The Federal Reserve has been unable to stimulate the U.S. economy, the presidential election is up for grabs and the European debt situation is a mess.
No wonder the four local experts in the Star-Advertiser’s 10th annual investment contest are uneasy about the outlook for stocks in the second half of the year.
But despite the uncertainty, the experts reached the midyear point with flat to impressive returns in their hypothetical $20,000 portfolios.
Dwight Melton, co-founder of the Hawaii Stocks and Options Group, is well on his way to becoming the first four-time winner of the contest. Melton, who won in 2004, 2005 and 2007, was up a commanding 34.5 percent at midyear after his portfolio climbed to $26,905.12. Still, that was down significantly from a 48.6 percent increase after the first quarter.
He said the first half was mixed, with surveys on durable-goods orders and exports "reassuring" but consumer confidence and the leading economic indicators "not so strong."
"I think stocks will stay in this range for now, given the current conflicting economic signals, but could later break to the upside," he said.
Richard Dole, CEO of Honolulu investment bank Dole Capital LLC, also had a double-digit percentage return with an 11.2 percent gain to $22,229.47.
The remaining two experts had returns that were virtually flat. Norm Caris, a Kauai resident and manager of institutional sales for investment bank Caris and Co., was up 2 percent at $20,389.76, while Barry Hyman, private client group vice president for the Maui branch of FIM Group Ltd., was down 1.3 percent at $19,748.11.
By comparison, the Dow Jones industrial average had a total return of 6.8 percent, the Standard & Poor’s 500 index was up 9.5 percent and the Nasdaq composite index was ahead 13.3 percent.
Dole said the market is slightly ahead of itself this year, taking into account the European debt situation and slow growth in the U.S. and emerging economies. He said slow growth has prompted investors to favor dividend-paying stocks, but taxes on both dividends and realized capital gains may increase next year with the scheduled expiration of tax cuts enacted under former President George W. Bush.
"Both low interest rates and cost of capital are key positives for the market going forward," Dole said. "Energy prices are tough to call. I do believe that the market will end the year higher than last year, but I can’t envision a runaway market."
Caris points to the upcoming election as dictating what plays out in the market during the rest of the year.
"If it looks like (Mitt) Romney is gaining an edge, the stock market will rally," Caris said. "If it looks like (President Barack) Obama will be re-elected, and nothing is done about Obamacare (the federal health care overhaul), it will be broadly perceived as being very negative for business and will drive stock prices lower."
Hyman said investors are anxious and that sentiment during the first half of the year swung to extremes on each bit of news.
"This is classic retail investor behavior where emotions cause investors to sell too early and buy too late," Hyman said. "When the dust settled, investors sold off many already beaten-down stocks in favor of stocks with better momentum but not nearly the value proposition. I suspect it will continue until there is more clarity and certainty in the U.S. and Europe, which will likely not be until the end of this year or 2013 at the earliest."
Melton’s best performer during the second quarter was the Direxion Real Estate Bull 3X (up 7.6 percent), a real estate fund that returns 300 percent of the MSCI U.S. REIT Index. Overall, though, his holdings declined 9.5 percent during the period.
He made one change to his fund for the third quarter by selling Direxion Technology Bull 3X and buying Direxion 20-Year Treasury Bull 3X, which returns 300 percent of the performance of the New York Stock Exchange 20-Year Treasury Index.
"I am still basically positive on the market but do caution that the head winds coming from Europe can produce turmoil from time to time," Melton said.
Caris had the best individual performer of any expert in the quarter with textile product manufacturer Unifi up 17.3 percent. But he sold Unifi, as well as semiconductor component manufacturers RDA Electronics (down 9.2 percent) and Marvell Technology (down 27.9 percent). In their place, he picked up Kratos Defense Systems, which provides defense primarily for the federal government; Lam Research, a manufacturer of semiconductor processing equipment; and Netflix, the largest video-subscription service.
"We still favor technology," Caris said.
He said Kratos "is right in the sweet spot of the defense business" and that Lam Research is gaining share from competitors and is underappreciated following its recent acquisition of Novellus Systems. He added that Netflix is the market leader in streaming movies, has strong growth and is in a strong position following its recent deal that allows customers to sign up for Netflix directly through Apple TV.
Dole, the defending contest champion, declined to add Matson Navigation Co. to his holdings after Honolulu-based Alexander & Baldwin spun off the ocean shipper into a stand-alone company. Matson, which began trading separately at the start of the third quarter, would have given Dole six investments in his portfolio, and contest rules allow only five. Given a choice between keeping one of the two, he opted for A&B. The old A&B was Dole’s best performer in the second quarter with a 10.6 percent return.
"I suspect that investors seeking dividends will choose Matson over A&B," Dole said, noting that Matson offers a 2.4 percent dividend and A&B no longer offers a payout. "Long-term investors looking for capital appreciation might favor A&B over Matson. With this choice and a desire to share in the future of the company, I am replacing the 100 shares of the old ALEX (its ticker symbol) with 200 shares of the new ALEX, based on the company’s prospects of increasing shareholder value through the development of its Hawaii real estate holdings."
Dole is also bullish on the technology sector.
"Many companies in this industry have large cash balances and are in the position to increase dividends or repurchase shares," he said. "The fundamentals in this industry are improving. Business investment in technology seems to be growing faster than other avenues of business investment. Such business investment tends to boost efficiency and productivity, by allowing customers (business owners) to produce more with fewer workers."
Dole also said that low mortgage rates should at some point be beneficial to the real estate industry.
"The cost of real estate can’t be avoided for long because, according to the old saying, whether you rent or whether you buy, you pay for the space you occupy," he said.
Hyman, a three-time contest winner (2006, 2009 and 2010), fell into the red at midyear after his holdings declined 15 percent during the quarter. His best performer was Gaiam (down 2 percent), a producer and marketer of lifestyle media and fitness accessories.
He said the low-interest-rate environment is helping stocks in several ways.
"It makes the cost of business lower and thus profits higher, it encourages stock investing because there is negative real return on cash and it encourages borrowing, thus consumption," Hyman said. "The worry is that it may also ignite inflation if central banks don’t reverse course once sentiment has turned up. This potential for inflation is yet another impetus for savers and retirees to own stocks."
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