Invest By Model

Audio Research

While we are having technical difficulties getting the research onto the site, we have an exciting announcement:  We will be providing audio updates selectively on names in the models.  Depending on the feedback we get, we hope to utilize this new feature extensively.  We will provide instructions on how to access the research as soon as it is up and running.  In the meantime, here is an example:

Download DORM092611

 

Top 20 Trade Snafu

Well, the timing is horrible, but the new name we are adding today, which isn't widely covered, was initiated by a new broker today with a 55 target.  I had warned against chasing this somewhat thin stock, so I wanted to pass along this news.  The stock is likely to trade well.

Trades In All Models

Seeing that the world isn't ending, at least this morning, I have rebalanced each of the models. 

For Top 20, we are selling the rest of a Technology name that has been a disappointment since earlier this year and trimming another one that has been outperforming.  Technology has been one of our biggest sectors in the model, and the sector has been doing well of late.  The sell offers 39% return to my target, while the trim is 44%.  The trim is slightly overbought, which is in stark contrast to the rest of the market.  On the buy, we are adding a name that we had sold last year in the Consumer Discretionary sector after enjoying a huge run.  It has declined subsequently, though it went on to higher highs after we sold.  This name offers 55% roughly to my target.  Best of all, I think that the company will do very well in a continued sluggish environment.  It really stands out in comparsion to its three largest customers in terms of valuation and recent performance.  I believe that it has been primarily a victim of its own success (profit-taking).  The name isn't widely followed and trades somewhat thinly (please don't put a market on open buy!).  We are also adding to our single Financial name in the model.  I reduced my target, but it still offers 73% return over the next year.  The stock had been doing quite well but was slammed as Emerging Markets cratered last week.

In Conservative Growth/Balanced, we are adding a small position in a new name.  This Financial has been slammed due to its investment portfolio's exposure to Europe.  I have reviewed the portfolio as well as the earnings power of the company and have concluded that the market has most likely overreacted.  Still, while this is a very "blue-chip" company and will certainly face no liquidity issues (it's an insurance company), I am taking into account some more potential downside and keeping the position smaller than the 70% return to my target would normally warrant.  My target is below the 52-week high.  We are buying this from cash, which was raised a week ago when we sold MCHP, bringing our equity exposure back to the maximum of 75%.

In Sector Selector ETF, we are continuing the shift that we began earlier this month from Technology to Industrials.  I see a disconnect here, as the two sectors should track each other fairly well given that both have similary high exposure to overseas sales. 

"Significant" in Fed Statement Slams Stocks

After one of the best weeks in years, we endured one of the worst, with volatility persisting.  The absolute returns were sharply lower, though Top 20 and CG/B tracked the market relatively closely:

 
Before I discuss each of the models, I want to briefly share my perspective on what happened this week.  We had moved to the top of the range since the market broke down in early August on Tuesday, but reversed sharply to end the day down.  On Wednesday, the FOMC concluded its two-day meeting and announced, as widely expected, its plan to extend the maturities of its Treasury holdings as well as to begin reinvesting principal and interest payments back into the mortgage market again.  The trouble with the market really began when the statement was released.  Already the FOMC had telegraphed its concerns about economic deterioration at the last meeting, in August, when it shared for the first time that rates would likely remain low until 2013.  Perhaps to justify its policy action, but also to encourage Europe to act quickly to fix its financial mess, the FOMC cited a "significant downside risk" to the economy.  The market sank 3%, but the trouble really kicked in on Thursday, with emerging markets breaking their old lows substantially for the most part (particularly China) and precious metals breaking down as well.  By the end of the week, the U.S. market was one of the few that hadn't taken out its August lows, though many key stocks surely did. 

Top 20 declined by 7.3%, which was about 0.76% worse than the S&P 500.  Given how much more dramatically smaller stocks fell, it might have been worse.  Performance was quite varied, with a few stocks actually rising.  On the other hand, we had a few stocks that were slammed to 52-week lows, including our Energy stock, our Financial stock and our Emerging Markets ETF.

Conservative Growth/Balanced declined by 4.45%, which was .87% worse than the blend of stocks and bonds. We retain a slight advantage relative to the benchmark so far in 2011.  Here, we were hurt by the same Financial stock that impacted Top 20 and our overweight relative to the benchmark (we had about 13% more stocks than the 60% in the hybrid index).  One stock managed a gain.  I have identified a new opportunity and expect to rebalance a bit and to use our excess cash potentially.

Sector Selector ETF fell 8.25%, which was 1.7% worse than the S&P 500.  I continue to be set up entirely incorrectly for the environment that has persisted over the past two months, with recent trades exacerbating the situation.  During the week, Financials, Small-Caps and Emerging Markets were all sharply lower than the the overall market.  While we have reduced our exposure to Mega-Caps and to Technology, our remaining holdings fell substantially less than the S&P 500.  While I may be forced to change my outlook in coming days, I continue to believe that our positioning will prove to be advantageous.

Outlook

I have been discussing three scenarios over the past couple of months.  The least likely scenario in my view, which is that the the lows of early August are taken out significantly, certainly feels more likely after a week like this.  After all, most other markets have done so already and are officially in bear markets.  My optimistic scenario (that this was all a big mistake) is looking less likely, but I wouldn't rule it out.  The world is fixated on European banking issues related to the debt of Greece and other weak EMU member countries (Italy, Spain, Portugal primarily).  For us to rocket out of here requires a credible fix, which is complicated but possible, but it needs to happen very soon. 

I continue to think that the most likely scenario is that we come out of the range we have been in positively, but that it takes a while.  This is not fun, because the environment stays risky and volatility remains heightened.  Hence, a week like last week followed by one like this week.  Did this week's action kill this scenario?  I don't think so, but I have to admit that my own fear level escalated sharply on Wednesday after hearing the Fed's statement (significant risks).  The cynic in me believes that the Fed is trying to push Europe to step up and implement a unified solution (just as they appear to be shaking their finger at Congress and the President).  It's true though, and we knew it before, in this interconnected world, we all suffer when leading global banks are losing confidence.

We saw a lot of capitulation this week, including the emerging markets breaking down.  This cascaded into US Industrials breaking down (DD, MMM, CAT) as well as commodity prices plunging.  There aren't too many areas of the market left to capitulate - maybe it has to happen.  After AAPL, there aren't too many.  Still, veteran market watchers know that the end of a correction or bear market usually takes place when investors throw in the towel on their favorite investments.  Gold's plunge certainly smells of this type of capitulation. 

Finally, as ugly as the two-day move proved to be, U.S. stocks, as measured by the S&P 500, held the lows of August.  Now, we can ill afford to stay down here long, so even those of us who remain hopeful may have to hide under the desk in coming days, but the market has proven to be resilient in the face of lots of challenges.

So, wrapping it up, the risk case certainly is gaining momentum, but it's too early to call it.  I have given some thought, for what it's worth, to what the downside might be.  I am coming up with about 1000 on the S&P 500, which is 12% below our close today.  That's not my expectation at all, but that's an area that we should expect if the market gets closer to the 1100 area.  On the other hand, I think a test of 1250 in the near-term is likely on a move just a little higher from here. 

Article

• Hail Mary? - Seeking Alpha
• 8 Beaten Up Tech Stocks - TradeKing

Final Thoughts

It's very easy to let one's emotions take over during periods of extreme volatility such as we have experienced over the past two months.  It's important to keep perspective.  Seeing a 7 or 8 percent decline in a week can lead to a fear that in another 12 or 13 weeks, it will all be gone, but that certainly isn't the case.  Just as the market rallied sharply five consecutive days last week when hopes had been dashed on the prior Friday (9/9), we never know exactly what lies ahead.  The best opportunities are typically when things feel horrible, while the worst ones are following extended periods of success.  Anyone remember early 2000? 

Stocks are roughly unchanged over the past year and even the past 10+ years.  There are no guarantees, but stocks look to be a great bargain.  I don't always say that because that's not always the case. I don't know if things start to get fun again Monday, October, January or 2013, but I remain optimistic that long-term investors will be rewarded over the next decade.

 

Regards,

 

Alan Brochstein, CFA

www.InvestByModel.com

CG/B Trades for Monday

As I had indicated Friday, we have a few tweaks to the Conservative Growth/Balanced Model Portfolio.  Here is what we are doing:

• Sell recent Technology buy
• Trim Energy name
• Add to Consumer Discretionary name
• Add to Healthcare name

The net result will be to raise just a bit of cash.  As far as the sales, we had purchased the semiconductor name in July (against selling CHS at 15.39), and it has corrected substantially, rising 8.6% in a tough market.  While the yield is juicy at 4% and I love the company, it offers just 23% to my one-year out target (which is perhaps too conservative).  In this market, that's not good enough.  The Energy company was an add-to on 8/10, and it has rallied 7.2% (slightly less than the S&P 500).  The stock was our largest holding, but, at 45% return to my target, is somewhat average.  We had funded it with our sale of CALM, which has declined, a few weeks before, but it was also a function of normal rebalancing after a sharp decline. Near the lows of the market, the equity portion had dipped a bit relative to the size of the overall portfolio.  Interestingly, bonds have declined slightly since that day.  This is an example of how active rebalancing can benefit a portfolio.

On the buy side, we are adding to our large Med Device company, which offers 41% return to our target if reached.  The stock is somewhat oversold and had been a below-average position.  We are also adding to a Small-Cap retailer with a very strong balance sheet, high inside ownership and a generous dividend policy (3.8% yield, 39% payout, 4 hikes in the past 5 years).  The stock offers 60% to my target and is slightly oversold.  This stock, too, had been a bit below average in size.

After the trade, the stocks have a projected return to my targets on a weighted basis of almost 47%.  The dividend yield for the stocks is roughly 2.7%, well above the S&P 500's 2%.  Of the 13 names, 3 are Small-Cap (2 more Micro-Cap), one is Mid-Cap, and the rest are Large-Cap.  9 of our names have more cash and investments than debt - the most leveraged company has a 26% net debt to capital.  Our weighted average forward PE is just 11.2, which is slightly below the market.  3 names have single-digit PE ratios, including our two big Technology companies and our Energy company.

As far as sectors, Technology is our largest at 25.5% of the total stock exposure (compared to 19.2% for the S&P 500).  Next is Health at 19%, which is about 7% more than the S&P 500.  Finance is 17.4%, which is about 3.5% more than the market.  Consumer Discretionary, at 14%, is 3% above the market.  Energy, at 9% now, is 3% below the market.  Consumer Staples, at 8%, is about 3% below the market.  Industrials, at 7%, is about 3.5% below the market.  We have no exposure to Utilities (3.7% of market), Materials (3.5% of market) or Telecom Services (3.1% of the market).  With sectors that are relatively close in weighting and with substantial Large-Cap exposure, the CG/B is less likely than our other models to vary significantly in short-periods of time relative to the market.  Consistency, stability, above-average income, steady growth, safety - these are the watch-words for this strategy.

Finally, a Big Up Week

Five consecutive days of rallying more than wiped out the deficit from last week and most of the pre-Labor Day sell-off.  Here is how we look as of 9/16:

 

We still have a lot of wood to chop in Top 20, but it was a good week.  The model rallied 6.74%, while the S&P 500 rose 5.42%.  While smaller stocks generally did slightly better than larger ones, which helped, it was really our exposure to Technology that boosted this week's results.  Over the past month, we have had widely varied performance among our holdings, with three stocks up more than 10% and three down by more than 10% in a relatively flat market.  I continue to see plenty of value in my watchlist and am contemplating some other changes in the model.

Conservative Growth/Balanced had a strong week too, rising 3.9%, about .9% more than the combined stock and bond benchmark.  Again, we were helped by a large Technology exposure, but we also benefited from being overweight stocks at 75% compared to our 60% benchmark.  With the recent recovery in the market, I am contemplating reducing some exposure - not sure yet.  In any event, we do have some outsized positions that could lead to a reallocation between holdings.

Sector Selector ETF had a tough week.  Emerging Markets were a drag, and our Mega-Cap exposure, which we have been trimming, held us back as well.  For the week, the model rose only 4.8%, trailing the market by about .65%.

Outlook

The market has moved again to post-crash highs, and I think that we can press a little further (1250-1260 on the S&P 500 looms as resistance).  What happens next is difficult to project.  While we have higher highs and higher lows since the bottom in August, we don't have a clear bullish sign yet.  As I said last week, there continues to be a lot more fear of slowing than reality.  We continue to hear some encouraging reports as well as others that are only modestly disappointing (certainly not in line with the thrashing over the past few months).  We are in the high season of conferences, so it is particularly encouraging not to hear too many pre-announcements or negative chatter.  Other signs of encouragement included continued high-profile insider buys as well as a steady pace of mergers and acquisitions.  There is a good shot we finish out the month (two more weeks) higher, which would produce our first positive month since April.  Let's get there first, but I think that we could get follow-through if that is the case. 

As I have shared, my official target for year-end of 1500 on the S&P 500 is a real long-shot at this point.  I will be developing my outlook for 2012, which I expect to be positive, overthe next two weeks.  With a cooperative market that doesn't include terrible liquidity, I believe that we could see some strong improvement relative to the market in Top 20 over the next few months, similar to 2010.  I worry for CG/B that a big rally could be difficult to match, but we are overweight, which hopefully would counter any slippage relative to the market among our conservative holdings.  It would be easy to give up on SSETF, but I am not counting it out yet.  I like our positioning, including our stepped-up exposure to Small-Caps, and hopefully our early commitment to Financials finally bears fruit.

Articles

• High-Quality Dividend Paying Financials - Seeking Alpha
• 8 Deep Value Ideas- TradeKing

While I am not sure we can count on another 5 straight up days, I am hopeful that we can test at least a little higher.  Have a great weekend!

 

Alan Brochstein

www.InvestByModel.com

Top 20 Trades

We are selling a recent purchase (from 8/4) that performed well and now offers below average returns (though still quite substantial).  The stock rallied almost 10% while the market fell slightly since we bought it.  While I really like the company, the situation has changed since the purchase:  It is no longer overbought, and it no longer stands out against other choices.  We are also trimming a position that has bounced but has been a big disappointment and a contributor to our overall performance challenges this year.  To my target, the sell has a 31% one-year projected return, while the trim has a 39% projected return. 

We are adding a new name that I have followed for the past six months since they appointed a new CEO.  The stock offers 50% upside to my target, has been performing well fundamentally and has a few drivers ahead even in a challenging economy.  We are also adding to two positions, both of which offer substantially higher projected returns than our average holding.

Trades in Sector Selector ETF

We are trimming our Mega-Cap exposure a bit further and adding to Financials, Industrials and Emerging Markets.  This trade is similar to the one from last week and reflects my increasing near-term optimism.  The very large stocks have held in better than the broad market quite substantially.  So far in Q3, the largest stocks have outperformed the S&P 500 by about 2.5%.  On the other hand, with the fears of global growth slowing and the financial system coming under stress, Industrials and Financials have underperformed by 6% and 7.5% respectively, while Emerging Markets have lagged by over 4%. 

While the longer-term outlook remains challenging, the near-term prospects for a meaningful rally justify these trades.  After implementation, we continue to have a barbell against the S&P 500 with Small-Cap and Mega-Cap as well as some tilt towards Financials, Industrials and Emerging Markets.

Greece Fires Burn a Good Week

The week started ugly enough but was very encouraging after a strong rally - until today.  Fears of default by Greece on its debt roiled Europe and sunk our market.  The models generally held up better than the averages:

 
Top 20 lost about .83% in the holiday-shortened week, while the S&P 500 lost 1.64% roughly.  We were helped by some improvement in Technology names as well as one of our Healthcare names.  Most of our stocks are so beat up that perhaps they just got tired of going down this week.  Despite the overall weakness, it looks like 5 names increased in price while 2 performed pretty poorly.  I continue to have several potential trades under evaluation. 

Conservative Growth/Balanced declined .48%, which was slightly better than the 1.02% loss in the benchmark of 60% stocks and 40% bonds.  Technology helped cushion the decline on the week, with positive  performance from all four of our names.  We regained a slight advantage YTD relative to the benchmark.

Sector Selector ETF gave up a little ground, declining 1.97%, which was about 1/3 of a percentage point worse than the market.  While our Emerging Market ETF had helped us last week, it gave up ground this week.  Additionally, we continue to be hurt by exposure to Financials.  As can be inferred from our small addition earlier this week, I am gaining confidence that the sector will rebound shortly.

Market Outlook

I am very frustrated by the continued high volatility (translation:  the market moves down a lot, as I don't mind "up" volatility), and the progress since the depths of this correction remains unsatisfying.  Still, we have stabilized over the past month, even if it doesn't quite feel like it.  I wasn't feeling any more bullish near the highs last week or even early yesterday, and I am not feeling any more bearish today despite the rough finish to the week.  I continue to believe that there is a decent chance the lows are in and a most likely case that despite the potential for modestly new lows later this month or in October that we will recover during the 4th quarter.  Still, I am cognizant of the risks of contagion.  Overall earnings estimates aren't yet coming down, and I have heard a few relatively upbeat though cautious comments from some Industrial companies this month.  So far, this remains more about a fear of a slowdown than a reality.  This week is quadruple expiration of options, so we should expect the volatility to continue.

Articles

• Careful on Dividends - Seeking Alpha
• 6 Companies with Lots of Cash and High Insider Ownership - Seeking Alpha
• Growth and Price Momentum- TradeKing

Please take a moment to remember the victims of 9/11 this weekend and to be grateful for the resilience of our great country.

 

Regards,

 

Alan Brochstein

www.InvestByModel.com

 

 

Sector Selector ETF Rebalance

In a trade that suggests a little more bullishness after the recent retreat, we are paring our Mega-Cap position, which is currently our largest single holding, to add to two sectors that haven't been performing well.  In the 3rd quarter, our sell is down -9.1%, while the buys are down 18.0% and 19.7% respectively.