Its been no secret that 2011 has been a difficult year. A year that can make you doubt everything you’ve ever learned, tested and retested our models countless times even on vacation. (I refuse to allow the glare of the sun on the beach disable my ability to read our strategy test results on my Ipad. I know, that’s pretty pathetic.)
It should be a given to any investor that no strategy works wonderfully all the time, 2011 is enough to prove that. Long term investing has more to do with perseverance and discipline to your strategy regardless of your emotions and the market environment. With persistence, in the long run you should do quite well.
I’ve never made it a secret that I’ve been a fan of James O’Shaughnessy and his book: “What works on Wall Street”. The RMHI investment model is based on Shaughnessy’s “Trending Value” model but interpreted for Socially Responsible Investors.
But more importantly what strategy has worked the best for the past 50 years?
Well, Shaughnessy has released a new paper on “Trending Value” and it has trounced every other model that I’m aware of for the past 50 years.
“Its annualized return of 20.58% through Sept. 30 crushes the All Stocks benchmark (an equally weighted benchmark of stocks with an inflation adjusted market cap great than $200 million), which has a return of 10.71%. Plus, the Trending Value approach achieves its return with a volatility of 17.69%, lower than the benchmark’s 18.26%.
“The strategy makes use of one of the main innovations from the book: the use of a composite value factor. In the original publication, we identified price-to-sales as the most effective value factor. In this latest edition of the book, we have learned that a composite that combines several different value factors delivers stronger returns and more consistency than any individual factor.
By spreading our bets and ensuring that a stock is cheap in a variety of ways, we believe we can identify better stocks. One version of the composite value factor combines the following measures of value:
• Price-to-Sales
• Price-to-Earnings
• Price-to-Book
• Price-to-Cash Flow
• EBITDA/Enterprise Value
• Shareholder yield (dividend yield + rate of share repurchases)”
Now this gets interesting since RMHI has been using a composite model since the beginning of our model based strategy. It would be fair to say that we were one step ahead of Mr. O’Shaughnessy but now the gap is closing and I find that confirmation of research affirming our strategy a major confidence boost in a difficult environment.
Significant differences remain between O’Shaughnessy’s model and our own. Its impossible to know what the weighting of each criteria are since they have not been provided. In addition, the O’Shaughnessy model focuses on only holding stocks ranked in the top 10% of their ranking system while we have found that holding the top 1% versus the top 10% over time sharply improves returns.
Chart courtesy of American Association of Individual Investors
It should be noted at this time that O’Shaughnessy does not have a public fund that exclusively advertises itself as “Trend Value” but many of the stocks highlighted on AAII as acceptable to the TV and included in his “Tiny Titans” screen are also stocks found in our portfolios in the recent past:
Material Sciences
Core Molding Technology
Datalink
Town Sports International – current RMHI long position
While its obvious to see that the volatility of the portfolio is greater than that of the S&P 500 the returns more than make up for it in the long run.
All the best,
Brad
Long CLUB
This may be premature but I’ve noticed that our portfolios have been outperforming for the past three days. That may not sound like much but I believe its an indication that the breadth of the market is improving and that the major indices are masking underlying strength.
When underlying market strength is weak, the major indexes that you can own via ETF’s or Index mutual funds tend to do relatively well. However, when underlying strength is weak there is a strong tendency for individual equities and small caps to outperform. This could be the case now, time will tell. It has been 10 months since we last outperformed so the tide may be turning.
We continue to hold Appliance Recycling Centers of America ARCI Green Plains Renewable Energy GPRE and have a small position in Perma Fix Environmental Solutions PESI.
Severe sell off in solar play First Solar FSLR a former high flying darling of the solar energy industry. FSLR came out with a statement that 2012 earnings will be roughly half of analysts expectations. We have no position in FSLR but I must say the price is getting interesting.
FSLR share price is $33.90
The balance sheet is solid: Book value is $46 which includes $8 in cash and the equivalent of approximately $7 in debt.
But the market cap is now below revenues, which indicates very good value.
Its probably too early to buy as the stock needs to stabilize and the source of the earnings weakness must be determined. Stating again for the umpteenth time: Europe is the primary source of Alt Energy revenues and Europe is cutting back severely through austerity programs to curb their debt. Alt Energy will be sacrificed in the meantime as for most countries its a discretionary expense.
Long ARCI, PESI and GPRE
Top of the list for a Green company – ARCI
Micro Cap stock with all the ingredients we love to see:
Price/Sales: .27
Price/Earnings: 7
Quarterly Earnings Growth: 30%
12 mos. Trailing EPS Growth: 87%
Earnings Yield: 10.7%
With better than average trading momentum
We are long ARCI for client accounts
Right now the SP 500 is selling off hard to 1126 down 40 points on the day in response to Fed’s remarks yesterday. While they see the weakness in our economy and the growing risks in Europe they’re willing to do little at this point. I must admit to feeling much better hanging on to our SDS hedges and not getting sucked into the rally last week, as this is a moment I’ve anticipated.
The SP500 is near the bottom of its trading range of 1100 to 1230 and this morning I’ve sold our SDS hedge for $25.41.
While the economy is weak the consensus opinion is that the US is already in recession, but this may not be the case: The Conference Boards leading economic index (LEI) rose .3% for the fourth straight month, expectations were for a .1% gain. The Conference Board put the chances of a recession at less than 50% but also suggested risks were rising.
The Ned Davis Economic Timing index has dropped but still remains at a level consistent with modest economic growth.
In addition, the FHFA purchase only housing price index rose .8% in July and while it remains 3.3% below its reading of a year ago it could be showing early signs of stabilization since this is the highest reading of 2011.
Investor sentiment is dismal, no doubt there but one must keep an objective eye on the data. While many consider the Fed’s lack of action as a negative, in my opinion the ball is really in the court of our political leaders. Fiscal policies are likely to have a greater impact on our economy than monetary policy. Monetary policy in balance sheet deleveraging economies is essentially pushing on a string since there is little loan demand. Individuals and corporations are saving capital rather than spending, hence you could drive rates down to 1% across the board and still see little ripple effect.
Lastly, from a technical viewpoint the early August low saw over 1200 stocks on the NYSE make new annual lows. At present the number is 735 which is a positive divergence and an early sign that selling could be exhausting itself.
While this smells acts and trades like a Bear Market, the news is not completely awful, just partially disgusting. Hence, based on my short term trading models we’re at a short term extreme and a bounce should be expected. Till proven otherwise we remain in a 1230 to 1100 trading range.
Brad
No positions
A short while back I decided to return to writing on the blog as a way to encapsulate my thoughts and review tactics and strategies. With the noise that exists within our culture and data driven industry we can lose ourselves to the impulses caused by the most recent data points.
The talking heads on TV uniformly speak with such clarity and conviction but are never held accountable to the results of their recommendations. Do they eat their own cooking the way I do? I doubt it very much. So while you the reader may consider that this blog is for your benefit please consider its also for my benefit at well.
What do we know:
The political leadership existent within the US and Globally lacks the political will and savvy to solve the debt and currency crisis. There is a continual sense that their intentions are to “kick the can down the road” for future leaders and tax payers. The lack of cross the aisle cooperation between parties is pathetic. The Republican’s lack of cooperation, even at the cost of benefit to the country in order to gain the White House appears to be the game plan. Speaker Boehner is even disagreeing with the proposed short term tax credits proposed in the jobs bill.
If you’re a country that cannot print money then you are crashing. Why this is lost upon the tea party, I have no idea.
There is a global race to devalue currencies. PIMCO predicts the Euro will fall to 1.20 USD within three to six months. When Janene and I were in Paris this May the Euro was 1.45 USD.
2012 estimated earnings for the SP 500 are coming down in deliberate fashion. In August the estimate for 2012 was $112, now they are at $110 and falling.
Most European stock markets are down 15%-20% while the US is down 2% for the year. Macroeconomic data continues to deteriorate. Last night Goldman Sachs lowered their end of the year target for the SP500 to 1250 down from 1400.
Investors are extremely bearish. AAII figures show 40% bears against 30% bulls. This is an uncomfortable status in light of my hedged positions. The issues of Greece, the Euro, our budget impasse, US debt, falling currencies and high odds of recession appear to be largely baked in the cake of many share prices.
Shares of dividend paying stocks look very attractive relative to bonds.
Contrary to Bernanke’s talk: US money supply is rising. Rising money supply frequently has a steroid effect in the short term for stock prices to move higher.
With Peyton Manning on the sidelines is there is no doubt that Tom Brady is simply the best at his position.
What I don’t know:
How low will SP 500 earnings estimates fall before they bottom? The average recession cuts earnings by 25% from the previous peak or in our case $75 a share.
While a Greek default is inevitable, can Europe handle a Greek default in an orderly fashion, and then an Italy default, followed by a Portugal default……..rinse and repeat.
Will the Chinese support the Euro to allow multiple currency options for its growth.
Can the European banks reduce their systemic risks and raise gigantic amounts of capital they require?
One potential cure-all would be for the Chinese to let the Yuan trade freely on its own merits? Is this just pie in the sky hopin and wishin?
Will investors finally purge Treasuries en masse and allow yields to rise?
Is our unemployment issue systemic (see Doug Kass) or cyclical (Paul Krugman)?
Can the opinions expressed by Tim Geithner in stating there will be no Euro Lehman’s be trusted?
How can Duane Allman and BB King be ranked higher than Eric Clapton in the Rolling Stone Top 100 guitarists of all time. I’ve adored Live at the Fillmore East since I was a kid and Riding with the King is superb but shouldn’t the breadth of work by Clapton be considered?
Long Clapton
