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.
Articles
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Have a great week!
Regards,
Alan Brochstein, CFA
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