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
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- 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
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