainly no growth. What gives?
Well, it turns out there is more supply than anticipated as farmers rushed to the hottest market and produced too many crops. At the same time, demand has not been as strong in the near term as consumers have pulled back on spending. However, I believe the growth potential is still strong with demand coming mostly from overseas. I expect ADM to trend to positive territory as a second-half economic recovery takes hold.
