Invest By Model

Top 20 Trades

On Monday, we will be trimming one of our more challenging stocks and reinvesting the proceeds into one of our more recent purchases, a promising growth stock, as well as one of our other more challenging holdings.

On the sell, which will take the name down to an average position size, the stock has actually performed well since we added to it after a plunge in March after the CEO was pushed out.  The company met my sales growth goals over the past year, but profitability remains elusive.  The most appealing part of the story is the "cheapness", but cheapness is abundantly available today, so it's not worth having it be our largest position.

Adding to the growth stock makes a lot of sense to me - this is the time (after a market pullback) to do so.  I have a lot more confidence in the long-term prospects of this company and believe the valuation is very attractive too.  The stock will be "average" in size after the add.  Adding to the shoe manufacturer may be somewhat controversial, but I liken it to the add that we made in March to the name we are trimming it.  It is oversold and trading substantially below asset value, but it also has reasonable short-term profitability.  I understand the challenges here and feel the market is overly pessimistic about what is a short-term challenge.  In this case, the position moves from average to above average.  Perhaps my target, which I reduced to 26 (1.3X TBV) remains too aggressive, but even if the stock recovers only to where I first got interested in the name late last year, it will return 50% (rather than 90% I am currently forecasting).

Top 20 Moves Back on Top

This market is so skittish that the best thing I can say about it right now is that it is closed.  We were generally fortunate this week in the models, with Top 20 moving back into the green relative to the market.  Sector Selector ETF too made up some ground:

 
For the week, Top 20 rose, while the overall market fell slightly.  We have recovered what had been a pretty big performance gap and are now ahead slightly year-to-date.  We had some good performance among our smaller names, with one (SCVL) actually hitting a 52-week high.  Technology was strong this week, and it helped the model too.  Similarly, our Consumer names were helped by the steep decline in the price of oil.  With limited Energy exposure, we were set up well.  With just four days to go in the quarter, it appears that we will most likely underperform the S&P 500 this quarter unless we pull a rabbit out of the hat next week.  This has been a tough year so far for the model, with several investments not performing very well.  Historically, Top 20 has bounced back strongly from brief periods of underperformance, as it appears we may have begun to do over the past two weeks.

CG/B lagged slightly, hurt by the improvement in bonds (we are underweight) as well as some weakness in a few names.  Still, the performance remains solid across all time-frames.  For the week, the model declined just 0.2%, while the benchmark of 60% stocks and 40% bonds increased by almost 0.2% (this was the bonds rallying). 

Sector Selector ETF actually rallied a bit on the week and was able to cut in half its performance deficit, which remains slightly negative since we launched eight weeks ago.  Encouragingly, the performance has slightly bested the market over the past month.  While I am disappointed that the performance hasn't gotten off to a strong start, I feel fortunate that we have tracked relatively closely given how wrong I have been positioned on a couple of fronts (especially Financials).  One thing we did well was to exit Utilities and Health on some strength.

Market Outlook

What a frustrating market, at best.  Every time it looks like we might be ending this malaise, we fall right back in.  I am somewhat concerned that the near-term price risk to the market may be picking up, as slightly lower prices could pull in some significant selling.  With that said, I remain optimistic that the economy will continue to muddle along, with stocks likely to experience some PE expansion.  While I maintain my bullish "1500" S&P 500 call, I am quickly realizing that I may have been too optimistic.  As we cross the fifty yard-line, so to speak, next week, it leaves us quite back-end loaded given where we sit at this moment (up 2% YTD).  My technical review of the market doesn't match my nervous gut - the charts look quite good to me.  One positive for this week was that the lows from last week held.  It's too early to celebrate, but I am hopeful, as a little stronger market could pull in a lot of buying.  Yes, we appear to be at a fork in the road.

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As the quarter draws to an end, I like the positioning of CG/B and Sector Selector ETF.  We have some work to do with Top 20, as I need to figure out whether we should remain committed to the several names that aren't working particularly well.  I have several potential replacements that I am considering and may look to "upgrade" the model this weekend.  It's essential to be patient in these situations and not let emotions rule.  So far, we have been rewarded in the case of one name that fell hard in April but to which we actually added - perhaps now is the time to sell.  We also have one name that is getting reasonably close to its target that I am contemplating selling, though I expect to hold on for a little more.

Best Regards,

 

Alan Brochstein, CFA

www.InvestByModel.com

Trades in CG/B

We are rebalancing our holdings in Conservative Growth/Balanced on Monday.  We are reducing two large positions that have about a 30% return to my target over the next year, making them more average in their size.  Both have held up very well, with the Healthcare company up 7% YTD and the Consumer Staple company up 15% so far in 2011.  The latter reports on Tuesday, and, while I think the stock remains attractive, it seems prudent to take some chips off the table.  The piece I am trimming is a LT capital gain, rising 30% since the purchase in February 2010.

On the buys, we are adding to a Technology name that we trimmed about 10% higher recently.  While my confidence level honestly isn't that high given all of the carnage in the sector, it is sitting on big LT support and offers 51% price return to my target over the next year (based on just 13PE and adding in $1 per share in cash).  We are also adding to our Energy holding, which offers 45% price return to my projected target.  We had also trimmed this one at a higher price in March and April.

With the rebalancing, the CG/B equities, which are at about 74% (bonds are at 11.5% and cash about 14.5%), have expected returns on average of about 48%.  With our portfolio weightings, the return is about 49%.  Honestly, it seems a bit unrealistic on the surface, but I believe that our assumptions are reasonable.  Most likely, we won't get as much multiple expansion as I project (stocks could stay very cheap to corporate bonds) and maybe the earnings won't be quite as robust as analysts currently forecast. 

 

Partial Recovery Week

While it wasn't as good a week as I would have liked, I'll take it.  This was one of the quarterly options expirations that can lead to crazy moves in stocks and in the whole market.  All in all, it was a bit choppy, but seeds of potential recovery in stocks may have been planted.  Here is how we look:

 
Top 20 improved slightly on the week, increasing 0.8% while the market increased just 0.1%.  Not much of a rally!  For the year so far, we remain behind by a little over 1%.  As a reminder, after an extremely strong finish to 2010, we got a bit behind early in 2011 before rocketing to a substantial lead at the end of April.  The past 6 weeks or so have been very tough, with some of our smaller stocks suffering from poor liquidity while some of our "value plays" have been shredded.  Today was the first of what I expect will be several tweaks to the portfolio.  I have a few other names that I am contemplating, with an emphasis more on growth rather than value.  While we have a few companies with deteriorating fundamentals, most of the stocks are still seeing rising earnings estimates.  Valuations look exceptional, and most charts are still intact in my view. 

Conservative Growth/Balanced bounced back nicely this week, rising 1.3% compared to an increase of just 0.1% for the stock/bond index.  Our lead in 2011 over the benchmark increased to 1.7%, which is disappointing to me given where we were several weeks ago.  For now, we remain pretty fully invested in stocks (75% is our max).  While several of the names looked extended or overbought a few weeks ago (we sold some of them), the portfolio looks to be in good shape now.  I have a retailer I am considering adding, but I am watching it for now.

Sector Selector had a negative week relative to the market.  In fact, the model actually declined .4%.  I am rethinking our large commitment to Large-Cap Technology, as it appears that the outlook for these companies isn't quite as bright as analyst estimates imply - a potential value trap.  There are a lot of very cheap names, but they just keep getting cheaper.  During this past week, we were helped modestly by our exposure to Financials but hurt by Emerging Markets and Mega-Caps. 

Market Outlook

The market hasn't hit the official 10% mark that would denote a "correction", but it got pretty close.  Many stocks have certainly pulled back substantially more.  Pessimism is certainly rampant.  While I continue to believe that most of this pullback is over, I don't have a lot of conviction yet that the low is actually in.  Some parts of the market have already taken out the lows from March, but the overall market remains just above those levels.  It seems very possible that we may eclipse those levels (1249 on the S&P 500 - less than 2% away).  There are 10 economic sectors - here is the scorecard for whether or not they have taken out the March lows already:

1. Energy - yes
2. Materials - yes (barely)
3. Industrials - yes (barely)
4. Consumer Discretionary - no, but it's close
5. Consumer Staples - no, not even close
6. Healthcare - no, not even close
7. Financials -yes
8. Technology - yes
9. Telecom Services - no
10. Utilities - no

The key to winning since late April has been to own Staples, Healthcare, Telecom Services and Utilities.  CG/B had some overweighting of Healthcare, but clearly the models haven't been positioned for a slowdown in the economy that investors (or traders) are anticipating.  I didn't see the double-dip coming last year, and I don't see it this year.  Japan's natural disasters have wreaked havoc on supply chains around the world, and our own floods too have caused some issues.  While the economy seems "stalled", especially when it comes to jobs, I have been encouraged by aggregate income data.  Clearly there is a lack of confidence, and it is reflected in hiring trends and certainly in demand for stocks.  Unlike last year, I don't expect this malaise to linger.  If we don't see some improvement shortly in the stock market, there may be some more selling ahead, especially if we move back into the red for the year, like we did briefly in March.  I still believe that we can get the 20% gains that I predicted, but I am close to questioning my assumptions (which were 8% earnings growth and a 12% PE multiple expansion). 

 

Regards,

 

Alan Brochstein

www.InvestByModel.com

Top 20 Trade

We are selling one of our names that has performed poorly this year, though not so bad recently, to invest in a company that I believe offers better long-term growth. The stock we are buying has pulled back sharply after moving to an all-time high recently and now trades at a historically low valuation (15.5 PE net of cash for a company that has historically grown and will most likely grow in the future in excess of 20%).

Dismal Week

I want to apologize for the tardiness and brevity of comments, but I am traveling.  I will be meeting with the CEO and CFO of KBALB tomorrow.  This week was another very challenging one, with all of the models lagging the benchmarks.  Further, the market has taken out levels that I had hoped would hold and is as illiquid as it has been in a year.  Here is the performance update:

 

Top 20 continues to see severe pressure on two fronts, with our very small holdings suffering from poor liquidity and some of our turnarounds being abandoned.  For the week, our YTD performance relative to the market worsened by 1.6%, and we are now lagging the market by almost 2% with a flat return. CG/B had a tough week too, with the YTD advantage whittled to .3% from .6%.  The new ETF model, Sector Selector, saw its since-inception relative return move down about 0.2%.

Market Outlook

My bullish thesis for this year is certainly looking less likely, but I haven't yet revised my outlook.  We will need to reverse this June weakness very quickly, and perhaps this week, with its quadruple witching day on Friday, will fall into the time-frame.  I am fearful that a little more weakness could induce some panic selling in the near-term otherwise. 

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Over the next few days, I intend to substitute at least one new name for one of our challenged names in Top 20.  I may also have to move to get more defensive in CG/B. 

 

Regards,

 

 

Alan Brochstein

www.InvestByModel.com

Trade in Sector Selector ETF Model Portfolio

We are adjusting the Sector Selector ETF, selling our small holding in the Utility sector and trimming Emerging Markets to buy Microcap.  If you log in, you can get the updated allocations.

Over the past month, the decline in Microcaps has been steep - we have certainly paid the price in Top 20, which has dramatically underperformed the ETF model over that time.  The rally in Utilities since our launch (they are up, even after declining since mid-May, has been due to the decline in interest rates.  I recently shared my thoughts on the ETF we are purchasing on Seeking Alpha.  Emerging markets, which I still like, have outperformed marginally since we added to our initial position and have actually fared better than the S&P 500 since we launched in late April.  Our allocation there remains quite large.  Implicit in this trade is a bet on better liquidity and most likely improving equity prices.  Hopefully, that will be the case.

If you are a subscriber to the other models, I do have a brief comment to share.  I had mentioned last weekend that 1280 is an important support level.  I have to admit to being quite nervous now that we are here.  My view is that the next drop down, should it take place, will be to 1230.  If that proves the case, I will likely be taking some equity exposure away from CG/B.  While my fundamental outlook is positive, I am humble about predicting market trends and recognize that supply and demand issues trump economic forecasts, certainly in the short-run.  As we saw with the flash crash last year, there is no limit to where people will sell stocks without regard to valuation at times.  With Top 20, I am still struggling with several very poorly performing names.  At the same time, some of the things I might have bought to replace them are declining as well.  I continue to evaluate these alternative names.  As a reminder, though, Top 20 is not built upon market timing, so just selling isn't an option.  Also, I don't like to transact in highly volatile markets, as I am required to place my trades in advance of the marekt being open.  If you find that the volatility is too much or that your risk tolerance doesn't permit swings like this in the market, you should reduce your own exposure.

June Swoon?

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 

May Ends Strongly

The best thing I can say about this past month is that it ended.  Actually, I can say that thankfully it wasn't as bad as last May.  Will someone remind me to be careful next May?

Here is how the models look:

 

Top 20 retook the lead over the S&P 500 due to some very strong action on a few names on the last day of the month. After an exceptionally strong April, May was quite disappointing.  Some of this poor performance was just a function of what was going on in the market (very weak performance by the smallest stocks), but clearly I have picked a few bad stocks this year.  Of the 20 stocks we currently own, one was acquired during the month and trades 2% above our purchase price.  The one we sold was up at the time (FLIR).  Of the other 19:

• 2 fell more than 20%, including our biotech - this is just bad stock-picking
• 2 of our stocks that had been winners and are still up year-to-date fell 14-15% - ouch
• 5 stocks fell between 5 and 10% - these were smaller companies and, with the exception of one, seem to be doing just fine
• 2 Large-Cap Tech names fell 3-4% (slightly worse than the market)
• Our Emerging Market ETF fell 3%, slightly worse than the market
• 2 Small-Caps closed down slightly, faring a bit better than Small-Caps generally after very large increases on the last day of the month
• A Small Tech stock was unch - this was nice
• Our Large-cap Financial was up slightly - good stock picking there (thanks for the upgrade, Merrill!).
• Two of our beaten-down Small-Caps actually rallied on the month (mean reversion)
• Finally, we have a retailer that was up 3%, bucking the trend.

When we have 9 stocks down more than 5%, we aren't likely to do well, and that was the case.  Our overall portfolio on a share-weighted basis offers about 55% to my target prices, so I am optimistic.  This isn't the first time we have had a really weak relative performance, and it likely won't be the last.  I manage the model for a one-year time-frame, and sometimes the returns can be wildly different from what the market does in a given month.  Fortunately, that usually means a lot better.

CG/B lagged the market only slightly during the month.  Here, the issue was a little bit of Small-Cap penalty, but also the fact that we are underweight bonds, which performed well.  We had weak performance from 3 names, including a semiconductor equipment maker, a small bank and a large retailer.  On the other hand, 6 of our 13 stocks actually increased on the month. 

Finally, Sector Selector ETF  didn't have such a great first month.  While I got some things right, like avoiding Energy and Materials, three of the largest exposures (Mega-Caps, Financials and Emerging Markets) didn't help.  We kept it somewhat close with some smaller but correct bets on Healthcare and Utilities, while the large Technology bet was neutral. 

As always, thank you for entrusting me.  I always work hard and give it my best, but things don't always play out the way I expect.  While I saw some rotation potential in May (especially in Energy) and was cognizant that the market hadn't closed down since last August on a monthly basis, I was a bit surprised with how poorly smaller stocks fared.  It wouldn't have been practical to jettison all of our names, even if I had known, as I view the recent action as short-term in nature.  I believe that we remain on a solid path and hope to see our relative performance pick up again in the very near future.

Regards,

 

Alan Brochstein, CFA

www.InvestByModel.com