Covestor Manager Comments September 2013

Note to Chairman Bernanke: Taper or don’t taper, but whatever you’re going to do, do it already so we can get on with our lives.

The Fed’s indecision regarding its plans for its quantitative easing program has affected our portfolios in different ways. The Dividend Growth portfolio had a rough summer, giving up a fair bit of its outperformance from the first four months of the year. As of August 30, the portfolio was up 16.2% year to date vs. 14.5% for the S&P 500. But over the past 90 days, in which the S&P 500 has been flat, the portfolio was down a little over 4%.

Yet our Sizemore Investment Letter portfolio has had a great summer. Since late June, the portfolio has rallied by about 9%, roughly double the S&P 500’s return for the period.

Why the reversal of fortune?

It’s all about Europe.

In the Sizemore Investment Letter portfolio, I had overweighted Europe—and I was two quarters too early. After trailing their American counterparts for all of 2013, European stocks took the lead in the third quarter. Since bottoming in late June, European stocks—as measured by the Vanguard FTSE Europe ETF (VGK)—have had returns double those of the S&P 500.

What gives? After months of dismal economic news, the European economy is improving. Furthermore, while the Fed has indicated that tapering is a matter of “when” and not “if,” the European Central Bank had gone to great lengths to convince the investing public that it would not be following suit. ECB President Mario Draghi said in July that rates would be at current or even lower levels for an “extended period.”

My bullish arguments for Europe remain intact. European stocks are cheaper than their American rivals and tend to pay better dividends. They are also broadly hated by the investing public and very underowned. If you believe—as I do—that the Eurozone with muddle through, having the occasional mini-crisis but avoiding a major blow-up, then overweighting Europe makes sense.

What about American income stocks? I noted last month that income sectors, and REITs in particular, had stopped reacting to rising bond yields. That is a good sign that we might have seen a bottom in the income-stock sell-off that started in May. We probably won’t see a major rally in dividend stocks until we get clarity from the Fed about what tapering might look like and when it will start. I expect tapering—whenever it starts—to be modest, and I expect bond yields to drift lower. At time of writing, the 10-year Treasury yields 2.85%. I expect to see something more along the lines of 2.3%-2.5% by year end.

Meanwhile, I continue to see a lot of value in high-quality triple-net retail REITs and in select master-limited partnerships and dividend-paying stocks. An ideal investment for the Dividend Growth portfolio is one that pays 3%-4% in dividends or 5%-7% in the case of REITs and MLPs.

Importantly, I need to have a reasonable belief that the company will raise that payout in the years ahead. While I expect bond yields to fall, I’m fully aware that I could be wrong. And if I am wrong—and yields continue to march higher—I expect a high-dividend-growth portfolio to outperform a pure high-dividend portfolio.

Note: All returns information for Sizemore Capital portfolios are from Covestor.com. Past performance is no guarantee of future results.

Charles Lewis Sizemore, CFA, is the editor of the Sizemore Investment Letter and the chief investment officer of investments firm Sizemore Capital Management. As of this writing, he had no position in any stock mentioned. Click here to learn about his top 5 global investing trends and get your copy of “The Top 5 Million Dollar Trends of 2013.”