Stocks were strong in the second-to-last week, with the S&P 500 moving back into the green just barely for what has been ultimately not a very exciting year for investors. Here is how we look in all of the models:
Top 20 put up another good week, aided by our newest purchase, AKAM, soaring after it made a strategic acquisition to eliminate a competitive threat. I was also pleased to see IIVI respond well to negative news (updated guidance). Working against us was the fact that larger stocks led the way this week. For the week,the model rose 4.17%, slightly besting the S&P 500's 3.79% return. After a decent October relative to the market but a bad November, the model is ahead of the market by 1.86% this month. With the recovery, it is still 0.9% behind the S&P 500 for the quarter.
Conservative Growth/Balanced rallied by 2.46% this week, which was 0.42% ahead of the 60/40 Stock/Bond index. While the model is lagging slightly in December, it remains ahead of the benchmark for the quarter slightly as well as the year. The performance this week can be attributed to the fact that we are overweight stocks and underweight bonds, with stocks rising and bonds falling this weak.
Sector Selector ETF gave up some ground, trailing the market by 0.65% this week. This adds to the underperformance for the month, with the model lagging the S&P 500 by 1.4% in December. So far this quarter, it remains slightly ahead of the benchmark. Small-Caps and Emerging Markets were the reasons for the poor performance this week. On the other hand, our largest position is in Financials, and they look like they may finally be ending their underperformance. This week was very strong. Unfortunately, I have been too early on the sector - same with Emerging Markets. I do expect to have a few trades to execute on Tuesday.
Market Outlook
The market got off to an ugly start but surged Tuesday as market participants began to better understand the recent global liquidity program announced earlier this month. Short-term government bond rates plunged in Europe as a consequence. The move was good enough to trigger an indicator I watch, the Investor's Business Daily outlook, which turned positive. The trigger was the "confirmation" of the move off the low set in late November. It took a very long 17 trading sessions to achieve the signal, which is a function of a large rally on increased volume.
The year is ending, and trading could be volatile over the next four trading sessions due to light volumes. One thing I expect to see is continued strength in some of the beaten-down names, especially in small-cap. In general, with pretty bad performance by professional investment managers this year, I think that we could see some real gaming with smaller stocks in general, as fund managers push up the prices at year-end to boost the performance. I know that I threw out a 1340 forecast a few weeks ago for year-end. While that's possible, I don't think we see it.
Not surprisingly, this is a time of year that people love to share their one-year outlooks. I usually set my outlook well before December, which I shared previously (looking for a big move up to 1600 on the S&P 500). What I am hearing from my clients and in the media is that 2012 will start slow and finish strong. While I tend to be somewhat nervous about the crowd's outlook (it never seems to play out as expected), I have to say that 2012 did play out as expected (not much change). I proved to be the outlier with an aggressive forecast (1500) that was on track until April but then quickly began to look foolish.
My value-add is not in calling the market, but in finding good stocks. Still, I think it's important to understand the big picture. My view is very similar to a year ago - stocks are extremely cheap relative to alternative investments due to poor sentiment following the once-in-a-generation slaughter for the second time in one decade. As I consider the fundamentals, I wasn't that excited last year, and I remain in the camp of "slow growth". We got slow growth this year, but due to natural disasters and the European financial challenges, fears about the future were even greater than last year.
Remember 2010? 2011ended up looking almost the same. In both years, the market marched to new highs in late April. In both years, growth slowdown fears led to horrible summers. In 2010, we bottomed at Labor Day, when the market made it's low for the calendar year. In 2011, we bottomed a month later. The rally at the end of 2010 was powerful, eclipsing the April highs. This year, while we ended up having a very strong Q4, we were unable to recover the previous highs.
Going back to the "slow start but finish strong" consensus that I see emerging (the bears would say slow start but slow finish, so everyone agrees on slow start), I think we get a fast start and strong finish. The difference this year will be the lack of the summer swoon of the past two years. Most likely, this will require Europe remaining at least stable, which includes a mild recession as austerity measures kick in.
As I have been saying, we do face many fundamental challenges, but our companies continue to plug along and our consumers seem to be past the extreme retrenchment following the 2008 Financial Crisis. We certainly aren't hitting on all cylinders, but there are signs of improvement in key housing and auto industries. I think the wild-card for the year will be the employment outlook, which is slowly improving. Keep in mind that growth solves a lot of the problems our economy faces. Getting people back to work, if it continues, is the best thing that could happen.
Of course, we have the elections with which to contend. My view here is that elections create uncertainty, so I can see how no matter what happens, we will see more optimism afterwards. The last time we elected a President, we were in the middle of a huge shock. While things aren't great, most people are better off today or feel better today than they did in late 2008. With a little more improvement, this perception will be even more magnified. Obama is likely to benefit from this improvement. I expect that he will be reelected.
Stocks are really, really inexpensive. Earnings are higher than a year ago and likely to continue to rise. Prices are on average the same. Interest rates are lower. Add that up, and stock are a bargain by any measure. I expect that we will see a lot of M&A as the new year begins, and this will be a major factor I consider when adding new names to the Top 20. Other themes I am pursuing is the concept of buying stocks that have record earnings but not record prices - there are lots, and we do own some.
Cheap valuations and challenging fundamentals leave many thinking that we are in a deadlock - no reason to buy stocks. I see this point, so I turn to the technicals: What is the price action telling us? My view remains that stocks began a new bull market in 2009 and have been tested now twice. We began a new intermediate uptrend in October and have spent the past two months consolidating it, including a very deep test in November. We had two consecutive declining quarters (Q2 and Q3) followed by a what will be a winning quarter. Slightly higher prices, in my view, will draw in a lot of buying, and we aren't far from those levels.
Articles
- Be Careful with PEG Ratios - Seeking Alpha
- Construction Stocks - Seeking Alpha
- High Quality Regional Banks- TradeKing
Final Thoughts
As the year-end approaches, I want to see if there is continued interest in conference calls. We held our first one at the end of July to discuss the market conditions and then again in early October as part of a process to hold quarterly discussions.
I am not so sure that the interest runs very deep. If you have a strong desire for the live call, let me know. Alternatively, I now have some good software that allows me to create an audio file. I am happy to field questions in advance by email and incorporate them into my presentation. Another option would be to collect questions by email and to provide written responses.
Please let me know your thoughts. No matter what, you can count on me to continue to keep you up-to-date with my weekly commentary and trade updates. I also have been sharing a more thorough portfolio review on the blog on a quarterly basis. My goal is to make sure that subscribers are confident that they understand my thinking when it comes to running the models, so please share your preferences.
Finally, if you are interested in a more interactive experience, My Own Analyst may be for you. Many of the subscribers also subscribe to Invest By Model, and they value the frequent discussions about the names in the models. MOA subscribers also have access to recommendations on names outside the models, especially those on my watchlist. If you are interested and would like to learn more, please read the brochure. I am offering a free look until year-end - just email me if you would like access or have any questions.
Merry Christmas!
Alan Brochstein, CFA
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