The investment team made the decision to take advantage of recent market strength and take our risk/return perspective from extremely favorable back close to neutral.  The decision is the result of economic factors we have pegged as worthy of concern and further monitoring, a potential peak in short term investor sentiment and the uncertainty surrounding the future currency situation in Europe.

Europe:

To some extent a story can become tired.  Investors become immune to the consequences of certain events because they are just plain bored of hearing about them.  Closing one’s eyes to the crisis in Europe does not make it go away.  The issue on the horizon is Portugal.

From the Financial Times:

Portuguese Debt Looms over Europe

“The brutal truth is that financial markets are pricing in a Portuguese default at some point in the next five years. They predicted the same fate for Greece last year, having concluded that a €110bn EU-IMF aid plan, arranged in May 2010, was insufficient to extract Greece from its debt trap.

For at least six months, however, European governments have assured private investors that the only country in the 17-nation eurozone on whose bonds they will be asked to accept a loss is Greece.

Their “haircut” will be no mere snip and trim. It may amount to 70 per cent of the long-term value of their investments in Greek debt. Still, it is a deal that will, in principle, lift rather than depress the survival chances of Europe’s monetary union.

But if holders of Portuguese debt were to take a haircut, this would destroy the contention of European leaders that they had successfully quarantined the Greek problem from the wider eurozone. Even before the haircut became a reality, anxieties over the integrity and value of private holdings of Irish, Italian, Spanish and other government bonds might rapidly resurface.

In other words, the relative market calm of January should not blind governments to the risk that the extreme tensions of last August and November might return.”

Greece is, essentially, in a process of incremental default.  If Portugal comes under the same program, it would be more difficult to believe Spain and Italy are immune.

China may perhaps be finally ready to come to the bailout negotiation table, Angela Merkel was is in China discussing/lobbying for EFSF Chief Klaug Regling’s “co-investment fund” proposal.

Global Economy:

This data point may have brought China to the negotiation table.  The Baltic Dry Index tracks world wide shipping prices, an indication of the volume of global commerce.  As an export economy trying to engineer a soft landing, this global slow down would be worrisome.

One data point does not make a trend, but we are always wary of the proverbial canary in a coal mine.  The spot price drop for shipping is noteworthy, but there are other factors to consider.  The supply of shipping capacity is expanding at a rate of 19% annually, global growth is more like 3.5%.  New, innovative and cheaper containers are coming online; old supply is being sold but will remain in use.  Is this global trade slowing or merely a supply glut in shipping capacity?

It is common knowledge that the emerging markets of the world have helped sustain global growth during recent back to back crises in the US and Europe.  The US seems to be gaining some traction with it’s recovery, this would be good for the entire globe.  Emerging market economies have, in the past, cycled through a 15 year boom-bust cycle.  Boom 1975-81, bust ’82-89, boom ’90-96, bust ’97-’04, boom ’04-’11.  Here we sit in 2012, emerging markets are at the tail end of a tightening phase.  There is plenty of discussion surrounding a soft or hard landing for China, we are watching.

Investor Sentiment:

Behavioral factors in markets are always worth watching.  In addition to technical factors indicating momentum, we also monitor investor sentiment, mutual fund flows and short interest.  We do not want to be part of a herd walking blindly toward a potential pitfall.  The herd mentality is determined both by the recent moves in asset prices and by media headlines.  Short term sentiment indicators are/have peaked and we would not be surprised by a short term pull back in markets.

American Assn of Individual Investors’ Survey

These are some of the factors, which in combination, lead to our decision to reduce risk in tactical portfolios ahead of the employment numbers.

Global Opportunites:

PCH

Back in early October we made a decision to allocate capital to timberland.  We saw an uptick in construction spending and made a call on raw lumber.  Potlatch is a US company with vast holdings of raw timberland.

Recent housing data indicates that we are still bouncing along the bottom, we are still optimistic.  The recent stock performance has been underwhelming and with distribution channels into Asia, this may not be the right company.  We still like the sector, Potlatch will remain on our watch list, but for now we will re-evaluate and offset some gains, a 13% loss.

Excerpt from the recent supplement to the earnings call.

OUTLOOK

“Our outlook for 2012 remains cautious and conservative, which is in line with our harvest and dividend reduction announced December 5th. Although there was a slight increase in housing starts late in 2011, the housing market remains depressed and we expect only a modest improvement in housing starts in 2012. In our Wood Products segment, although there has been a small near-term improvement in some markets, we expect lumber prices in 2012 to be very similar to 2011. With the continued weak housing outlook and the impact of our customer’s mill closure in Arkansas, we plan to reduce our harvest volumes by 17% to approximately 3.5 million tons for 2012. In our Real Estate segment, although we do not anticipate any large non-strategic timberland sales in 2012, we will still have smaller sales of non-strategic properties. In addition, we expect a consistent level of rural and HBU sales to continue, at slightly higher prices. We remain in a position of strong liquidity with over $70 million of cash and short-term investments on our balance sheet. We have debt maturities of $22 million in the first half of 2012 that we will be able to cover with our cash on hand.  We are cautiously optimistic about our outlook as we move into 2012 and beyond, as we expect the recovery of the housing market to begin slowly in the near term but then accelerate as we move into 2013, and demand from China should continue to positively affect our business,” concluded Mr. Covey.”

CTXS

Citrix is a leading provider of desktop virtualization solutions.  This is a growth stock we added during weakness, again back in the first week of October.  The stock has performed very well.  But, the street is expecting 80% growth in earnings for 2012 and the stock carries a beta of more than 1.5.  So execution by management and continued economic strength become paramount to the continued success of Citrix.  Citrix has moved beyond our fair value estimate, given its potential for poor performance should the market lose steam, we have booked the 20% gain.

ABV

Ambev is the largest producer of beer in Brazil and the dominate player in all of South America.  They also have a significant presence in Canada.  Ambev was a conservative portfolio add in 2011, and has performed beyond expectations.  On relative valuation metrics AmBev, with a forward P/E of 21+, is beyond our near term target and thus we took the 21% profit.

World Allocation Portfolio:

We feel there is increased probability for an outlier event in Europe.  Portuguese interest rates became volatile mid week with 10yr gov’t note yields sky rocketing above 17.25%.  We added to European exposure during the extreme pessimism last fall and have elected to sell into the recent strength and to eliminate 50% of our current developed international equity exposure, 5% of the portfolio.

 Select Countries:

As portfolio managers, we periodically undertake an internal review of decisions we have made.  The exercise is called attribution.  In 2011, we made an active decision to allocate away from Europe and concentrate our exposure to the far east.  The results, a nuclear disaster in Japan, flooding in Thailand, large capital surges from the quantitative easing in the US and retrenchment because of tightening and economies leveraged to the capital of developed European nations.  We won’t forget.

Last November, upon the release of a UN document detailing credible evidence of Iran’s nuclear ambitions, we sold our exposure to Israel.  We feel the west is being proactive with this issue and this was one positive takeaway from President Obama’s State of the Union.  Israel is an innovative country, a hot bed for start up technology firms and an outstanding central banker in Stanley Fischer.  The valuations for Israeli equities is extremely compelling at a forward P/E of 5.

This week we made a small move away from Asian exposure, selling 45% of our exposure to Taiwan on recent strength and reallocating to Israel.

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For information on Alhambra Investment Partners’ money management services and global portfolio approach to capital preservation, Douglas R. Terry, CFA is reachable at dterry@4kb.d43.myftpupload.com