Who is left to buy?

“Who is left to buy” is a rhetorical question of course.  But for those not understanding the implications of rampant bullish sentiment, its  a quick and easy explanation.

Investor Sentiment is an inverse indicator.  The greater the positive sentiment the higher the risk and odds of a market pullback.    Peaks in sentiment don’t have to mean the rally will come to an end but it usually implies there will be at least a pause.  And, more frequently a sell-off great enough to instill fear back into the market place.   As the saying goes: “If this was easy, everyone could do it.”

Adding to the list of extreme sentiment indicators is the National Association of Active Investment Managers.   According to Sentimentrader.com the average manager is now 94.6% exposed to stocks along with a very low standard deviation which means there’s a whole lotta group think goin on.

There there is the Investors Intelligence (add joke here) Bearish Percentage: 15%   That is a level only achieved three times since since 2008 and in each case there was a moderate pullback.


Brad Pappas

No positions

The week ahead and a visit to the Little Bighorn

Background music: Just chillin by Polished Chrome

Earlier this week we went on a road trip to check off a Bucket List item that after living in Colorado for 20 years and a deep interest in 19th century western history: The Little Bighorn.    While Custer’s defeat in Southern Montana is not the black hole conspiracy mystery such as the JFK assassination, it remains so full of unanswered questions. One of the many things remarkable about the Little Bighorn is the placement of markers on the spots where U.S. cavalrymen fell. The various Indian nations are still in the process of placing their own markers where their warriors fell as well. These markers give you a really good idea of happenings of those fateful hours.


Happenings from last week and looking to the week ahead:

Our client portfolios exceeded the return of the S&P 500 by a hefty 2.7% last week due largely to the sale of National Technical Systems which surged 38% on the news of its sale for $23 a share.

While its possible we may currently be in for a mild market pullback the underlying economic fundamentals still support our full equity exposure.

Bob Diehl of nospinforecast.com who developed the Aggregate Spread is giving us an all-clear signal in the search for an impending recession. His method looks 9 months into the future and is giving a green light up to at least April 2014.

In other macro economic news recessionalert.com is giving an all-clear signal as well. Dwaine Van Vuuren of recessionalert (RA) has developed a very intriguing stock market health model that incorporates economic data and stock market technical statistics. I expect I’ll be tinkering with his models shortly and investigating how well the synergy exists between his work and our own.

Green Investing Alert: Our proprietary quantitative ranking systems have identified a stock long enamored by the socially responsible / green investing community: Gaiam

Gaiam is a retailer that caters to the yoga/wellness market. What may be the catalyst going forward is the sale of their stake in Real Goods Solar which is allowing Gaiam to add a significant amount of cash to their balance sheet.


We have no positions in Gaiam at the time of this post.

Brad Pappas

Citizens Republic Bancorp CRBC

Two weeks ago for the first time in a very long time small regional banks started to show up on our model selection list.  It was refreshing to see them after a half dozen years in financial Siberia and one of them appears will have a very good short term payoff.   Just as in the case of Sun Healthcare in June, we’ve only had a short time to build the position but the position is in place for most client portfolios.

Citizens Republic Bancorp is a small regional bank operating in Ohio, Michigan and Wisconsin.

Our client cost basis is in the $17 t0 $18 range which may not seem like much with the stock now trading at $19.17 up $1.53 on the day.  Its the news that matters:  CRBC announced it is hiring JP Morgan to seek a buyer for the bank.

Assuming JP Morgan can find a buyer the big question will be at what price.  Here we have to dig into the financials of the bank:

CRBC Book Value: $26.53

Capital ratios are healthy and non-performing assets are improving.

Over the past three months insiders have purchased 11,200 shares.



The similarities: Moneyball and investing

It was a cold and snowy day yesterday which isn’t uncommon this time of year in the Rockies, actually many of the heaviest snowfalls of the year occur in April.  But last night I was able to see Moneyball which is movie starring Brad Pitt and based on the experiences of Billy Beane who’s the general manager of the Oakland A’s baseball team.

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.



Investing in 2012 will likely be very profitable

Despite a terrific first quarter, 2011 morphed into a miserable year as the combination of US political bickering and misplaced worry over the prospects of a European debt contagion caused both professional and individual investors to flee to ultra safe alternatives.   What made 2011 especially maddening was that investors who did stick with equities chose to hold their assets in the Dow 30 stocks which became almost bond surrogates at the expense of small and mid cap equities.  This bifurcated situation created one of the largest spreads ever in performance between the Dow Jones Industrial Index of 30 stocks (+1%) and the Russell 3000 (-7%).

Consistently ignored in second half of 2011 was improving domestic economic data:  Improvements in Housing, Consumer Confidence, Auto Sales and Jobs was ignored by the deafening, attention grabbing headlines from Europe.   Corporate earnings which are the primary driver of stock prices continued to grow at an approximate 10% pace and look to repeat this performance in 2012.

Despite the improving data, the consensus of opinion amongst investors is gloomy and that is where I believe the opportunity for 2012 is.   Professional and individual investors have abandoned equities with a ferocity unseen since 2008 and are settling for yields in Treasuries in the 2% range.  Simply put, at a yield of 2% it will take 36 years for the principal to double in value.

Investors having sold heavily in the second half of 2011 have likely discounted the bad news from Europe and the unfounded fears of a US recession.   I seriously doubt renewed fears of European recession or budget issue can muster a second similar selloff.  Domestic and European issues are well known and have a likely probability of diminishing in consequence.

It’s a frequently commented upon topic that the consensus view of economics and investing will usually be the strategy that bites you the hardest since it’s rare that the consensus view actually comes to fruition.  Investing would be quite easy if that was the case, since you could simply find what the prevailing opinion was and invest accordingly.

For 2012 I offer what I believe will be five minority/contrarian views that have a better than average chance of being accurate in 2012.

1.  The stock market has a very good year and our models and client portfolios have a very good year.   The long term top of 1500 on the S&P 500 is a very good possibility by 2013 as

investors realize the fear driven mistakes of 2011 and move assets from bonds back to equities.   A Romney victory would likely be a significant market positive (I am a Democrat) and could propel stocks to 1500 sooner than expected.  Newt, on the other hand would likely be a major market headwind while the re-election of President Obama (the likeliest possibility) would be a moderate positive for stocks.

Investors who shunned small and mid-cap sized equities in favor of Index mutual funds and bonds had either minute gains or losses while the vast majority of Value portfolios had a terrible 10 months.  The biggest groups of investors: Institutional, Hedge Funds and especially Individual investors are very poorly positioned with very high allocations to cash, gold and bonds.

It’s my belief that 2012 will be a year of mean reversion, where the investments that performed poorly in 2011 will produce outsized gains while bonds post negative returns and Indexes lag managed portfolios by a wide degree.

The 50 year average yield on the 10-year Treasury note is 6.6% and now its 2% while the 50 year average multiple on stocks is 15 times earnings, now it is at 12.

As mentioned in my blog previously:  The US market risk premium (earnings yield minus the risk free rate of return) is at a 37 year high.  This is another statistical metric highlighting the unusual value and upside potential in equities at present.

2.  Treasury bonds will post negative returns in 2012. 

I expect 10 year Treasury bond yields to rise in excess of 3.25% resulting from an expanding economy and less worldwide fear.   The decline in bond values should provide the impetus for an asset allocation shift away from bonds and into stocks.

3. There will be no recession in the US and we will have at least one quarter where our GDP growth is in excess of 3%.   Earnings growth in 2012 remains at a moderate 10% growth rate and the US Federal Reserve leaves interest rates unchanged which is very friendly to a rising stock market.

4.   President Obama is re-elected.  In my opinion the President’s electability will have much to do with the comparative un-electability of the Republican opposition.  Be it Romney, Gingrich, Paul or Santorum, they all have major comparative flaws and would be hard pressed to gain the important Moderate electorate.  If I’m wrong and Romney is elected, there is the possibility of reaching 1500 on the S&P 500 earlier than expected as his election would be viewed as a market positive.

5. The European Union will not crash.  Problem solving in Democracies is almost always a messy proposition.  Seamless and definitive political decisions are the hallmark of Authoritarian rule.   Only until a crisis is upon the decision makers do they generally drop their political biases and come to an agreement.  I don’t think that there will even be a defining moment when the Euro crisis has been solved; it will be from a series of decisions and actions rather than an all encompassing point in time.

Deep discounted financing (loans provided by central banks at very low interest rates) worked in 2008 to avert our banking crisis and they will likely work again for Europe.  The import issue is that their banks simply get financing, the rate is of secondary importance.

Investment Status:  Equity markets at present are in excellent shape with all major US indices breaking out to new rally highs. I believe it’s quite possible that that the rally will continue for several more months at least and that 1500 on the S&P 500 are attainable.  As you can see in the chart below the SPX has been making a series of higher lows since September but our portfolios really began to out-perform in early December.

Another positive factor for equities over the next several months is that volatility continues to subside.   This is necessary for investors to feel secure to deploy funds into equities and is frequently common in the early stages of new market rallies.

One of the biggest factors that I see driving markets higher in 2012 is that the alternative investments, particularly money market funds, CD’s and US Treasury Bills all pay under 1%.  Should markets continue to move higher there will be a tremendous amount of cash coming out of those investments to seeking a higher rate of return.  Investors may actually panic at the thought of being left out while their present fixed income returns so little.

All in all I expect that 2012 will result is a good year for our clients.   Investor expectations are virtually nil and the masses have parked a huge amount of capital in ultra low yielding money markets and short term bonds.  1% returns are not going to help anyone in their retirement or capital growth plans.  If equity markets continue to show strength and reduced volatility I do expect a very large asset allocation swap out of low-risk investments and into equities.  Regarding equities, I am especially in favor of equities that had a rough year in 2011 due to their expected better than average risk / reward rather than the much beloved darlings like Apple and Google.

RMHI Model:  There was no surprise that our investment model took a beating last year.   Since my own retirement accounts are invested in the model as well, I can certainly identify with investor pain.


The chart above is the hypothetical back-test of the RMHI model (without hedging) dating back to 2001 till the first week of 2012.   Actual client portfolios have tracked very closely to the chart below and while 2011’s decline was severe the performance began to curl higher in December. The chart is divided into thirds and the blue line is the S&P 500, which appears as a simple flat line over 10 years due to its lack of net progress.

The best way to gauge the model will be to track its progress during our current rally and all appears positive at this present time.  As of today (1/23/2012) equity portfolios year to date are up an average of 7.5% net of fees and expenses versus 3% for the S&P 500.


All in all, I expect a good to very good year.


Brad Pappas


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