During the month of December, Black Cypress portfolios delivered respectable absolute returns, rising nearly 2.0%. Over the last six and twelve-month periods, our portfolios have outperformed their benchmarks by 5.3% and 4.0%, respectively.
2011’s notable losers included J.P. Morgan, Wells Fargo and Becton, Dickinson & Company. J.P. Morgan performed in-line with financials while Wells Fargo, although down substantially for the year, did manage to at least outperform its sector. Becton, Dickinson & Company declined due to slowing growth expectations among analysts. While these growth expectations fell to levels consistent with our more conservative estimations, our foresight was rewarded with an unrealized loss.
The year’s notable winners included Costco Wholesale, Chevron, Intel, and Abbott Labs. We liquidated Costco in December in quite a fortunate manner–the stock hit an all-time high and has fallen 8.0% since our exit. Arguably, you cannot find a better run retailer, but the stock price no longer represented outsized returns. We also sold Abbott Labs in December. Chevron benefited from rising oil prices, while Intel gained from a low valuation and solid business execution.
Our recent portfolio changes (four new positions, one addition to an existing holding, and three sells) have improved the return prospects of our domestic equities. While the market has risen over 14% since September of last year (where our implied return expectation on our portfolio was 24.5%), as of January 17 of this year, our portfolio still has an 18.5% implied return. That is, if our securities were to rise to fair value and we collected the current yield, our domestic equities would return 18.5%. As far as we can tell, no valuation metric of the broad market has a higher implied return.
Of course, just like in golf, where if you are driving the ball well you are inevitably putting poorly, our fixed income positioning was handily trounced by the Barclays U.S. Aggregate Bond Index. Our fixed income positioning is short-duration with very limited Treasury exposure, while the benchmark is Treasury-heavy with much more interest rate sensitivity. Rates fell considerably in 2011 and thus we underperformed. As we have written in the past, we are comfortable with underperforming under such circumstances and maintain an unwillingness to put capital at risk of decline for a measly 1.85% in yield.
At the beginning of 2012, we are well-positioned for a few scenarios. In our fixed income positioning, we should experience positive returns–in both absolute and relative terms–if rates are flat or rise. Our equities should outperform the broad market under moderate market returns, flat returns, or a falling market. Conversely, if rates decline to new historical lows our fixed income securities will rise in value, but less so than the benchmark. And if equity markets rise substantially (greater than 15%), we should likely suffer in relative terms. While our expected return is greater than what is expected from the market, our positioning is more conservative. We do not own highly-leveraged (except our financials), overly cyclical securities. We do so not because we are averse to own these types of securities, but rather that we are reluctant to do so when their values are rich considering the risks to the economic landscape.
Economic data reported during December and early this month continued to show marked improvement. Employment inched higher, housing investment grew, and manufacturing accelerated. There was notable weakness in real core retail sales, but year-over-year readings were still encouraging. None of the data is overly strong, but enough so to make us still believe the U.S. economy will continue to “muddle through” over the next year. Euro area imbalances, however, remain unresolved and represent the greatest risk to market participants.
The ultimate end-game for Europe is still unknowable. The risk of a complete collapse is still possible, if not highly probable. It is for this reason that we have not been buying additional European exposure. What is knowable is that Europe is in for a long and difficult road to sufficiency. The path of austerity is painful and will hurt economic growth in the Euro area. That much we can assume.
Thank you for your continued trust.