The week started and ended well, with the high set on a gap-up Monday morning followed by a test on Thursday and then a nice recovery on Friday, leaving the market up modestly after the huge gain in the prior week. Here is how the models looked at the close:
Top 20 had a good week, but we still have lots of wood to chop after a rotten November. For the week, the model rallied almost 2.5%, which was 1.5% better than the market. It leaves the model still lagging the S&P 500 so far this quarter by almost 3%, which is quite disappointing. Historically, the model has performed better in rallying markets. We continue to have several names that are under pressure from tax-loss selling in my view, but there are signs that this is lifting. As I mentioned last week, there is still one beaten down name in the model that I am trying to embrace more, but I am questioning my confidence. Otherwise, I like the portfolio. I have seen how quickly the model can rally, and I feel like it is loaded up with stocks with tremendous potential. We have been through a very tough patch that coincided with the market becoming more defensive in late April.
Conservative Growth/Balanced advanced 1.4% this week, beating its stock and bond index by 0.7%. It remains ahead of the benchmark for this quarter. Typically, the model lags in a big rally, but it has defied history. Fortunately, we have been overweight stocks, which has helped and accounts for more than all of the difference. The model has outperformed in 2011, but it hasn't done as well as I had hoped. We recently reduced our exposure, and I am looking at several potential additions. By my calculations, the lowest expected return over the next year for any security in the model is more than 30%.
Sector Selector ETF tied the S&P 500 this week, rising about 0.9%. So far this quarter, the model has recovered half of the under-performance from May to September, rising 13.5% compared to 11.5% for the S&P 500. The model was poorly positioned from the onset, but I believe it is set to benefit from a recovery in Financials and continued leadership by Small-Caps.
Outlook
This week may have marked the end of the pause to the rally that started in early October. What was most impressive was that we closed up despite no "bazookas" out of the European Central Bank (ECB) or the International Monetary Fund (IMF). Market pundits have been rightly concerned with sharply rising bond yields for Italy and Spain, but the expectation that they could come down only with intervention proved to be wrong. The pundits and many market participants have been arguing too that Europe's Monetary Union could die, threatening the very existence of the Euro as a currency. Instead, European leaders re-embraced the Euro and pledged to work on fiscal alignment. So, European problems will likely linger, but it is rapidly becoming clear that the imminent threat to the global financial system is highly exaggerated.
In the very near-term, with just three weeks to go, I wouldn't be surprised to see some improvement as the market is gamed higher. I expect the month to finish strong - so far we are up about 1%. I could be way too optimistic again this year with my even higher target (1600) for year-end 2012, but I am sticking to my view, which is based on 14 PE (down from the 15PE I used for my 1500 target this year). My forecast failed this year because PE multiples slipped rather than expanding slightly as I had expected. Next year, with a Presidential election that could reinvigorate calls for "hope and change" in a somewhat different and ironic twist to the campaign theme from four years ago, and an economy that looks a bit more resilient than this year's (which was hit by tsunamis, floods, financial contagion fears and the threat of government shut-down), we could move to an all-time high in the Dow Jones Industrial Average (14,200 is just 16.5% away. It's easy to get lulled into complacency and fear, but I see a nice alignment of technicals, valuation and fundamentals here. No doubt, we have some headwinds, like federal spending and a still-challenged mortgage finance market that is holding back the housing market, but a little growth in the economy can go a long way to addressing the challenges.
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Regards,
Alan Brochstein, CFA
www.InvestByModel.com
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