Invest By Model

CG/B Trades for 10/31

While it might seem odd that we are buying back most of the stock we sold a week ago, active portfolio management is one of the tools I use to preserve capital in CG/B.  The stock we had trimmed was the worst performer in the model subsequently, declining 3.4% during the week (the stock we bought rose 7.8% during the week).  The two stocks we are trimming are among our largest holdings.

As I look at my current one-year projected price returns, the stock we are buying offers 38%, while the two we are trimming offer 40% and 31%.  They are both also moderately overbought.  After the trades, the stock we are buying will still be somewhat smaller than the two we are trimming. 

The net effect of the trades from 10/31 and 10/24 is to increase our Consumer Discretionary exposure and to modestly reduce our Energy and Technology exposures while also increasing cash slightly.  I don't attempt to manage to a specific desired sector exposure, but I do monitor it to control risk.  I view Consumer Discretionary names as more volatile and thus providing more trading opportunities, as is the case currently with the three names we own.  To be clear, these names are all consistent with the goals of CG/B (income, growth &  capital preservation), but their prices tend to be more volatile.  One reason that I believe it may be appropriate at this time to have relatively high exposure to the sector for CG/B is that these domestic names provide some diversification in terms of foreign currency exposure.  The Dollar weakened rather dramatically against the Euro following last week's plan, but there is a chance that we could see reversals ahead as the ECB potentially cuts rates. 

Here is how we look with respect to sectors after the trades:

• Consumer Discretionary:  23.2% (+12.7% vs. S&P 500)
• Tech:  21.2% (+1.7%)
• Health:  18.4% (+7.0%)
• Financials:  16.4% (+2.2%)
• Consumer Staples:  7.0% (-3.9%)
• Energy: 7.0% (-5.6%)
• Industrials:  6.7% (-3.9%)
• Telecom:  0% (-3.0%)
• Materials:  0% (-3.6%)
• Utilities:  0% (-3.6%)

 

Historic Rally Extends

This was a great week in a historic month.  All three models recaptured their mo-jo and are beating their respective indices this month:

Despite some tough moves on two stocks due to earnings reports, Top 20 moved back into the green for the year thankfully.  For the week, the model was up 6.3% compared to 3% for the S&P 500 as smaller stocks were on turbocharge.  So far in October, the model is up 16.4%, which is 2.5% ahead of the S&P 500.

Conservative Growth/Balanced rallied 3.3% this week, a full 1.1% better than the blend of stocks and bonds.  Our stocks performed well, but it also helped that we are invested at the maximum 75% compared to the 60% "normal" exposure.  In October, I am very happy to have more than kept pace with a rocketing market, as the model is up 10.5%, 2.5% better than the benchmark.

Sector Selector ETF, which launched pretty much at the top of the market and wasn't at all positioned for the disaster this summer, has recovered most of its poor relative performance.  For the week, aided by Financials, Small-Caps and Emerging Markets, the model was up even more than the Top 20, rising 6.7% - almost 3% better than the market.  Month-to-date, the model has rallied 17.8%, which is 4% better than the S&P 500.

Market Outlook

The 1998 scenario that I have been describing appears to be playing out.  Earnings season has generally been good, and the terrible overhang of Europe appears to be dissipating.  We are back to where we were atthe lows of June.  Recall, I wasn't surprised when the market pulled back from late April, and these levels looked quite good to me in June.  Of course, this was before the U.S. downgrade that followed the embarrassing debt ceiling debate and the meltdown in European Financials.  So, here we are again. 

To me, it looks like the nightmare is over.  We are left now with great valuations, good technicals and decent fundamentals, especially to the extent the emerging economies are continuing to grow.  I am most encouraged recently by easier monetary policies in several emerging economies, particularly Brazil.  Summing it up, while the market isn't likely to hit my 1500 S&P 500 target for year-end 2011, I think we could get there and then some in 2012.  For the balance of the year, there is a lot of money that will likely be working its way back into the market.  The Super Committee is one potential obstacle, but I think we could see Washington surprise us to the upside (the bar is low!).

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Final Thoughts

I am glad to have recovered lost ground in all the models in absolute terms and for Top 20 and SSETF in relative terms.  I want to thank you for sticking with Invest By Model through these trying times.  I appreciate the kind words from many of you over the past few months as I have tried to navigate some extreme challenges.  We have more work to do.  Rest assured, I remain focused on continuing the value proposition we have delivered since the middle of 2008:  Great performance at a ridiculously low cost.

 

Regards,

 

Alan Brochstein

www.InvestByModel.com

 

 

Trade for CG/B in Financials

We are selling a little more than half of the bank we own in CG/B after a sharp rally.  I still like the stock, which offers 26% to my target, but it is overbought.  Our buy, which is one of the original model positions and one that we have traded in and out of successfully on a few occasions, isn't overbought and offers 31% to my target. The dividend yield is in excess of 3.6%, a little higher than on the sell.  A good question might be why not sell all of the one we are selling.  I think that there may be some upside to my target would be the answer.

We are also adding to our bond position, not because I like bonds here but because we drifted below the 10% minimum...

Top 20 and CG/B Trade

While the stock we are selling in Top 20 remains attractive and is likely to trend a bit higher, we are buying a stock that looks a bit better to me.  The sell offers 33% to my one-year target, while the buy offers 50%.  While it's not intentional, we are in fact reversing a trade from early July in Top 20.  Since then, the stock we are selling has declined slightly, while the stock we are repurchasing has fallen over 20%.  In CG/B, we had sold out of the stock we are buying in July at an average price in excess of 15.50, so it has dropped substantially.   We are keeping half the stock we are selling in CG/B.

Rally Continues

The tone of the market continues to improve.  After closing strong last week, the market flat-lined until bursting to new post-August highs.   While stocks were better bid, performance was mixed in our models:

Top 20 had a rotten week, to say the least.  While part of the challenge was slight underperformance for smaller companies, the weakness was pretty broad-based and looked like profit-taking for the most part.  For the week, Top 20 declined almost 2% while the S&P 500 increased over 1%.  So far in October, Top 20 has improved 9.47%, just slightly worse than the S&P 500.  In trying to explain the large underperformance this week, it's not exactly clear.  We have begun earnings season, but the three stocks that reported this week were not among the big losers.  In fact, two stocks had strong reactions after reporting, while the other was just modestly weaker.  Rather, it looks like 3 of our stocks with some exposure to government spending were hit pretty hard.  Also, the name that we added at the beginning of the week performed quite poorly.  Needless to say, I am disappointed to have given up the ground we had picked up over the prior two weeks. 

CG/B, on the other hand, had a great week, gaining 1.44%, which was about .6% better than the blended return of stocks and bonds.  For the month, the model has gained some ground as well.  While our stocks are holding their own (no easy feat when the market is running hard), the model is being helped by being overweight stocks and underweight bonds.

Sector Selector ETF gave up a little ground this week, hurt most by some weakness in Emerging Markets.  Also, our exposure to Small-Cap took away from performance to some degree as well, with both of these overshadowing strength in Financials.  So far in October, the model is up 10.4%, which is about 0.8% better than the S&P 500.

Outlook

The market broke out of the recent range.  Importantly, Europe appears to be headed in their own way towards some sort of resolution, but this remains a near-term overhang.  Perhaps more importantly, earnings reports have generally been good, with the outlooks much better than expected typically.  It appears that the end-of-the-world scenarios of a deep recession with a huge slash to earnings is proving unfounded.

From a technical perspective, the lows from early October appear to be "good".  It remains to be seen how much more the market can recover in the near-term.  So far, the 1998 scenario is playing out, and this would suggest more upside.  I note some leadership this week from Financials - that's a change.  The reports from several leading financial institutions weren't so stellar, but the stocks shrugged off the results.  I find this change to be encouraging.  Financials are like a thermometer, and the temperature is becoming more normal.

Valuation remains dirt-cheap - enough said.  Individual investors typcially are the last ones to sell when things are going down and the last to get in when they are improving.  Once again, this has proven to be the case in 2011 just like it was in 2010 and in countless other times.  With zero interest-rates, it is quite difficult to earn any sort of return on investment.  Stocks appear to be one of the few investments that can help investors meet long-term goals, but, as long as they don't act well, fear keeps people from snatching bargains.  This begs the question:  How high does the market have to go to convince people it's now "safe" to buy.  Kind of ironic the way that works - higher prices mean MORE safety (when that is actually not true).  It's not just individuals, though.  Many funds (including Top 20!) are "behind", and you can count on aggressive bets being laid by pros to "catch up".  This phenomenon could suck in some of that cash on the sideline.

I remain optimistic but I also want to be realistic.  The S&P 500 closed the year near 1257, a level that looks to loom ominously overhead (1250-1270).  Given that many of the sectors of the market are already up on the year, I think we get through it.  This month is on track to be the single best month since 1982.  Less emphasis on Europe, more focus on high and stable earnings, and improving technicals bode well for friendlier days ahead. 

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Have a great week!

Regards,

 

Alan Brochstein, CFA

www.InvestByModel.com

6 Trades in Top 20

The sharp move in the market has created several opportunities to rebalance Top 20.  We are trimming 3 names and selling another in order to add a new name as well as to add to an existing position. 

As far as the sells, we are eliminating a recent purchase, following through with a trim from last week.  The stock has moved 17% higher since we bought it in mid-September and offers only 33% upside to my increased target.  While I like the company, it's no longer one of my best ideas.  We are trimming a large-Cap Consumer Discretionary name with 41% to my target.  We had added to the position in early August, and it has rallied a little.  We are also trimming two Technology names, including our largest position, which will still be above-average.  It offers 48% to the target.  The other name, which offers 51% to the target, goes from above-average to average.  We are selling the stock we added in Mid-September when it was extremely oversold now that it has rallied by 9%.

On the buys, our new position, which offers 56% to our target, we are going back to one of the original holdings for Top 20.  The company is well-positioned for continuing challenging economic conditions, and the stock is somewhat oversold in reaction to an analyst lowering his target this week.  We also continue to build a position in a name leveraged to aerospace and offering 57% to my target.

September Losses Erased

The powerful reversal from last week gained legs and can now be called a rally.  All three models posted strong absolute performance in what was the best week in over two years for the market and have advanced relative to their benchmarks so far in October:

Top 20 rocketed 8.14% for the week, besting the S&P 500's 6.01% gain.  So far this month, the model has advanced 11.6% compared to the S&P 500's 8.4% gain.  Top 20 has also rallied more than the Small-Cap Russell 2000 index, which has increased an impressive 10.7%.  The model is now down just slighly year-to-date, trailing by 1.6%. 

Conservative Growth/Balanced rose 3.2% this week, trailing its stock/bond index by less than .3%.  As I have suggested in the past, it can be quite challenging to chase a rocketing market with "conservative" stocks.  With that said, the model is up 4.4% so far this month, .8% more than the benchmark.  YTD, the model is now in the green again and is 1.1% ahead of its index.

Sector Selector ETF rallied strongly, benefiting from some of our recent shifts and gaining 7.5%, which was 1.5% better than the S&P 500.  So far this month, it has increased 9.8%, also 1.5% better than its benchmark.  While we have recovered some of the poor performance over the past 5 months since we launched, the model remains 2.7% behind the S&P 500.

Outlook

Certain parts of the market have moved into the green again for 2011, though the broad market, as measured by the S&P 500, is still slightly in the red (-1%, including dividends).  Smaller stocks remain down over 8%.  The NASDAQ 100, aided by AAPL, AMZN, CELG, INTC, SBUX and a few others, is in spitting distance of an all-time high.  I like to look at the 10 sectors of the market in order to get a better sense of what's going on.  While a few are down big (Financials, especially, as well as Industrials and Materials), 5 sectors are actually up on the year:  Consumer Staples, Consumer Discretionary, Utilities, Healthcare and Technology.  These 5 sectors account for about 58% of the S&P 500 in terms of market cap.  As of Thursday night, less than 40% of the market was up so far in 2011, highlighting how the gains have been concentrated in a few large names, like AAPL, IBM, CVX, INTC, AMZN and PM.

At this point, the rally from the oversold lows looks vulnerable to profit-taking ("too far, too fast"), but that's not my call.  I think that earnings season, which began this week but really picks up next week, will likely provide some more relief - there aren't too many "smoking guns" out there in terms of companies willing to disclose substantially reduced outlooks.  Quite simply, the market is priced for negative growth in earnings, but most companies appear to be able to show growth in 2012.

Last year, I was comfortable sharing my "official" year-ahead outlook in early October, but I am going to wait until early November this year given all of the cross-currents.  My preliminary view is that the 1500 on the S&P 500 I thought we might get in 2011 may present itself in 2012.

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Final Words

Thanks again to all who participated in the quarterly conference call earlier this week.  I shared replay access information by telephone in a previous email, and I remind anyone who hasn't had a chance to listen that the call has been archived to the website.  Just log-in and scroll down to find it.  We had some good feedback from subscribers and it's only a twenty minute investment of your time.

As I said on the call, as much as the past few months have been challenging for me, I know that the volatility in the markets has been even more trying for subscribers.  That which doesn't kill us makes us stronger!  I appreciate your confidence and will continue to invest my best efforts in trying to provide superior returns for subscribers.

Regards,

 

Alan Brochstein, CFA

www.InvestByModel.com

Trades in all Models

In Top 20, we are trimming a recent purchase from mid-September to add to our most recent purchase, making the position sizes more reflective of their potential returns.  The stock we are trimming has done well since our buy, rallying 14%.  To my one-year target, which may be a bit too conservative, it offers just 28%.  Our add, on the other hand, offers more than 50%.

In CG/B, we are selling our recent buy in the Financial sector.  The stock rallied dramatically over the past two weeks since we added it, improving by 27%.  It offers 33% to my one-year target, which is one of the lowest returns in the model.  More importantly, the stock has moved from oversold to slightly overbought.  I view the stock as somewhat risky at the higher price in the near-term - perhaps we will get another chance to buy it.  We are also trimming one of our Technology names that has performed well and is now slightly overbought.  The stock offers 38% to my one-year target.  The trades give us a little cash to work with should any opportunities present themselves during the upcoming earnings season. Before these sales, the recent rally had left us slightly above the 75% maximum in equities.  Afterwards, we will be at 71%.

In Sector Selector ETF, we are downsizing.  By this, I mean we are reducing our Mega-Cap exposure and increasing our Small-Cap exposure.  The trade leaves us positioned a bit more aggressively.

Potential Low Set Early in Week

In what was one of the most stunning closes to a trading session that I can recall, the market reversed losses and rocketed to sharp gains on Tuesday, rallying the balance of the week despite closing lower Friday.  Here is how the models looked one week into the year's final quarter:

 
Top 20 was able to outperform the S&P 500 this week, gaining 3.2% compared to the 2.18% for the market.  The strength was widespread.

CG/B has moved slightly positive for 2011 now and gained about 1% relative to the hybrid stock and bond index.  Bonds weakening helped, but the stocks in the model also outperformed the S&P 500.

Sector Selector ETF lagged the S&P 500 very slightly.

Market Outlook

Remaining constructive has been quite challenging.  Just a week ago, I was forced to acknowledge that the August lows were unlikely to hold, and this played out very quickly this week with an almost 3% extension to the downside early in the week.  I find the recent action quite encouraging, but it's hard to have conviction that we have exhausted the selling.  I continue to hope that 2011 ends up looking like 1998, which ended  with a powerful rally close out the year.  In fact, the last time we had as ugly a start to October as this past Monday was 1998. 

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Final Thoughts

While this year has been very challenging for Top 20, I want to take just a moment to review our recent activity.  We have been able to add value through trading this year, even before the successful trade we completed today.  Since August, here are the new position trades we have done:

• 8/4, we sold TECUA at 9.49 (now 7.25) to buy FLIR at 25.04 (now 25.91)
• 8/29, we sold SKX at 16.49 (now 14.24) to buy SMCI at 13.70 (now 13.64)
• 9/15, we sold FLIR at 27.70 (now 25.91) to buy SHFL at 8.72 (now 8.60)
• 9/26, we sold MFLX at 20.09 (now 19.99) to buy DORM at 30.09 (now 33.92)

As I indicated last week, despite the challenges, I will continue to make every reasonable effort I can to improve the performance in all of the models in the weeks ahead.  As a reminder, we will be hosting a conference call on Tuesday.  Please refer to the previous email for dial-in instructions.  I encourage you to email your questions in advance.

Regards,

 

Alan Brochstein, CFA

www.InvestByModel.com

Trades in Top 20 and SSETF

In Top 20, we are cashing in after a sharp move on one of our names and adding an Industrial that has been absolutely hammered.  I have long followed the name we are adding, which offers 56% to my target.  Their first Investor Day last month as well as their addition to the S&P 400 Mid-Cap index earlier this year should help boost awareness of this under-the-radar company that has grown dramatically over the past decade.  I like the 40% exposure to commercial aerospace, which is likely to stay strong, and the company's recent acquisition, its largest yet, should drive years of top-line and EPS growth as the company realizes sales synergies.  While I continue to like the stock we are selling, it offers just 24% to my target following the recent 19% increase in price since our addition last month.

In Sector Selector ETF, we are marginally increasing our exposure to Emerging Markets, a somewhat bullish trade.  Since the launch of the model in late April, the ETF has declined dramatically and remains oversold.  We are trimming our exposure to Mega-Caps to fund the purchase.