Sizemore Capital First Quarter 2013 Letter To Investors

It seems we’ve been here before. In 2012, we had a massive first-quarter rally in which U.S. stocks outperformed most other asset classes. European shares lagged and concerns about the stability of the Eurozone caused a major surge in volatility.

Sound familiar?

History would appear to be repeating itself in 2013. Through the first quarter, our portfolio with the least exposure to Europe—the Dividend Growth Portfolio—has massively outperformed our portfolios with significant Europe exposure. As of March 31, the Dividend Growth Portfolio was up 19.7% vs. 10% for the S&P 500.

Individual security selection has been important—Two Harbors (TWO) has been a particularly good performer—but asset class has been far more critical. Much of Dividend Growth’s outperformance has been due to its high weighting in midstream master limited partnerships and in conservative retail REITS—both of which have outperformed the broader market. I expect both of these asset classes to continue to perform well in 2013, meeting or exceeding the broader market return, though I do not expect this degree of outperformance to persist.

The Sizemore Investment Letter Portfolio and the Tactical ETF Portfolio have been more of a mixed bag in 2013. Both portfolios were positioned to profit from a rebound in European and emerging-market equities, neither of which have performed as well as I had expected. And the market jitters surrounding the Cyprus bailout caused both portfolios to have a terrible end to the quarter due to their exposure to Spanish equities in particular.

As of March 31, the Tactical ETF Portfolio was up 6.3% for the year, trailing the 10.0% for the S&P 500. The Sizemore Investment Letter was up 3.3%.

All of this is water under the bridge; the key question is “what happens now?”

I expect Spanish equities to rally and to outperform over the course of 2013. Spanish equities are some of the cheapest in the world and offer great indirect exposure to emerging markets via their strong presence in Latin America. Of course, none of that matters at the moment. Right now, investors are scared to death of contagion, that a banking run in Cyprus will accelerate into a broader run on Spanish and Italian banks as well.

I do not see this happening, and even if it does, the European Central Bank is prepared to offer emergency liquidity to otherwise healthy banks—such as Sizemore Investment Letter Portfolio holdings Banco Santander (SAN) and BBVA (BBVA)—in the event of a run.

The bigger risk in my view is that Italy’s political stalemate disintegrates to the bond that the bond markets revolt and send yields to punishing levels. I do not expect this, but it is a risk factor that I consider significant enough to warrant watching.

As a contrarian investor, you have to make a judgment call. Do I go against the crowd and buy when others are selling, or do I join the crowd and sell before a small loss turns into a large one? There is no “rule” here, or certainly not one that is reliable. You have to use your own judgment and determine whether the returns you expect are worth the possibility for loss.

Today, in the case of Spanish equities, my answer is “yes,” though I am prepared to take some money off the table if the crisis accelerates. For now, I’m keeping an eye on Spanish and Italian bond yields. Spanish yields show no signs of rising aggressively and remain in the downtrend that started last summer. Italian yields started to rise in late January, though yields have since leveled off. Until I see panic in the bond market, I am comfortable being invested in European stock markets.