Invest By Model

All Three Models Outperform in January

One down, eleven to go....

Top 20 gained 6.4%, almost 2% ahead of the S&P 500.  One of the key drivers of the strong performance was improvement in the demand for Small-Cap stocks.  We were also aided by our lack of exposure to the weakest sectors, which included Utilities, Telecom Services and Consumer Staples.  Looking at the returns of our holdings, the dispersion was rather extreme.  One stock plunged, another was soft and six rose more than 10%.

Conservative Growth/Balanced gained 4.8%, well ahead of the benchmark of 60% stocks and 40% bonds, which rose 3%.  The strong performance was aided by some Small-Cap exposure, avoidance of traditional "conservative" sectors (all of which declined), heavy exposure to Technology and close to our maximum equity exposure of 75% for most of the month.  4 names rose more than 10%, while only 1 declined.

Sector Selector ETF had a stellar month, recovering almost all of the underperformance in 2011 (following the launch in late April near the peak of the market), with the model up 8.3% (3.8% better than the S&P 500).  Small-Cap exposure was the biggest driver of the performance, but sector selection (heavy weightings of Financials and Technology) and a big bet on Emerging Markets also contributed to the strong results.  Every single holding outperformed the S&P during the month.

Sector Selector Trades

We are adding a new ETF, reestablishing exposure that we had eliminated in mid-November.  This trade reverses one of the changes we made that day, which had been to increase Micro-Cap exposure.  Our buy from that day has increased about 10% since then, while the sector we are repurchasing has been flat.  We are also trimming further our exposure to another sector that has performed well.  I view this trade as risk-management, as the trade diversifies the portfolio a bit at what appears to be a favorable time.

Trades in Top 20 and CG/B

In CG/B, we are doubling the most recently added position following their earnings report this week.  It offers over 50% to my one-year target.  To make room, since we are invested at the maximum of 75% stocks, we are trimming a Healthcare name and a Financial, both of which offer less than 30% to my one-year target.

In Top 20, we are also increasing this same name as well as our other recent purchase, which also offers over 50% to my one-year target.  We are adding an Energy name that I have long followed.  The company is a technology play, as a provider of material used in E&P as well as other services and related products.  The plunge in natural gas prices had been weighing on the stock, and the earnings release last week confirmed some near-term challenges.  The stock was pushed to an extremely oversold level and offers over 50% return to my target, which was reduced to reflect the near-term challenges.  The reason I am adding the name is that I don't see a demand issue.  Despite the reduced outlook, the company will likely continue growing like gangbusters, though at a less robust level than previously anticipated.  Even after the addition, we are still modestly underweight the sector.

To make room for these buys, which so far in 2012 range from up 4% to down 17%, we are selling a small Industrial (up 16%, moderately overbought and offering 38% to my one-year target) and trimming two names that have rocketed this year.  The Industrial we are trimming is up 28%, moderately overbought and offers 32% to my target, while the Healthcare name is up 20%, moderately overbought and offering 42% to my one-year target.

Models Perform Well in a Quiet Grind Higher

The S&P 500 made it 4 for 4 in 2012, rallying ever-so-slightly for the week.  Here's how the models look as we approach the end of the first month:

Top 20 rose 1.88%  compared to the 0.16% rise in the S&P 500.  Part of the gains can be attributed to generally better performance by smaller companies, but we had some good action among several names.  Our best performer was one of our laggards.  Hopefully, the trend is changing there.  We also got good performance out of our largest position, a Large-Cap Healthcare company that reported earnings this week.  Its guidance was slightly worse than the prior expectations of analysts, but investors were apparently fearing a lot worse.  We had another large position do well too, our Large-Cap Financial.  Of course, not every stock was working as well as these, but the good performance for the week came from a broad group of contributors.  I have a potential new addition for next week, so stay tuned.

Conservative Growth/Balanced moved to an all-time high this week, rallying 0.55% compared to a 0.28% increase for its benchmark (60% stocks and 40% bonds).  Our stocks performed well, overcoming our underexposure to bonds, which did well this week.  As I have been sharing, my optimism for stocks in general leaves me a bit concerned that it will be difficult for the stocks in this model to keep up with the overall market.  So far this year, we have been helped by our lack of exposure to more traditional "conservative" sectors like Utilities, Telecom Services and Consumer Staples, all of which are off to a slow start and actually down so far.

Sector Selector ETF had another great week, supported by strength in Small-Caps (our biggest bet) as well as Emerging Markets.  All of the positions (except Financials, which were unchanged after a huge run-up in the past few weeks) beat the S&P 500 this week, with the model up almost 1% compared to the a 0.16% gain for the S&P 500.  We have recovered almost all of the underperformance in 2011 (since the launch at the peak of the market in late April) as the model has gained about 1% over the market per week since year-end.  

Market Outlook

No change at all in my optimistic view, but I do want to address Fed Policy.  The Fed changed its outlook in a material way this week, suggesting that rates would remain extraordinarily low until 2014, pushing out the window a year.  This is a game, and a potentially dangerous one, with the Fed having few other policy tools at its disposal at this point.  By talking down interest rates, it is trying to encourage capital to shift towards riskier investments than Treasuries.  My fear is that the Fed is underestimating the potential for global economic recovery and is placing itself in a box.  The risk is that as the economy recovers, the Fed will keep rates too low too long, raising the prospects for inflation.  It's too early to adjust one's outlook, as it is likely in my view that the Fed can extricate itself should its commitment to low rates begin to look dangerous.  I believe that the only immediate takeaway is that longer-dated Treasuries are risky, with traders perhaps feeling a bit safe pushing rates down given the Fed proclamations.  

Articles

• Win Big by Investing Small in 2012 - Seeking Alpha

 

Regards,

 

Alan Brochstein, CFA

www.InvestByModel.com

 

Another Top 20 Trade

I apologize for not getting it all done on Friday, but this trade completes the rebalancing.  We are selling the rest of the Industrial we trimmed.  After their report last week, I was unable to raise my target, which suggests less than 20% upside over the next year after the big move Friday.  We are also trimming another name which offers 36% and is moderately overbought.  I continue to like this company's prospects, but the position is above average in size prior to the trade.

On the buy, the company we are adding is one that I actually added last week to CG/B.  It gets us exposed to auto production somewhat as well as other end markets that are better than the name we are selling.  It's somewhat of a value play, as the current valuation, including the massive cash position, is unsustainably low in my view.  I don't have any reason to believe that they will be acquired by their parent imminently, but it sure seems like it would make sense.  To my target, the buy would return 46%.

Stealth Breakout

It was a great week for all the models - the year is off to a nice start:

Top 20 rose over 3% in the past four days, easily beating the 2% return for the S&P 500 and building a lead for the first three weeks of the year.  The model really struggled from May through November, but it has regained some ground over the past two months.  We have a lot of wood to chop, but this has been happening without the benefit of a big move in Small-Caps, which I think is coming soon.  Of course, not everything is working, but a few things are working well.  We had 3 buys and 4 sells today (only one new name - the rest were trims/adds).  As a reminder, I always post my rationale for doing any trade before the market opens on this blog.

Conservative Growth/Balanced had a stellar week, rising 3.15% compared to an increase of just 1.07% for the 60% stock and 40% bond index, which was weighed down by weak bond prices.  We remain very fully invested in stocks (near the 75% maximum) and near the bare minimum (10%) in bonds.  We had a good week due to the strength in Technology, but other things worked well too.  While we have a 1.78% lead so far this year, I am somewhat cautious that a rallying market will be tough to catch with "conservative" stocks.  Hopefully our high weighting will make up for it.

Next week marks nine months in the short life of the Sector Selector ETF model.  The first five months were absolutely horrible, but the model has been making up ground steadily.  This week was quite strong, with the model rising 2.8%, 0.86% better than the S&P 500.  All of the big bets are now working, especially Emerging Markets and Financials.  I am hopeful that our largest bet (Small-Caps) will help us make up the remaining deficit since inception.  Up 7.5% so far this year, the model is beating the market by almost 3%.

Market Outlook

The bullish thesis I have been describing is getting a bit easier to defend.  Stocks are cheap still, fundamentals remain challenging (perhaps less so) and the technicals are improving.  Smaller stocks could really pick up some ground.  So far, they are doing a bit better, but not as much as I thought, especially given the improving sentiment.  Meanwhile, QQQ moved this week to new highs, and the DJIA is very close to its recovery high set last April.  I get excited as I look through many of the holdings in the models, as they remain well below prior peaks.  I watch for things like being "overbought" or "extended", technical terms to describe scenarios that can end trends, but I am not seeing much to make me cautious at this time.  

The past two years have seen good starts to the year, with rallies persisting to April before huge plunges in the summer with rallies into year-end.  The "consensus" going into this year was that the year would start weak but end strong.  Well, the start turns out to be the best since 1987 - a very strong January.  I expect that most investors aren't yet embracing the rally, but stocks like Microsoft, Apple, Intel and many others are giving us the "tell".  

Articles

• Recover These Six Fumbles? (Seeking Alpha)
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Happy Chinese New Year!

 

Alan Brochstein, CFA

www.InvestByModel.com

TOP 20 Trade

I have been patiently awaiting the trade out of one of our Technology holdings into another one on my watchlist, and I believe that the opportunity is here.  It's always a challenge deciding a trade in advance of the market opening, but it looks like the stock we are selling will likely be unchanged or perhaps higher while the buy will decline moderately.

The new name offers about 50% to my one-year target.  It's a big company but much less mature than the one we are selling, which offers less than 30%.  We are also adding to two laggards and trimming several names that have popped of late.  

A sharp and surprising plunge in natural gas prices has pushed one of our stocks into extreme oversold territory, and, while I may need to refine my target, I believe that the stock's value is more than 2X the current price.  The other laggard to which we are adding offers over 75% to my target.

On the sales, we are trimming a Large-Cap Tech company which is running into technical resistance and is somewhat overbought.  My target is about 40% above the current price, so the position is still attractive.  The other two are also a bit overbought, offering significantly less than the new name or the two adds.

Over time, we have been successful with this type of tactical trading.  I have several other names I am considering adding, including a value name as well as a growth name.  Earnings season is likely to give us some volatility among our holdings, and I will continue to optimize the portfolio. 

 

Conservative Growth Trades

We are eliminating one of our banks, as it offers 15% to my one-year target and is overbought on a short-term basis.  This is a stock we have traded in and out of successfully on several occasions.  I am quite pleased with the recent action - we bought the stock in late October and it has performed quite well.  We are also trimming one of our Technology stocks - it reports tomorrow.  While I view it as having a little upside in the near-term, it could go either way with respect to the earnings report.  Given that it is moderately overbought and offers 30% to my one-year target, I think reducing the position size makes sense.

The Technology stock we are buying is a Mid-Cap.  I have followed the company for a decade and find the valuation extremely compelling.  Almost 1/2 the market cap is backed by cash and investments.  It currently trades at just 20% premium to its tangible equity.  The company is leveraged to auto sales (an end market I am increasingly liking) somewhat (18% exposure) as well as other consumer and industrial applications and cell phones.  The stock offers 48% to my one-year target.  The CEO is getting near retirement age, and I have a sneaking suspicion that the 70% owner of the company might acquire them eventually.

Another Up Week

Friday the 13th ended up being just a little scary, eating into an otherwise friendly week:

Top 20 tracked the S&P 500 almost to the penny, increasing by 0.9%.  Within the model, there were some rather extreme moves.  To the downside, our Energy company was slammed along with its peers as the price of natural gas plunged to two-year lows.  On the other hand, we had four companies rally by more than 5%, including one of the names to which we added during the week.  We have two names reporting this week.  I have a couple of potential additions that I am contemplating, but I will most likely wait until after the earnings reports on Thursday.

Conservative Growth/Balanced gave up a little ground, rallying 0.52%,which was 0.25% behind the benchmark of 60% stocks and 40% bonds.  The slight underperformance was a function of the stocks lagging slightly.  Considering how typically conservative stocks are faring poorly so far in 2012 (a reversal of 2011's good fortunes), the model is performing reasonably well.

Sector Selector ETF had a stellar week, rallying 2.63% and exceeding the S&P 500 by 1.7% to bring its YTD lead to almost 2%.  The story here is the big allocation to Financials, Emerging Markets and Small-Caps, all of which performed quite well during the week.

Market Outlook

The action remains encouraging overall.  Perhaps the best part about the week was today.  Though the market fell slightly, it reacted well to what might have been damaging news regarding the S&P downgrades of the European countries.  We didn't quite blow away the highs from October, but we certainly have fully recovered.  I am somewhat cautious about trying to read too much into the rally at this point, as a lot of it can be attributed to an increased tolerance for risk-taking subsequent to year-end.  Many of the worst performing investments from last year are drawing tremendous interest already this year.  Encouragingly, we are starting to see less correlation across the markets.  This week, we will begin to see a significant number of earnings reports from key companies across various sectors.

Articles

• Autos Instead of Homes? - TradeKing
• Is the Rally in Financials Sustainable? - Seeking Alpha
• Technology Sleepers - Seeking Alpha

Regards,

 

Alan Brochstein, CFA

www.InvestByModel.com

Top 20 Trades

We are tweaking Top 20 today,trimming a big and a small Technology company to add to a small Industrial (which I actually view as a Technology company) and to Emerging Markets.  The two trims have performed very well of late and are near resistance, though each offers close to 50% return to my one-year target.  I continue to like both of these positions - this is tactical.  They are both moderately overbought.  Both of the adds have been laggards and are coming out of bases.  The ETF, which we first added in February, also offers about 50% to my target and is a little oversold.  I believe that my target could be too conservative.  The trades leave all three of these positions slightly below average. 

The other add is also coming out of a base.  The company recently pre-announced a weak quarter and updated its guidance, so an overhang was removed.  The stock moved up, but it offers still over 60% to my target.  It too is a little oversold.  This stock will now be one of our larger positions.