After coming off of a terrific first quarter in which the markets soared 12%, reality seemed to return.  For the quarter, the broad market, as measured by the S&P 500 Index fell 3.3%.  However, that little statistic belies much of the volatility in the quarter.  In the first quarter, the focus seemed to be on the U.S. while the second quarter returned its focus to Europe and the ongoing financial issues there.  The quarter saw not one, but two Greek elections as the first one in May did not have a clear majority winner.  The controversy leading up to the second election in June surrounded whether or not Greeks wanted to bend to the austerity measures the European Union is forcing on the government – cut spending and increase taxes in order to reduce the billions in debt the country has racked up – or whether Greece would bail out of the Euro and return to their old currency system and spendthrift ways.    The big fear was that if Greece bailed out of the Euro, this would lead to runs on banks in other troubled European countries such as Spain, Portugal and Ireland and a collapse of the Euro as a currency altogether.  In the days leading up the second Greek election, the markets tumbled about 9.25% to nearly the level we started the year before rebounding just over 6.5% to finish the quarter only down a little bit.

This does not tell the whole story, however, as investors seemed to “run for cover”.  The threat of the European crisis leading to a recession was not the only issue we faced in the second quarter.  We saw a slowdown in growth in both India and China.  This slowing growth has put downward pressures on many commodities and commodity-related stocks.  Oil, for example, tumbled from $110 per barrel in March to around $82 per barrel by June.  While this is good for the U.S. as we now have lower gas prices and energy costs, it’s also indicative of the potential for a recession.  In addition, we saw some worse than expected jobs numbers in June.  All of this led investors to move from the hot sectors from the first quarter to safer sectors in the second.  Some of the best performing areas during the second quarter included utilities and consumer staples (i.e. food, tobacco, drinks) while sectors such as energy and financials suffered.

While we managed to “outperform” the broad market by virtue of losing less, we were a bit less than satisfied with our overall performance for the quarter.  There were a few notable successes for us this past quarter as we took advantage of some of the volatility in early and mid-June.  Among our better performing securities was Phillips 66 (ticker:  PSX) which was a spin-off from our ConocoPhillips (COP) holding in many accounts.  Phillips 66 – the name is a blast from the past – soared 28% from the time we received our shares at the beginning of April.  Another top performer for us was Progress Energy (PGN) which completed a merger with Duke Energy the first week in July.  We sold out of our shares of Progress Energy the end of June after racking up about a 56% total gain for clients and a 13% gain for the quarter.

Another success for us across many accounts was a return to a past strategy.  In mid-May, with more risk in the markets, thanks to Europe, we sold a put option that obligated us to purchase shares of Nucor Steel for $35 per share.  We collected $136 for every 100 shares we were obligated to buy, which seemed like a great deal to us.  You see, if we had been forced to purchase Nucor Steel when the option expired in June, our cost per share would have been $33.64 which would have provided us with a dividend yield on Nucor’s stock of 4.34%.  While this high a dividend yield was perfectly acceptable to us, when the crisis never materialized, we closed out this position and booked a gain of around $105 over a three week period.  This works out to a return of 3% for those three weeks.

Not everything was a success for us, though, as several of our top picks suffered for the quarter.  For example, Rent-a-Center (RCII) dropped 10%, Hewlett-Packard Company (HPQ) was off 15% and Communications Systems, Inc (JCS) fell 13%.  Despite the decline for the quarter in RCII’s stock price, we are still 10% ahead in this stock since our initial purchase.  And we didn’t just wring our hands as the other stocks fell.  We started taking advantage of this buying opportunity.  We added to our position in Communications Systems which lowered our average cost for our shares.  We still believe this company – which manufactures and sells connecting and wiring devices for the telecommunications industry – is a great long-term investment.  The company’s only debt is a mortgage on their company headquarters and they have over $4 in cash per share.  The company lost a key customer back in the spring, which was old news as it had been announced a year earlier but apparently took the market by surprise.  In the meantime, this stock is paying a 5.7% dividend yield, so we are being paid handsomely to wait for the recovery to come.  We are continuing to seek out good investment opportunities.  We do have several new names on our radar and we continue to evaluate them as solid, long-term investment ideas.  We only want to purchase a company when we believe we have a comfortable margin of safety.

Over the next few weeks, those of you with IRA’s that we manage will be getting a couple of forms from us.  These forms seek to upgrade the type of option trading we can do in your account.  We are seeking permission to enter “spreads” in your account.  These option trades, when used effectively, can hedge a position or portfolio or can add income to the account.  This is just one more tool that we wish to have available to better serve your needs.  If you have more specific questions about what a “spread” options trade is, please feel free to give us a call so we can more thoroughly discuss this with you.

And, as always, we truly appreciate the trust you have placed in us and the opportunity you have given us to manage a portion of your assets.  If you have any questions or need to discuss any issues please feel free to give us a call.


Alan R. Myers, CFA

President / Senior Portfolio Manager

Aerie Capital Management, LLC

(866) 857-4095