Michael Cuggino // Portfolio Manager // Permanent Portfolio (PRPFX)

Comments & Outlook

The European debt crisis has exposed structural issues that won’t be solved quickly. While it bears watching, investors should not heed every utterance that emanates from across the pond. The Europeans will have to make some long-term decisions about their preferred rates of growth, levels of social spending, willingness to finance some countries’ shortfalls and desire to maintain a common currency.

In the US, we’re seeing signs of anemic growth that I would liken to an undervalued stock waiting for some sort of event to unlock its value. Nevertheless, the US is still growing despite the regulatory, monetary, fiscal and political headwinds.

The US presidential election offers a stark choice between a slow-growing, command and control economy or a higher-growth, market-oriented economy. If we proceed with the model under which we’re currently operating, the US economy will continue to underperform its economic potential. Anti-business sentiment and excessive regulatory oversight have created an environment that’s not conducive to business development and growth. If the upcoming election results in a philosophical change in the direction of the country, then the US could unlock some of its growth potential.

Asia and the emerging markets are a multi-decade growth story. While emerging markets will outpace US growth this year, US companies with exposure to the developing world will continue to benefit from facilitating global growth. 

US sectors engaged in the production of raw materials necessary for economic growth–such as the industrials, commodities and energy sectors–have outperformed so far this year and that trend should continue. And some financial services companies have managed to strengthen their balance sheets, which has enabled them to stabilize and grow.

Recommended Strategies

In the US, the Federal Reserve has stated its intent to hold interest rates at their current levels through 2014 and it isn’t ruling out further stimulative measures. The European Central Bank has provided a similarly accommodative policy so that Europe has sufficient liquidity until it’s able to resolve its sovereign-debt crisis.

With all that liquidity from the world’s central banks sloshing through the global economy, investors need exposure to physical assets such as gold, silver and other commodities, as well as real estate and real estate investment trusts (REIT). 

REITs are a hard-asset play because their shares are underpinned by portfolios of real estate. These portfolios have growing rents, which enable their shares to offer healthy dividend yields.

At present, dividend-paying names offer solid yields supported by strong earnings, and their risk- reward ratio is superior to bonds. But investors should still have some exposure to investment-grade corporate bonds as a hedge against deflation and liquidity events. These securities not only offer steady income, they also afford some balance sheet protection against a decline in asset values.

What to Buy Now 

Wynn Resorts (NSDQ: WYNN) will benefit from a bump in disposable incomes as the economy improves. Additionally, the resort and casino operator is a play on growing economic prosperity in Asia. Although it’s domiciled in the US, it has a substantial presence in Macau. And the economy in Las Vegas, the company’s base of operations, is finally showing signs of perking up.

Freeport-McMoRan Copper & Gold (NYSE: FCX) is one of the world’s top copper producers and has broad geographic diversification. The company manages its operations efficiently and offers a healthy dividend.

Global demand for copper should remain strong. In addition to a tightening supply-demand balance, loose monetary policy should provide a significant tailwind for materials stocks.

Air Products & Chemicals (NYSE: APD) is the world’s top supplier of hydrogen and helium and its gas products, equipment and services are utilized by industries ranging from energy to health care. With international sales accounting for roughly 60 percent of revenue, the company is a play on global growth and offers a healthy dividend supported by earnings.

Gustaf Zinn // Portfolio Manager // Ivy Core Equity (WCEAX) 

Comments & Outlook

Currently, our economy is still in a muddle-along environment. The US appears to be in a sustainable recovery, as evidenced by improvements in economic data as well as key economic drivers such as the housing and labor markets. As the economy continues to grind higher, the US appears to be faring better relative to the rest of the world.

The recent commentary from the Federal Reserve was important because it suggested that if the economy weakens, then there likely will be additional monetary easing. Beyond that, the Fed will maintain a low interest rate environment far longer than we had previously thought. While the Fed may be able to mitigate some bad economic news via monetary policy, this approach will not completely offset any weakness in the fundamental data.

Over the past year, investors have gravitated toward companies that are returning cash to shareholders in the form of dividends and share repurchases. We expect this trend to continue, so this theme has become a significant part of our stock selection process.

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We invest across the value-to-growth spectrum by looking for companies that have a two- to three-year earnings power outlook that significantly exceeds market expectations. When you think about what could drive a company’s earnings power to beat market expectations, sometimes that’s a more growth-oriented, top-line story, and other times it’s more of a value-oriented, turnaround story.

With regard to market capitalization, we’re a little more flexible than most large-cap core funds because we invest in stocks that range from the biggest large-cap stocks all the way down to stocks with market caps as low as $5 billion.

We run a concentrated fund, with a portfolio of 40 stocks to 50 stocks, so we construct our portfolio with our highest-conviction names.

Our portfolio is divided almost evenly between stocks identified through rigorous fundamental analysis and stocks selected according to top-down investment themes. These top-down themes often include plays across multiple sectors.

Our investment department holds daily meetings which we use to develop most of our investment themes.

One investment theme that we’re exploring is the renaissance in US energy production, which is once again experiencing multiyear growth. The shift in US energy production from natural gas plays to oil shale formations will have meaningful investment implications. Some of our holdings in the chemical sector as well as a lot of the energy companies that we own such as Halliburton Co (NYSE: HAL) capitalize on this trend.

We’re also focused on the trend toward greater smartphone adoption through our holdings in companies such as Apple (NSDQ: AAPL), Altera Corp (NSDQ: ALTR) and Google (NSDQ: GOOG).

The other half of our portfolio is comprised of companies that we identify via fundamental analysis, including some restructuring plays. For example, Harley-Davidson (NYSE: HOG) has a new CEO who’s pursuing a manufacturing transformation of the company that will result in much higher margins than current analyst expectations.

And with regard to our aforementioned focus on companies that return cash to shareholders, Time Warner Cable (NYSE: TWC) offers a solid yield in a steady business that has good pricing power on the high-speed data front.

What to Buy Now

CBS Corp (NYSE: CBS) is a play on all the new ways in which media and entertainment content can be monetized. In the past, CBS was largely dependent on advertising revenue, but the company has recently started to earn high-margin revenue from television distributors who pay fees to broadcast its content.

While cable channels historically earned retransmission fees by offering content to cable providers, the broadcast networks have only begun to receive these fees from distributors relatively recently. At present, CBS is earning roughly 50 cents per subscriber each month, but that should rise to around $1.50 per sub on a monthly basis within three to five years. For the sake of comparison, ESPN receives roughly $4 per sub each month from its distributors.

Now that CBS has a more diversified revenue stream and is enjoying some success with the international syndication market, the company is becoming less economically sensitive, though this shift in its business model will likely take several more years to unfold.

Harley-Davidson (NYSE: HOG) enjoyed 20 years of unabated growth until its dismal performance during the Great Recession. To regain its footing, the company hired a new CEO who’s wringing greater efficiencies from its manufacturing facilities.

For the first time in Harley-Davidson’s history, management is really studying the manufacturing footprint of the company. At their main production facility in York, Pa., for example, they’ve succeeded in reducing the number of production lines from 40 to just one. Harley-Davidson should emerge from this transformation with an inventory management system that enables it to better align production with end demand. Additionally, management’s renegotiation of union contracts has resulted in a more flexible, lower-cost labor structure.

Still, this is a story that will require some improvement in demand. We built our position in Harley-Davidson when it traded in the mid-to-high $20s and we think there’s $4 to $5 in earnings power. The stock currently trades around $44 per share, but we believe it can go as high as $60 per share.

In a recent commentary, you characterized your outlook as cautiously optimistic, but your portfolio has a sizable weighting in consumer staples, which is a more defensive sector.

Many of our consumer staple holdings are actually higher-growth staples, such as Whole Foods Market (NSDQ: WFM) and Estee Lauder (NYSE: EL), as opposed to purely defensive stocks.

However, we also hold stocks such as Philip Morris International (NYSE: PM), Mead Johnson Nutrition Co (NYSE: MJN) and Anheuser Busch-InBev (NYSE: BUD). These are more stable businesses that offer good dividend growth stories and held up well during the periods of volatility the market suffered over the past several years.

Our portfolio currently holds a 15.5 percent weighting in consumer staples versus the S&P 500’s 10.9 percent weighting. At the same time, we are roughly two times overweight in consumer discretionary names, which are far less defensive.

So while we don’t feel super cautious about the economy’s prospects, it still has substantial room for improvement.

What is the possibility of a multiyear recession in Europe?

If Europe falls off a cliff, then that’s going to have global ramifications. While some areas of Europe could experience economic contractions, other nations such as Germany should persevere in a relatively strong manner and help moderate the otherwise dismal state of the region’s economy.

To be sure, a significant recession in any major global economy is a big deal, and that would affect the earnings outlook on a lot of companies.

We have reoriented our portfolio in the last quarter or so to become a little less cyclical in Europe and that’s somewhat reflected in our oversize allocation to consumer staples.