Within the next few weeks or so we have several cycles that are converging between now and June.  It appears that any market trough developing soon will not be considered a major market low but a normal run of the mill trough.   However, the matter of significance is the post-cycle trough which could be a major move higher, probably to 1500 on the S&P 500 or 11% by the end of the year.

The explanation for the trough and rally will, at present be open to interpretation.  For those that fear Europe being our market’s downfall, the odds are quite low that Europe will derail the U.S. since its extremely rare that a major issue be discounted in stock prices more than once.  One other issue that made news over the weekend is China lowering reserve requirements.  China has been attempting to slow economic growth for close to two years and they may have finally seen enough slowdown to take their foot off the economic brake.

As the chart reveals the 9 month cycle typically is a counter move to the primary trend.   In other words, if markets are in rally move (as they are at present) the 9 month trough is a very nice entry point whereby the rally eventually resumes.   In a bearish trend, the reverse is true.  The 9 month cycle is usually not The tipping point for a change in the primary trend.

Overall, all of our models and timing systems remain positive.  So far our present pullback resembles a garden variety pullback seen once or twice a year.  Unless the character of the retreat changes in character for the worse I’d view this as an opportunity to add new funds or increase equity exposure.

Brad Pappas

No Positions mentioned

Long ESIC

The movie captured the highs and lows of the A’s 2002 season in which they found themselves losing three key free agents to larger franchises and trying to find a way to cope with the realities of being a franchise with a $35 million dollar payroll competing with teams like the Yankees who at the time had a $120 million payroll.

Due primarily to  one of the strongest unions in the country: the MLB players union, a salary cap on team payrolls is nonexistent and has made for an unfair, unlevel playing field between large market teams (Yankees, Red Sox) and small market teams (Royals, A’s, Padres for example).

Billy had to find a way to replace his stars with players who could contribute enough to make up for the loss in production yet be cheap enough to fit within his payroll.  He simply could refit the roster with high priced free agents or trade for players with large contracts, there was no question he couldn’t expand his player payroll budget.

Baseball has long been a sport in which scouting has played a significant role.  Scouts were frequently older baseball men who used their experience to extrapolate what a young players potential could be.  The process is highly subjective and as in most professional sports, most of the prospects never make to the major leagues let alone be stars.  Billie was tired of hearing the old phrases “he’s built like a ballplayer, a five tool player, a smooth level swing, and he’ll improve with time”.  All Billy wanted to know was: “Can the kid get on base?”  If the kid can’t get on base, be it from a walk or a hit he’s of little use to the team and all the pat phrases from the scouts won’t mean a thing.

While visiting the offices of the Cleveland Indians in an attempt to make a trade his offer is shot down based on a mouth to ear relay of information to the Indians GM from an unlikely looking young man.   This young man was one of the first to use data analysis to formulate opinions on their young players.

This young man catches the eye of Billy Bean because is on the cutting edge of incorporating data or quantitative analysis (QA) to determine if the player had the potential to contribute.  The young man didn’t care if the player could even field his position he only cared about his on base percentage (OBP).

The use of quantitative analysis (QA) in baseball was the brainchild of Bill James.  Eventually the use of QA in baseball spread, even to the large market teams like the Red Sox who in fact are owned by John Henry who is a proponent of QA in managing his hedge fund.  However, to this day the issue of QA is still contested since baseball is an old school sport where change rarely occurs and jobs are entrenched.

But this isn’t really a post about baseball as much as it is a post on the advantages of quantitative analysis in many of life’s endeavors especially investing.

In place of the subjective “it has a great looking chart” / “the stock has a low PE and a 2% dividend and we expect it to move 20% higher this year!” is our proprietary RMHI model that allows us to backtest over a decade of data to determine which balance sheet profiles and stock selection formulas actually work in creating above average shareholder wealth.   Can this stock “get on base?”

In baseball the large market teams are captivated every year by the super stars that hit the free agent market just as investors are fascinated by the attention getting stocks such as Apple.  The past does not equal the future and while the Angels may feel adding Albert Pujols to their roster for an average of $25 million a year till 2021 is a good deal, you must consider he is a richly valued player who is peaking at age 32.  Will he be able to contribute at ages 38 to 41?   For every Ted Williams there are many more Manny Ramirez’s who were done at 38 leaving the team stuck with a dead money contract.

But investors miss the questions they should be asking themselves:  Is my chance of making an above average return on Apple (which sells at 17x 2012 eps, 4.4 times revenue and 6x book value) better going forward than shares of a stock selling 9x 2012 earnings, 0.46 times revenue and .75 times book value).  This is the essence of Moneyball or as a wise man once said to me “Price is what you pay and Value is what you get”.  FYI the unnamed stock is Voxx International, symbol VOXX.

And the Oakland A’s won their division in 2002 with a better record than the year before.

Long VOXX

While the S&P 500 returned 12.6% (total return)

RMHI Growth accounts returned 18.31%
RMHI Moderate Growth returned 16.76%

RMHI returns are net of all fee’s and expenses.

Quick comment: While I’m very pleased with these returns the RMHI model performance exceeded our client returns due to accounts having diversified positions in Gold and in some cases a higher level of cash than normal.  Portfolios diversified from equities lagged in performance due to the lack of upward price momentum in gold and bonds.   Realizing that the government may not be in support of QE 3, we’ve sold our gold positions and would prefer to own cash in lieu of metals or bonds.

All market models remain in Bullish mode where any form of market weakness is being fought by aggressive buyers.   While we do see some signs of incoming economic weakness (today’s poor job creation stats for example) the weakness has not translated to declining equity prices.

Arsenic in our chicken  NY Times

Speaking of food and the opening day of baseball one of our largest holdings is a food stock: John B. Sanfilippo and Son symbol JBSS.  JBSS sells raw and processed nuts including peanuts.   Before you speak up, yes peanuts are a legume and not a nut.

Unquestionably the stock is cheap as book value is $18 and the shares sell for $12.88.  The stock is also very close to being a classic Graham “net net” but only if you don’t deduct 50% off the value of their inventory of nuts.  If you take into effect that the price of nuts is strong and only deduct 25% off the value of their inventory it could qualify.

JBSS ranks at the very top of our proprietary ranking system and we own the shares for our clients.  I own them as well.

• Too much competition which results in price cutting and profit margin pressure which results in volatile earnings and significant stock volatility.
• Reliance on government subsidies in an era of budget restraints.

But these issues are the primary problems associated with investing in solar cell manufacturers.

What about investing in Solar Farms that have their infrastructure in place and long term selling agreements with credible utilities?  This is an entirely different enterprise than just selling solar panels since this is really an issue of cash flow.

Warren Buffett’s MidAmerican Energy Holdings Co. agreed to buy the Topaz Solar Farm in California from First Solar Inc. on Dec. 7. The project’s development budget is estimated at $2.4 billion and it may generate a 16.3 percent return on investment by selling power to PG&E Corp. at about $150 a megawatt-hour, through a 25-year contract, according to New Energy Finance calculations.

“After tax, you’re looking at returns in the 10 percent to 15 percent range” for solar projects, said Dan Reicher, executive director of Stanford University’s center for energy policy and finance in California. “The beauty of solar is once you make the capital investment, you’ve got free fuel and very low operating costs.”

With Treasury yields in the 2% to 3% range solar farms offer a viable alternative to bonds.  In my opinion its only a matter of time before solar farms are offered in either a REIT or MLP structure to the public, where the cash flow generated is passed on to shareholders with special tax considerations.  Best of all, the cash flow comes without the risks and headaches of solar panel manufacturing and sales.

Now we’re finally getting somewhere.

Brad

No positions

There are several issues to keep in the radar including debt worries in Spain and a further slow down in China.  No doubt there will be a market correction at some point and even if 2012 turns out to be a terrific year there are always potholes along the way.  Yesterday I spent a few hours sifting through data of how our model reacted in 2004.   The back test data showed a terrific return by any measure but there were also two pullbacks in the range of 10%.

At this point in time only Investor Sentiment measures are in the warning zone, all trading and momentum models remain bullish.  For the time being we remain fully invested.

The current psychology of the market is “risk on” which also means alternative investments that need “risk off” such as bonds and gold are doing poorly and I don’t expect this situation to change anytime soon.   While I have almost no bond positions, I am liquidating our GLD holdings into strength and just holding cash with the proceeds.  GLD has become a drag on performance and until there is a change in the trading trend of GLD, I prefer to take the most conservative option.

While most market participants are transfixed on Apple shares I continue to look elsewhere for largely unknown names that are quite cheap with positive trading trends.

Intertape Polymer Group symbol ITPOF represents a socially benign company, a Canadian small cap company with interesting postential:  They manufacture a wide variety of tape for retail and industrial clients.  Example are masking and packaging tape, cloth tape foil and film tapes, packaging tapes, and duct tape.

The market value is small: $270 million but the Price to Sales is just .30%.   After several years of lagging operational profits but losing money after tax the company has seen accelerated growth in revenues and margins along with a sharply reduce tax expense.  Revenues have risen from $615 million in 2009 to $786 million in 2011 and net income of (-$14,389,000 2009 / -$48,549,000 2010 to a profit of +$8,954,000 in 2011).

Long ITPOF, GLD

I have great admiration for Apple and the legacy of Steve Jobs and today my gorgeous wife finally got her Ipad.  My guess is we have 9 Apple products in our home (does the Jobs bio count?) and love them to bits but being a consumer and owning the stock are two different things.

No positions.

But last weeks mini decline had a big effect on investor sentiment as many investors changed their tune flipping from overly bullish to bearish, hence we’ve reverted to a less defensive posture hoping the mini decline was enough to add fear back into the markets.

As of March 13th, Investors Intelligence had 43.6% of advisors they tracked in the bullish camp down from 54.8% on February 14th. This recent reading was the lowest since November 1st. The American Association of Individual Investors (AAII) in their weekly poll had the bullish contingent at 42.4% down
from 51.6% on February 10th.

The Dow, S&P 500, NASDAQ and Wilshire 5000 plus the Advance Decline line all made new highs this week.  The laggard, curiously enough is the Russell 2000 which is trying to break through formidable resistance.   I believe its a matter of time before this index breaks through to a new high as well

A popular investment trend over the past three years has been to lock in high dividends to offset the miniscule yields in bonds and money market funds.   This trend can work well as long as interest rates are stable but with an expanding economy Treasury bonds are beginning to appear headed to a Bear Market.  This is not unexpected but in fact was one of my 5 surprises for 2012.  Interest rate sensitive mutual funds and stocks may be vulnerable now.

An interesting bit from Ned Davis Research is that the low volatility we’re experience now is likely a good thing.   2012 is only the 9th time since 1928 where the S&P 500 has started the year not experiencing a 1% decline in the first 40 days of trading.  The average gain for the remainder of the year was 18.4%.   There was only one March to December period with a loss, 1966.