Is Your Portfolio Ready for the Next Big One?

What in particular would I recommend selling at this early stage in preparing for the Next Big One. I’m going to use examples from my on-line portfolios.

Selling emerging market banks kills two categories with one trade. Tomorrow August 16, I’m selling India’s HDFC Bank (HDB) and Itau Unibanco (ITUB) out of my Jubak Picks Portfolio. I’m up 103.74% in HDFC since I added this bank stock, the best in India in my estimation, to this portfolio on November 18, 2014. But India isn’t immune to a slowdown in the global economy nor to the consequences of its truly misguided policy in Kashmir. The shares are down 5.34% in the last three months.

The stock seems a good candidate for a sell on its own merits and it plays into my worries about a slowing global economy, a potential global recession, and a credit crunch. Brazil’s economy looks to be following its politics into chaos. Somehow Itau has managed to record a 0.48% gain for the year to date but with Brazil stocks again slumping on big growth and currency problems–the iShares MSCI Brazil ETF (EWZ) is down 10.75% in the last month, it seems a good time to step to the sidelines in Itau Unibanco. I have a 28.2% loss in the shares since I added them to the Jubak Picks portfolio on October 31, 2014.

Selling the retail stocks I added to my Jubak Picks Portfolios earlier in this year has the advantage of taking some potential recession risk (or at least slower growth risk) out of my portfolio and of locking in some decent profits. So as of August 16, I’m selling shares of Wall-Mart (WMT)  and Dollar General (DG) out of my Jubak Picks Portfolio. Selling Wal-Mart tomorrow takes advantage of a big bump in the shares–6.11% on August 15–due to the better than expected retail report for July. My position in Wall-Mart is up 14.86% as of the close on August 15 from my purchase on February 27, 2019. My position in Dollar General, which didn’t get a retail sales report bump on August 15 and instead fell 0.03%–is up 14.12% from my purchase on March 19, 2019. These are, indeed, low-cost retailers that could be expected to do well in a downturn, except that they source much of their merchandise from China and face tariff “inflation.”

Selling the secondary plays in the energy sector such as Schlumberger (SLB) and Tenaris (TS) in my 50 Stocks long-term portfolio. In my post of August 19 “Concho Resources highlights problems in the oil shale patch” I used Concho Resources, the biggest producer in the Permian Basin to illustrate the cash flow crunch facing U.S. oil shale producers. I don’t own much in the way of producers in the sector anymore–Parsley Energy (PE) is my mergers and acquisitions play that I expect to get taken out by one of the international or U.S. majors and Pioneer Natural Resources (PXD) is my one Middle-East disruption play. So I don’t have any really weak hands to sell right now.

But the way I read the trends, we’re looking at increasing softness in capital spending by oil shale producers (and by international majors too) that I don’t see ending anytime soon. Oil demand–which means oil cash flow–looks weak and short of some Middle East disruption I don’t see oil prices moving up strongly. An end of the year $65 a barrel (from $56 on August 19) is certainly plausible if global economic growth picks up against all expectations, but it’s hard for me to see a sustained recovery from there. Which means less cash for capital spending programs and less cash for companies that make the drilling pipe (Tenaris) and the companies that make the drilling tools and software and analytics (Schlumberger.)

Both stocks are in my long-term 50 Stocks portfolio because I think they are the best in the world at what they do. But I see demand for what they do falling. I once had a much bigger profit in Tenaris–I’m not showing a gain of just 4.46% since I added the shares to this portfolio back on December 30, 2008. And I had a substantial profit in Schlumberger that has now turned into a 19.04% loss since my December 30, 2008 buy. I will be selling these two stocks out of this portfolio tomorrow August 19. Other stocks in this category that I would sell now–but that I’ve already sold–include Helmerich & Payne (HP) and Diamondback Energy (FANG).

Selling emerging market (and developed economy with big emerging market revenue) stocks with big exposure to the slowing global economy–and especially the Chinese economy. Here too I find that I don’t have a whole lot of exposure to stocks with this description. I’ve been light on the sector for a while because the global economy was faltering before the U.S. economy. But I do have a few examples that I think can guide your thinking. And figuring out what to sell and what to hold among emerging market stocks focuses a few really important questions about  preparing a portfolio for the Next Big One. First, how BIG will the Next Big One be?

If we’re talking about a normal recession with global growth going mildly negative for a few quarters, then selling stocks that you think of as long-term winners becomes less pressing. It’s another issue entirely if you think we’re facing something like the Great Recession the followed on the Global Financial Crisis. Second, do you see some sort of infection vector that will pass the recession from one economy to another and increase the virulence of the disease as it spreads? Third, is this a uniform global recession–should there be a global recession, or are some economies going to be hit much harder? And finally, do you see a V-shaped snap back after a recession and a market dip of relatively short duration? My take is that so far we’re looking at a normal recession but that current  trade wars could extend the problem. The obvious infection vector is the dollar.

A strong and rising dollar will make problems worse for an increasing number of leveraged companies in an increasing number of leveraged economies. Right now I see a v-shaped recovery in some financial markets–China is the prime example–but a slow recovery in much of the world if for no other reason except that global central banks have very little ammunition available to fight another recession.

The European Central Bank, for example, can’t deliver much in the way of an interest rate cut since it’s key interest rate now is already a negative 0.4%. In my efforts to balance protection against a Next Big One that isn’t guaranteed to arrive but that could be really painful if it does, with the potential for future gains from growth in developing economies, I start with two lists. First, there’s a list put together by consulting giant McKinsey & Co. of countries ranked by how little cash companies have to cover their debt.

For example, in the United States, McKinsey found from studying corporate balance sheets 17% of companies have an interest coverage ratio of less than 1.5. As McKinsey said in its study, at these levels, corporations are using a predominant share of their earnings to repay their debt. In 2017, the year of the study 17% of U.S. companies fell below this safety marker. But the study, which concentrated on Asia, found that in 2017 47% of companies in India, 43% of companies in China, and 32% of companies in Indonesia had an interest coverage ratio of less than 1.5. Australia at 27% and the United Kingdom at 26% also have a worryingly high level of leverage. (This is especially true when you remember that this study looked at balance sheets from 2017. That is before Brexit and before the slowdown in the global economy that has hit Australia’s commodity export economy.) Second, there’s my own list of countries with political/economic management risk. These are countries where investors can’t count on central banks to act in the best interests of the economy as a whole because an autocrat has seized significant control over the central bank.

I’d put Turkey and Brazil on this personal list. Which leads me to this list of emerging market sells: Tencent Holdings (TECHY) out of my Jubak Picks Portfolio but remaining in my long-term 50 Stocks portfolio (with a gain of 2.58% since October 2, 2018), Latam Airlines (LTM) out of my 50 Stocks portfolio with a gain of 0.58% since December 30, 2008, Banco Santander Mexico (BSMX) out of my Volatility portfolio with a loss of 20.43% since October 2, 2018 and AutoLiv (ALV) out of my Jubak Picks portfolio with a loss of 27.01% since April 29, 2016.