The sale in CG/B is due to the technical of being overextended as well as offering the lowest return to my one-year target of any stock in the model (24%). I am happy to lighten up a bit, as we are slightly overweight our benchmark.
The double-top I highlighted last week now looks more ominous, as stocks fell sharply in the holiday-shortened week. Here is how the models look with a week to go in January:
Top 20 fell slightly less than the overall market, declining 2.51% compared to the 2.62% drop in the S&P 500. The three energy and gold stocks we own actually rallied, but we were slammed on the recent purchase we made in the retailer, where the CEO exited just two years into his tenure, with the stock dropping 12%. Of small consolation is the fact that the stock we sold to fund the purchase fell 8%. Years of experience tell me this initial hit might actually be a good thing in the long-run, as we can increase the position at a much better price. Another retailer in the model fell 8%, as this sector remains quite weak, with the overall Consumer Discretionary sector down 5% in January. As a reminder, this model is not managed for cash levels - it is always fully invested.
Conservative Growth/Balanced declined 1.79% compared to a 1.45% loss in the index, which is based on 60% stocks and 40% bonds. Part of this was due to being less exposed to bonds, which rallied on the week, part to being overweight stocks slightly and the balance to a few stocks that dragged down returns as well. The gold stock was the only one to rally, and the energy stock, unlike the two in Top 2o that rallied, fell in line with the market. We trimmed the investment manager that we had sold completely out of Top 20, but the remaining portion was our worst performer. Our equity weighting is currently 65%, slightly ahead of the the benchmark.
Trees don't grow to heaven, and markets don't rally ad infinitum. Last week, I pointed to a topping process that included a divergence of larger and more conservative stocks (i.e. the Dow Jones Industrial Average) underperforming. Through Friday, the S&P 500 has dropped 3.1%, which is 1.4% worse than the Russell 2000. The DJIA has declined 4.2%.
One of the primary concerns is the weakening in emerging markets, with the emerging markets index now down almost 8% YTD. The weak U.S. consumer in Q4 is worrying investors as well. I don't see these fundamental issues as too concerning. Rather, this appears to be just a correction of an extended market. My own projections are that we could pull back to 1700-1740, which, as measured against the all-time high double-top near 1850, would represent a 6-8% correction. This move is consistent with the path that I envisioned as the year began given that we enjoyed four consecutive positive quarterly returns for the market. Recall that I suggested range for the year of 1650-2000 in my year-end summary. 2014 will likely prove much more volatile than the prior year.
Have a great weekend!
Alan Brochstein, CFA
In CG/B, we are reallocating capital back towards two retailers we trimmed in recent months at higher levels - they now offer about 35% roughly to the one-year target. The sell, from the financial sector, offers only 23%.
In Top 20, we are trimming a November tax-loss selling buy that has rallied. It now offers just 35% to the one-year target, suggesting it is attractive but should be below the average position size after the recent rally. We are also selling a financial, the same one that is in CG/B, to buy a retailer that offers 37% to the target shared in the research.
Stocks rallied to their 12/31/13 high but then reversed. Here is how we looked mid-way through January:
Top 20 recovered some of its weak relative performance since the year began, posting a 0.27% gain as the S&P 500 pulled back 0.18%. The main factor was the better performance of smaller stocks relative to larger ones. Our sporting goods company had a negative pre-announcement yet was the second-best performer, rallying 5.5%. Our other leaders were 2013 laggards, with the restaurant stock up 6% and a few other laggards leading the way. On the downside, though, three stocks fell between 4.5-6.3%.
Conservative Growth/Balanced gave up some ground, declining 0.21% while the index of 60% stocks and 40% bonds rose very marginally, supported by bonds. We are at about 24% bonds, below the benchmark, and we were slammed on our retailer holdings.
No change in my views that I have shared more elaborately in recent weeks. The market has seen some rotation with the calendar flip, and one fundamental negative has been in retail, where Q4 was quite challenging. Technically, the market is starting to look a little tired, and the quick rejection of 1850, creating a double-top, is a bit alarming. Smaller stocks posted a new high, but larger ones, as measured by the OEX or the DJIA, did not, and this is a bit concerning. I expect that Q1 could be negative after four straight positive returns for the market. With that said, I am vigilant but do not see reason to be concerned that this would be anything more than a potential 5% or so pullback if it were to materialize.
Have a great weekend!
Alan Brochstein, CFA
The stock we are trimming offers just 19% to my one-year target (based on 16PE) and is moderately overbought. The add is oversold and out of favor. Technically, it looks like a bottoming formation, and I think that this security is a hedge against potential inflation concerns to some degree. This offsets the negative of a bit more debt than I like to see for companies in this model. The buy offers about 45% return to the target, which is 1.5X tangible book value.
In Top 20, we are selling a stock that we had previously trimmed and buying a new name. Here is the price action for the two stocks over the past year. The stock we are selling is in red, the one we are buying in blue:
The stock we are selling is moderately overbought and offers just 22% to my one-year target, which may be too conservative, especially if the device tax is repealed and/or if the Covidien royalties extend. The entire sub-sector has started 2012 strongly - we do have another name in the portfolio from that sub-sector as well. The buy is from a sector that is somewhat weak to start the year. The stock is very oversold at this point, and the target price suggests a potential 33% return over the next year. The trade raises cash slightly.
In Conservative Growth/Balanced, we are trimming a retailer and a financial to and adding to a consumer discretionary company. The stocks we are trimming offer 21% and 25%, respectively, to the one-year target, while the stock we are buying offers 29% and is somewhat oversold technically.
The market recouped the losses from last week, with all of the major averages very close to their all-time highs.
Despite a strong day on Friday, Top 20 still lagged a bit after having gotten off to a good start last week. While the overall market advance 0.63%, the model pulled back 0.6%. SWI was up almost 5%, while EZPW and BGFV dropped 5.5% and 8%, respectively.
Conservative Balanced/Growth trailed its 60% stock and 40% bond index, rallying .11% compared to 0.56%. Being underweight bonds hurt the performance a bit, and a few stocks were soft, in particular CHS, the smallest position fortunately, which fell almost 6%.
The weak payroll report ignited a rally in bonds, but fixed-income investments have not been the place to be, nor are they likely to offer much in the way of return. Within equities, we have seen some shifts as the year has begun out of high-flyers from 2013, a process which as kept a bit of pressure on the overall market. After four straight quarters of positive returns for the S&P 500, it seems like Q1-14 could be lackluster. I continue to expect a narrow trading range in 2014 with a peak below 2000 and a close near 1968, with lower prices than the current levels along the way. Healthcare has been the strongest sector by since the year began, rising 2.3%. A final observation is that commodities remain quite weak.
Have a nice weekend!
Alan Brochstein, CFA
The markets began the year in retrenchment:
This is an abbreviated version of the weekly blog. In case you missed it, I shared a year-end review two days ago - you can access it here. I also shared a discussion about earnings yields and interest rates on Seeking Alpha. Finally, thanks to all of you who shared your feedback with me over the past week. I am likely to move InvestByModel to Marketfy at some point in the near future. I will keep everyone apprised of any changes well in advance of implementing them. Have a great weekend!
Alan Brochstein, CFA
2013 has ended, and it was a year that exceeded all but the most optimistic expectations for stocks. The S&P 500 returned 32.39%, including dividends, while the smaller stocks did even better, with the Russell 2000 total return at 38.82%. Stocks rallied in each of the year's four quarters, and for the second consecutive year, the low price was above the prior-year close. Bonds lost money, with the total return of the Barclays Aggregate Bond Index at -2%. The benchmark 10-year rose from 1.76% to 3.03%. Commodities generally declined in price, with oil up modestly. The dollar gained strength against the yen, while it weaked slightly relative to the euro.
Top 20 lagged the S&P 500 for the year marginally. Here is the performance since our May 2008 launch:
The model marginally outperformed the S&P 500 in December, rising 2.7% compared to 2.53% for the index, but it was a rough quarter:
After a very strong Q3, the model lagged in Q4. The main challenge was committing too early towards a shift into laggards. Had we held the original model in place a year ago without any changes, the model would have returned less than the actual results. Two of our holdings were acquired during the year (Met-Pro and Mako Surgical).
The current portfolio has a PE of 15.5 compared to 16.5 for the market. The balance sheets are stronger than the S&P 500. On a weighted-average basis, the YTD price return of the current portfolio was just 7.4%, so the overall portfolio can be desribed as lagging the market. As far as market caps, 5 stocks are below $1 billion, 10 are below $10 billion and the remaining 5 are bigger than $10 billion, with a weighted average market cap of $13 billion (compared to $120 billion for the S&P 500. Our sector exposures are much more balanced than typical. The only substantial deviations (more than 5%) from the S&P 500 are "Other" at +6%, Materials at + 6%, Tech at -6% and Financials at -7%. Sector exposures are:
CG/B had yet another great year:
The model marginally outperformed in December, with a 1.17% return compared to the 0.93% return for the 60% stock and 40% bond index, but Q4 was the second consecutive quarter of lagging its benchmark:
The model currently has a 66.5% weighting in stocks, slightly ahead of the benchmark. Bonds are just 23.6 , with the balance in cash (10%). The current holdings have a YTD price return of 17%. The dividend yield of 2.5% exceeds the 1.9% yield on the S&P 500. The forward PE is 14.7X compared to 16.5 for the S&P 500, and the net debt to capital is just 12%. 7 of the 15 stocks have market caps between $2.3 billion and $6.7 billion, while the balance include 4 betwen $11.5 billion and $36.5 billion and 4 mega-caps (>$100 billion). The weighted average is $48 billion compared to $120 billion for the S&P 500. Industrials at weighted at 11% below the index exposure and Financials at -6%, while Technology (+12%) adn Consumer Staples (+8%) are more heavily weighted. Here are the actual sector exposures:
"More of the same but to a lesser degree" is a good way to think about the markets this year. Stocks aren't exactly expensive, and the economy isn't extended despite a relatively long-duration recovery. Interest rates remain too low. The bottom-line is that we should expect the economy to chug along , with the potential to surprise to the upside. Stocks should advance modestly - my official forecast is for a 1968 close and a 1650-2000 range. I have no crystal ball - keep that in mind! My projected close represents a forward PE of 16 on potential earnings in 2015 of $123 for the S&P 500. There should be a tug-of-war between higher earnings and higher interest-rates.