News Analysis date published New: 
Wednesday, July 11, 2012 - 13:00
New Date created: 
Wednesday, July 11, 2012 - 13:17
New Date last updated: 
Wednesday, July 11, 2012 - 13:00

I'm Selling This Major Portfolio Holding

Wednesday, July 11, 2012 1:00 PM

For subscribers to my $100,000 Real-Money Portfolio, you'll notice a clear set of rules I live by: Every pick has to have solid downside support, potentially robust upside and clear catalysts in place. Having just two of three investment merits isn't good enough. You need all three to preserve capital and post solid gains.

You should be thinking about these factors as you review your existing investments through the upcoming earnings season. If key factors behind your thesis start to wane, then you need to seriously assess whether it's still worth owning that stock.

Well, one stock in my portfolio just broke the rules, so it's time to sell it. It still has limited downside and potentially robust (long-term) upside. But the single-biggest catalyst underpinning my investment thesis has changed.

I'm talking about Alcoa (NYSE: AA), which I first added to my portfolio in early January at an average price of $9.59 a share. Back then, I noted that Chinese government appeared intent on reducing that country's output of aluminum, and in time, domestic demand would exceed domestic production, making China a net importer.

Yet just two months later, I noted that Chinese production cuts were not happening as planned. As a result, I predicted that "aluminum may be headed for a pullback." At the time, it seemed premature to assume that the Chinese government would completely derail the supply and demand balance for this industry. So I chose to sell half of my 1,000-share stake in Alcoa (at a profitable $10.21 a share, for a 6.1% gain).

Well, we can now conclude that China is aggressively boosting output and will keep aluminum from rallying any time soon. Chinese smelters are now on track to add an additional 1.4 million tons of aluminum smelter capacity this year, according to a just-release report from Merrill Lynch. (The fact that Europe now looks a lot worse than it did six months ago, doesn't help the investment backdrop).

So if a key pillar of my investment thesis (and catalyst for medium-term upside) is now gone, then I need to be disciplined and sell my remaining 500-share stake in Alcoa. Considering my 6% gain on the first 500 shares sold and the likely 10-11% loss on the remaining share sale, my investment in Alcoa has been a wash.

Yet this whole scenario underscores my investment approach in this portfolio. Even if a stock fails to fulfill the investment thesis I've laid out for it, I still want to be shielded from major losses. In fact, it's unlikely that Alcoa has much more downside from here, thanks to a robust balance sheet, led by a global network of low-cost smelters. And I'll be one of the first people to hop back on board the "Alcoa trade" when industry dynamics turn.

After all, Alcoa is doing an outstanding job in the areas it can control. Management has been aggressively paring the cost structure, while low aluminum prices have enabled the company to post solid margins in its downstream products such as extruded aluminum sheets. The just-announced $1.4 billion contract with Airbus was likely aided by the low prices of aluminum.

I still think this stock could reach $15 or $20 in a few years, but also think it's dead money for the rest of 2012. And with so many other inexpensive stocks available that have near-term catalysts in place, I want to free up funds to own them.

When will Alcoa become timely? Look for these mile markers:

If and when China decides to curtail aluminum production, then aluminum prices will likely start to rise.

When signs emerge that Europe is exiting a continentwide recession and is on track for meaningful gross domestic product growth, the supply side of the equation will likely start to perk up.

When the U.S. economy is on a sustainably higher plane of growth.

Again, I don't think we'll be talking about these catalysts for at least the remainder of 2012.

Action to Take -- > I will sell 500 shares (or roughly $4,200 worth) of Alcoa 48 hours after you read this.

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David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC owns shares of AA in one or more of its “real money” portfolios.