Invest By Model

Trades in Top 20 and Sector Selector ETF

In Top 20, I am adding to two names as I had suggested yesterday, taking them from about average to above average.  Of course, this means we have to sell something, and I actually really like what I am selling.  So, let me explain my thinking.  Our 2 buys, which take the names to slightly above average, have projected returns in excess of 60%.  Our 2 sells, on the other hand, which take the names from above average to about average for the holdings in terms of allocation, have projected returns of 47%.  So, the trades allow us to tweak the portfolio modestly.  My guess is that our sells will go up, but maybe we get an opportunity to add to them later at better prices.  The road is not straight, that's for sure, as both of our adds on Tuesday are to stocks we trimmed at higher levels in the past few months.

On Sector Selector, we are punting one of our S&P 500 sectors that we had already trimmed.  When I launched the model, this sector was on fire already, and I allocated to it because of momentum.  At this point, I think it's pretty much played out in terms of relative performance.  We are adding to another sector that is quite downtrodden in my view.  I hope that my timing is right here.  We are also adding to our Mega-Cap exposure.  This trade positions the model to correspond with my view that this flight to quality (certain sectors and Treasuries) is over, with investors likely to reenter "risk" trades soon.  An ETF that I have added to my watchlist and should have just bought LAST week is one that invests in Micro-Caps, which have really had a rough time lately.  Unlike Small-Caps, which have moved to all-time highs, they sit about 15% below the 2007 peak.  When I see more signs that the lows are in, I anticipate adding a small position.

Bottom In?

Today's weekly review will be somewhat abbreviated, as I will post a more thorough review of the month on Tuesday evening or Wednesday morning.  The last couple of days almost got us out of the slight YTD performance hole, but the early part of the week was quite rough.  Thankfully, May ends.  It certainly was not what I envisioned.  Here is how we stand as of this evening:

 
In Top 20, we gave up some more ground this week, with our return falling a bit more than the market.  One of the more disappointing performances came from our small Healthcare company.  We had trimmed this three months ago (and watched it run up a bit further), but it is lower now.  I anticipate adding to it in the near future and am also contemplating a new name.  Encouragingly, we had several stocks, especially some of our smaller companies, perform very well.  In fact, two of the retailers who went down after they reported have reattained their pre-report levels.  On the other hand, one of my favorite holdings (a Tech holding) had a slight miss and was hammered.  We had trimmed this one earlier in the year too - I would like to add to this as well.  While Top 20 is giving me some challenges right now, I would like to take just a moment to point out that it enjoyed its 3-year anniversary this week.  Since the launch in May, 2008, the S&P 500 total return has been 3.5%, while Top 20 has almost doubled.  We have had our challenges along the way, but we have always bounced back and then some.  While I am frustrated to be essentially in line with the market now after almost 5 months, I am not ready to throw in the towel on the goal of beating the S&P 500 this year by 12-20%. 

CG/B has performed much better this month than Top 20.  This week, it declined about 0.3%, while the stock/bond index actually climbed about .2% (bonds were very strong).  We are still sporting a lead (1.4%), but this is behind the pace I had hoped to see at this point.  The model is about not only beating the market, but also preserving capital.  Given the very slight decline this month, I am satisfied on that front.

Sector Selector actually gained some ground relative to the market, though it was quite minor.  The model declined ever-so-slightly.  This first month has been quite challenging, and I will detail what worked and what didn't in my month-end review next week.  For now, we are about 0.4% below the market since the launch, but I remain very optimistic about the positioning.

Market Outlook

I had called the 1320 area as likely support, so I was glad to see it hold near there (1312 low and 1317 closing low) and work its way higher.  We aren't out of the woods yet on this vicious rotation, but the action the last few days tells me it is quite possibly over.  I still believe that this was just profit-taking and not the beginning of a new trend.

Articles

• Joplin Tornado Blows Away This Dividend - Seeking Alpha
• 5 Big Dividends on Small Companies with Large Insider Ownership - Seeking Alpha
• 7 Dirt-Cheap Small-Caps that are Growing - Seeking Alpha
• 14 Energy Buys to Consider- TradeKing (note that paragraphs 2 and 3 should be removed)

It's a long weekend. I would love to say that I am taking a little break from all of this, but I will be at it full-speed tomorrow working on some repositioning in Top 20.  Hopefully, I will get a bike ride in too.  Have a safe and relaxing long weekend!

 

Alan Brochstein, CFA

www.InvestByModel.com

Soft Market Continues

While the market may have found its lows for May during the week, it was another challenging week for stocks and for all of our models.  Here is how we stand:

 
 

Top 20 has now given up all of the relative performance advantage earned early in the year.  For the week, Top 20 fell 1.25% while the S&P 500 fell 0.28%.  While this isn't the first time we have had a horrible month, it really disappoints me.  As I searched for explanations for the dramatic underperformance over the past few weeks, I concluded that there are two significant reasons.  First, unlike last year, when we really were fortunate to avoid landmines, we have several stocks that have performed very poorly due to fundamental issues.  As you can see in the table below on the far column, we have 4 stocks that have fallen by 18-27% YTD (we have owned three of them the full year and one we added down somewhat already).  Fortunately, we have also had several winners.  The net impact of winners and losers has been somewhat neutral, which is worse than what we usually experience (solid average performance with some big winners).  The second factor really goes further to explain the sudden retreat:  Micro-Cap weakness.  Before I go on, let me share the graphic:

 
The stocks highlighted in yellow are "Micro-Caps", meaning having market capitalization below $500mm.  As you can see, the list, which is sorted by MTD return, has them clustered way down.  This data is through Thursday.  The Russell 3000, which includes Large-Caps and Small-Caps, was down 1.5% so far this month, while the Russell Microcap Value, which is the flavor of these stocks, is down 5%. 

As the market has rotated aggressively this month, Micro-Caps have been hammered.  Individuals tend to own these stocks rather than institutions, and the sentiment figures I have seen have shown individuals to have gotten more bearish than institutional investors recently.  Top 20 succeeds because I am able to focus on these stocks - over time it works.  Several of them have no formal analyst coverage, which means if I am doing my job, we can take advantage of good deals.  As I look at these 7 names, I generally see extraordinary value.  A couple of the names are performing well YTD and appear to be simply consolidating.  One has been a real pig.  The others are performing well fundamentally in my view.  One of the reasons I like the space besides my analytical advantage is that we are in an environment of M&A - several of these are potential buy-out candidates in my view. 

I hope that this additional level of detail is helpful.  One of the most frustrating things for me in 2010 was how a few folks were flushed out of the market in May and June of last year, when the Top 20 struggled.  Of course, we came back very strong, as I expect we will this time too.  It's sometimes two steps forward and a step back.  In this case, it feels like two steps backward. 

CG/B had a tough week too, with the model declining by 1.44%.  So far this month, it has held in fairly well, declining 2%.  Two retailers we own had a tough week, and one of our Technology names was hit by a downgrade.  Bonds were strong this week, and we are well under our benchmark, which contributed further to the performance short-fall. 

The new ETF Model Portfolio, Sector Selector, is off to a rough start.  Our biggest deviations from the market are the ones that are hurting us - Emerging Markets, Mega-Caps and Technology.  For the week, the model declined 0.4%, just slightly worse than the S&P 500.

Market Outlook

As bad as things felt on Friday, it looks to me like the lows may have been set mid-week.  From the very highest level of the past 2+ years (1365.2, on May 2) to the lows of this week (1318.5 on Tuesday, just below the 1320 level I had suggested might be the low), we fell just 3.2%.  Not even a "pullback" in my book (that would be 5-10%).  This move has been highly rotational, with money seeking safety and moving out of formerly profitable areas like Energy and Commodities.  Many of the imbalances I have been discussing have now been corrected.  I think that those who bought into the adage "Sell in May and Go Away" are going to be in for a rude awakening.

Articles

• 5 Watchlist Names with Momentum and Good Valuation- TradeKing
• 5 Surging Apparel Companies - Seeking Alpha
• Blue-Chips that are Earning More than Ever but are Below Former Highs - Seeking Alpha

With the major rebalance of CG/B on Thursday, I don't expect to do any trades there on Monday, though I continue to want to lighten two names and to add to another.  I also have a low-leverage REIT I am considering adding.  In Top 20, I continue to cultivate several potential replacement names, though I don't expect to act just yet.  In Sector Selector, I may make an adjustment for the Energy sector.

Have a nice weekend!

 

Alan J. Brochstein, CFA

www.InvestByModel.com

 

 

Trades in CG/B

I have been waiting to reposition the Conservative Growth/Balanced model somewhat over the past couple of weeks and have decided to take most of the actions I had been considering or to at least move in that direction.  We have been carrying one name that has done very well since we bought it in February - it is overbought now and offers just over 20% price return to my one-year target.  Not bad, but not prudent to hold so much in my view.  We are trimming that as well as a recent Tech name add that worked out very well.  This one has a higher projected return but is somewhat overbought and is at resistance.  I hold it in Top 20 still - I think it is going higher.  On the adds, we are buying a consumer staples name with commodity exposure - surprisingly, it hasn't bounced though it seems to be on support.  It has 40% upside to my one-year out price target.  We are also adding to a Tech name that offers about 45% upside.  In these buys and sells, we are increasing expected return and also moving away from overbought and into neutral or even slightly oversold.  Finally, we are repurchasing some of our Energy position that we had trimmed in April at a nice discount to that sale price.  I would like to buy more of this one - will be patient.  It offers 40% or so to my one-year target and has corrected an overbought and extended condition that had prompted me to reduce exposure.  These trades are just as much about risk reduction as they are about improving return.

We are also paring our bond exposure.  I am sticking to my forecast that the returns for bonds this year will be roughly flat.  With the recent rally (since we added to our exposure), the near-term outlook is slightly negative in my view.  Our cash position will rise to reflect bonds heading towards our minimum 10%.  My guess is that we will get a chance later this year to buy them back cheaper.  If I am wrong, I don't expect the cost to be material.  Dividend-paying stocks are a much better deal than bonds in my view, and our portfolio reflects this sentiment.  I might have added short-term emerging market bonds (there is an ETF), but I think that its not clear that they fit in a conservative portfolio.  I would sure value your input if you have an opinion, as I believe that a 5% position would be consistent with the mandate of the model.  It offers an inflation hedge to some degree due to the currency angle.

CG/B Trade

We have a little cash in CG/B and are adding to a position in the Consumer Discretionary sector that I believe offers 38% upside to my slightly reduced target.  I continue to have a few trims ahead as well.

Tech Swap in Top 20

We are exiting a position Monday in one Technology name and buying another.  Our sell has done quite well since we added it earlier this year, while the purchase has been creamed lately on near-term disappointment.  This company offers approximately 50% upside over the next year in my view and perhaps a lot more over time.  We are also trimming another stock that I currently peg as having about 33% upside.

CGB Rises in a Tough Week, Top 20 Slips

What a strange week!  I am not referring to my visit to Las Vegas, where I spoke at the MoneyShow, but the market action.  I will update my outlook below, but the swings were wild.  Today was particularly challenging for Top 20 and the Sector Selector ETF models.  Here is how we stand:

 

Top 20 lagged slightly on the week.  We ran into a couple of issue specific problems that explained the poor performance on the week.  Our YTD lead has dropped to 1.32%, down from 1.83% a week ago and 5.44% just two weeks ago, at month-end.  I am very disappointed with the near-term results, but we have had months like this before.  A big part of the move can be attributed to Small-Caps underperforming larger companies over the past two weeks, but really the blame lies with some bad picks on my part.  I was very proud last year to have not a single declining stock during the year from my beginning of the year portfolio, though we did take a loss on at least one security purchased during the year, but this year has been more challenging so far.  Through the first four months of the year, we had been able to make up for those underperformers with lots of strong picks.  That hasn't been the case yet in May.  The fundamentals have deteriorated in the near-term for only one of the challenging stocks, so I remain optimistic that the price action is most likely short-term.  In any event, while I am not happy with where we are compared to the market at this point in time, I am glad to be up over 8% so far this year despite the weaker returns in smaller stocks.

For CG/B, the story is totally different and, fortunately, better.  CG/B actually rose this week, improving by 0.66% while its index of stocks and bonds was essentially unchanged.  This improved our performance advantage to 3.3% from 2.6%.  We accomplished this despite being underweight bonds.  Strangely, we had five names up 2% or more, and two of which exceeded 5%.  Just as I think the action in Top 20 is unlikely to persist, I would suggest that CG/B is likely to give up some of the rotational benefits it has enjoyed.  I have a couple of trims lined up and will consider pulling the trigger over the weekend.

Our newest model, the Sector Selector ETF, had a horrible day today.  The model is just two weeks old and has been essentially flatlining relative to the overall market.  Going into today, 5 of the 8 funds were outperforming the S&P 500 on the week, but two of the laggards, XLF and VWO, were two of our largest positions.  Still, on  a weighted basis, we were pretty close.  Today, though, we took hits on XLF and VWO again as well as XLK.  While we are off to a slow start, I remain optimistic that we are well positioned, though I am concerned about the Financials (see below).  I think that our "beta" or market exposure greater than the market, so the weakness is not helping.

Outlook

While I have no change to my bullish view, I must express a little caution.  It's not much different than what I said last week - we have a good shot of testing 1320 or so on the S&P 500.  The weakness in commodities and energy doesn't bother me at all, though I respect the near-term negative impact it can have on the market.  What bothers me is the weakness in Financials, as they took out their March and April  lows today.  This is a yellow flag only at this point, but it bears watching.  My key focal point for clues about the market remains corporate bonds and high-yield bonds.  There is certainly no reason for concern based on the price action in either of those.

Articles

• Energy Decline is Positive for Market - Seeking Alpha
• Webinar:  Finding Your Target Price- TradeKing (note - link live, but video not yet uploaded)

I have several names I continue to consider in Top 20, though I am not sure if I will be taking any action, though one is very close.  In CG/B, my near-term expectation is to take some profits in some of our over-sized positions.  I have a position that I will likely increase as well.   

Have a nice weekend!

 

Alan Brochstein, CFA

www.InvestByModel.com

 

Questions from a Subscriber

Ken T asks:

I'm interested to hear you take on CSCO. I think this is a case of over reaction to their guidance. In any case, the sentiment seems to be turning down to account for the end of QE2 in June. Volatility has certainly shot up as well. I'd be interested to hear your thoughts on both these topics.

Ken, thanks for the questions.  Before I address them, I want to remind subscribers that I am hoping to be able to post more current information in a secure environment (i.e. not open to the public, like this blog), but we aren't there yet.  I would add, though, that my new subscription blog service, My Own Analyst, addresses questions like these on a regular basis, in addition to offering actionable ideas both on names in the models on a short-term basis, stocks on my watchlist and even companies outside of my narrow focus.  If anyone is interested, I have a brochure now available at http://ab.esiteasp.com/MOA.nxg

On CSCO, I clearly have been early.  The rationale for buying it was valuation and sentiment driven, and they remain at play.  The stock is frustrating me, but I believe that it should reward us eventually, as INTC and JNJ have done recently.  With that said, it's not clear that a bottom is definitely in, but I expect that the lows, which were tested successfully on the open yesterday, are likely in.  Curiously, most of the EPS estimates actually are rising slightly.  While the guidance was light next quarter, they overachieved this quarter.  Next quarter marks the end of their year.

On QE2, I think it's a non-event.  Let's focus on the real issue, which is short-interest rates.  They should be higher!  I find it funny that rates rose after QE2 was announced, and they are falling now that everyone and his brother are citing concerns over the ending.  The bigger issue is to figure out how the eventual rise in short-rates (in early 2012 is my best guess, but maybe sooner if Q2 GDP numbers are stronger than expected and Q3 data continues to  be strong) will impact longer-term rates.  As I have been suggesting all year and really since last summer, let's watch longer-term corporate bonds and high-yield.  Stocks are still very inexpensive to these alternatives and are likely not at risk unless those start to really break down. 

Top 20 Trade

While I continue to evaluate several new names, I haven't yet decided to add any of them.  We are reducing one of our largest names to fund a purchase of one of our names that has below-average exposure but average expected return.  Our sell-candidate declined 2% last week, while our buy was down 11%.  We had reduced that name on strength earlier this year, and it is now technically safer, in my view, to increase our exposure.  By the way, with the pullback, I am projecting price return of about 52% on the entire model now over the next year.  While we could see a little more downside this week, this feels like a good time to me to add to exposure in general.

Rough Week for Top 20, CG/B and Sector Selector Fare Better

The good news is that earnings season is essentially over.  While it had been very kind to us, this week dealt Top 20 a couple of blows. Pile on Small-Cap underperformance, and we had a rotten week in Top 20:

 

So, first, let me apologize for tooting the horn last week!  It's not my nature, but I did it on the request of my marketing department.  Kidding aside, while we had two bad earnings reports, we had 6 really bad stocks.  For the week, Top 20 fell 4.75%, while the S&P 500 gave up about 1.7%.  Small-Caps, though, were hammered, with the Russell 2000 falling 3.7%.  For the year-to-date, we are up a little more than 9%, which is 1.8% ahead of the market.  I honestly can't recall such a bad week relative to the market for this model.  Clearly, I am disappointed by the way the month has started.

As I said in the title, CG/B fared better.  While our Energy stock had a rough week, it's one of our smaller positions.  For the week, the model declined just 1.2%, which was just modestly behind the combined stock/bond index.  Year-to-date, the model is now up 7.8%, which works out to be roughly 2.6% better than the benchmark. 

This was our first full week for the new model, Sector Selector ETF.  The model actually held up very well in my view, aided by a lack of exposure to Energy, Materials and Industrials but hurt by the emerging market exposure.  Exposures to Health, Technology, Consumer Discretionary and Utilities were beneficial.  So far in May, the model is up about .25% relative to the S&P 500.

Outlook

Last week, I expressed my concerns that we were ahead of pace and close to near-term resistance.  In fact, the market failed just shy of the level I had highlighed, 1375 on the S&P 500.  Further, I have been concerned about some imbalances in the market, specifically the love-fest for Energy.  I view this week's action as painful but actually good.  While many have been focused on the end of QE2 or, more broadly, the potential for a change in Fed policy, I have been most concerned about the rise in oil prices.  Our economy is really improving and, absent certain commodities, there is very little in terms of inflationary pressure.  High oil prices, though, could certainly be a drag.  With the mass exodus from oil and other commodities, it's not surprising that the initial move by stocks was negative.  This is called "de-risking".  Looking beyond the near term liquidity implications, though, the reversal in commodities paves the way for higher stock prices in my view.

I would expect that this little pause will be contained within 4 or 5% from the 1370 intra-day high on 5/2.  That suggests just a little more downside if my expectation proves to be true.  We closed today at 1340, and I expect that 1320 should prove to be the low if it wasn't already seen this week.  5% would be closer to 1300.  May could prove to be a down month - certainly starting off in the hole.  The market can't go up every day, week or month, but I don't believe that this is anything but a consolidation/rotation at this time.

Articles

• 13 Potential Energy Sells - Trade King

This was a very sloppy week.  For those who have followed me for a while, you know that market dislocations are fodder for me to adjust the models.  I think I took care of most of what I felt I needed to do with trades today, but there may be a few more for Monday.  I have several names for Top 20 that I am considering.  In CG/B, we have a little cash to spend, though I don't feel compelled quite yet.  For Sector Selector, you guys can have Monday off!

I will be presenting at the Money Show on Wednesday in Las Vegas.  If you happen to be attending, let me know, as I would appreciate the opportunity to say hello.  The topic is the same one as the webinar I conducted for TradeKing on Tuesday - target prices.  As soon as they make it available, I will provide a link to the TradeKing website for those interested in the topic.  These are my first efforts to interact with subscribers and prospects beyond the blog, and I am hopeful that I will be able to do more in this regard.  We are planning on adding audio clips to the Invest By Model website as well. 

Regards,

 

Alan Brochstein

www.InvestByModel.com