The week was short in days but long in disappointment. We got off to a nice start as May ended, but that proved to be a month-end mark up. The next three days were all down, especially Wednesday. For the week, Top 20 moved roughly with the market, Conservative Growth/Balanced lagged and Sector Selector ETF gained ground:
Top 20 declined 2.3%, which was about the same as the 2.29% decline in the S&P 500, so we remain slightly behind the market on a YTD basis. We had one stock up 9% (and that was after a big decline yesterday). I don't know why it had such a move on high volume. If I had to guess, as cliche as it sounds, there was a buyer, as it's not easy to buy that name. On the other hand, we had way too many names decline by more than 5%. Most of these were smaller names, continuing a trend of very poor liquidity for the smallest companies that has been in place for the past month. One of our weak names reported a slightly disappointing quarter, but I remain confident in this position, which is also in CG/B. One name that worries me is Skecher's, which has fallen more than I had envisioned. The company trades well below its asset value now, indicating either a huge market inefficiency or the potential for their inventory to be marked down. I continue to evaluate several new potential adds for the model. We currently hold 4 names that have been fundamentally disappointing and that now have questionable charts, and it seems prudent to consider culling at least one of them. I don't anticipate making any changes on Monday except a rebalancing between existing holdings potentially.
After hanging in very well considering we were "overweight" stocks in May, CG/B underperformed this week, declining 2.04% compared to the stock/bond index falling 1.24%. The largest part of the underperformance was due to our overweight of stocks. As a reminder, our benchmark is 40% bonds and 60% stocks, and we are currently positioned at 12% bonds and 74% stocks after reducing bonds in late May. So, about 1/2 of the relative decline against our benchmark was due to our stock/bond positioning. The balance was due to two of our stocks declining more than 5%, including the company I mentioned above as well as a retailer that has been doing very well but endured some profit-taking. Our median stock performance was actually in line with the S&P 500. Our YTD lead is now 0.55%.
Sector Selector ETF showed signs of life and now has climbed back to performance similar to the S&P 500 since we launched five weeks ago. For the week, one of our largest holdings, Emerging Markets, was actually up, which helped cushion our decline. While the S&P 500 fell 2.29%, Sector Selector ETF declined 1.85%. Our heavy exposure to Financials hurt, while our large exposure to Mega-Caps helped.
Market Outlook
I share my market outlook so that you understand the thinking that goes into my portfolio construction as well as my asset allocation for CG/B and Sector Selector. I am disappointed that the level I had been targeting for support (around 1320 on the S&P 500) failed to hold. I remain constructive, but I have to admit some concern. Two issues that bother me are the weakness in Financials and fraud in China. With that said, I believe that the major factor that is creating the perceptions of a "slowing" economy relates to the natural disasters in Japan, with the supply chain accelerating purchases in April and then normalizing inventories in May. I do not think that we will see another big down month for the market in June despite the weak start, which would follow last year's pattern when May fell 8% and June followed with a 5.2% kick in the groin. With that said, it's very possible that we test 1280 or so, but I continue to believe that the S&P 500 will touch 1500 later this year, a forecast I first shared in October. That would entail a 15% rally from our 1300 close (or 9.5% higher than the peak on May 2). At the end of April, I warned that we were a little ahead of pace (we were up over 9% YTD), while now we are certainly a bit behind. It would be nice if markets moved consistently higher, but that's not the way it works!
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Special Note
I was recognized this week in an article by Dirk Quayle on Seeking Alpha for my stock-picking abilities based upon my contributions to Seeking Alpha over the past 26 months. While I certainly am grateful for his analysis and agree with his conclusion generally, I want to point out that the only record I really care about is how these models are doing. As I have conveyed over the past month, I am disappointed to have taken what feels like not one but two steps backwards since April.
Relative performance, just like the market itself, ebbs and flows. Having good performance doesn't mean always getting everything right all the time but rather getting most things right most of the time on balance. Top 20 turned three last month. Most of you haven't been around that long, though some of you have. We survived a disaster in 2008, where a security lost all of its value - a mistake I vowed never to make again (and haven't!). We have had a few losers along the way, that's for sure. What has troubled me this year has been the number of poorly performing stocks, which has been higher than normal. Is this bad luck? Am I making poor decisions? Are my contrarian tendencies out of favor? I don't have all the answers, but rest assured that I am not satisfied with status quo, but I never am. For those who recall, even when we were up huge in Q4 of 2010, I kept looking for new ideas and trying to make our portfolios even better.
In the end, my clients (investment advisors) don't pay me because they like me, value my integrity or appreciate how hard I work, but they employ my services because I help them with superior stock-picking. I expect that to be the case with InvestByModel subscribers as well. Why pay $20 a month to match the market? I continue to have confidence in my abilities, and I expect that we will get back on track shortly. Top 20 has a good mix of growth and value, superior balance sheets, and several exceptional management teams. The last time we had a performance leak (about a year ago, and it was much worse), we bounced back quickly - just like PLPC over the past few days.
If you have any concerns, I encourage you to share them with me. One of the most disappointing aspects of my experience with Top 20 and CG/B was to see how human nature kicked in last summer, when we lost several subscribers when the markets were challenging and our performance was even slightly worse. Long-term investing, which is what Top 20, CG/B and Sector Selector ETF are all about, isn't always fun. It would be nice to be able to avoid these stressful periods and other challenges, but that's not very realistic. I do still plan to offer a "hedged" model that has less market risk, but it would be performing very poorly right now in all honesty. I also continue to plan an "equity income" model, which will likely be introduced next. As always, I appreciate your confidence.
Regards,
Alan Brochstein, CFA
www.InvestByModel.com