I mentioned last week looking for slippage in the relative performance between SMID caps vs large caps, and for panic buying on the upside, and in the last week we have seen both of these signs.
Yesterday we had panic buying and today we had a sign of the changing of the guard (the S&P 1000 fell 2.38%, while the S&P 500 fell 1.67%).
If this keeps up, we'll get both a rollover in the market, and a change in leadership.
We've had four shots at breaking 1210 on the S&P 500 in the last month. The S&P 1000 looks as though it is rolling over, having peaked April 26th, and volatility is increasing within the markets as a whole.
Hard to know whether todays price action was simply end of month shenanigans or something else. The way I see it, investors are vulnerable to traps on both the bull side and the bear side of the equation.
When in doubt go to the sidelines.
Friday, April 30, 2010
Monday, April 26, 2010
SMID Market Commentary
First Quarter 2010 Quarterly Commentary
The Stewardship Partners US SMID Cap BRI strategy composite – gross returned 4.70% in the first quarter, but underperformed the S&P 1000 benchmark by 4.24% over the period. Our defensive posture, underperformance in stock selection, and underweighting of cyclical sectors, all served as a drag on relative performance.
Market Review – Still Climbing
It remained the best of times for small-mid cap investors in the first quarter, as the market continued to climb a wall of worry. The SMID cap sector, as captured by the S&P 1000 index, rose by 8.94% during the first quarter of 2010. The S&P 400 index (mid caps) rose 9.09%, while the S&P 600 index (small caps) rose 8.61%. The market extended its gains and momentum from 2009 into the new year. However, all was not a straight line, as the market took a tumble in January, before staging a recovery to finish the quarter up more than 14% from its February low. Growing confidence in the sustainability of the recovery, surging earnings, strong momentum, and low interest rates continue to underpin market strength. Although mid caps and small caps provided a similar return over the period, they did so via different routes. The leading sectors in the mid cap space were Consumer Discretionary (13.46%), Materials (12.95%), Health Care (12.34%) and Consumer Staples (11.46%). While the leading sectors in the small cap realm were Consumer Discretionary (19.46%), Financials (8.50%) and Health Care (8.05%). Value trumped growth by handy margins in both the mid and small cap sectors (15.08% to 11.42%, and 20.7% to 8.05% respectively). Sector laggards among mid caps were Utilities (1.08%), Telecom (3.6%), and Energy (3.7%). Sector laggards among small caps were Telecom (-12.19%), Materials (0.43%), and Utilities (1.25%). Of note, the SMID cap sector continued to outperform the large cap sector, highlighting the bullish predisposition of the market.
Recovering Balance Sheets, Recovering Psyches
It is becoming clearer that we are in the midst of a cyclical recovery, and there is little in the near term outlook to derail that process. Bolstered by exceptional monetary and fiscal policy, growth is spreading, weak sectors are stabilizing, and confidence is growing. However, recovery is fragile and we are still dealing with the de-leveraging effects of a balance sheet recession. The question remains as to whether the economy is robust enough to pass the baton from the public sector to the private sector, and when it will transition from recovery to expansion. The test is likely to come in 2011. Further down the road, it will be the middle-class who get squeezed on all sides (higher taxes, rising living costs, increasing interest rates, and higher energy costs). Having risen more than 75% off its lows, the market has already signaled high hopes for the future. But market history and common sense caution that there is less margin for error after such a move, and that the trajectory will flatten. And it is worrying when everyone seems to be on the same side of the trade. For those concerned about the risks, waiting for another collapse may be a little premature. Normally the pre-conditions for collapse (or in this case re-lapse) require high valuations, increasing leverage, and a reasonable period of stable growth in order to breed the complacency necessary to ignore risks. But with everyone focused on the risks, the likelihood that they will morph into reality is reduced. That does not mean however, that we will continue on the moon shot ride. When good news translates to bad news, then that may be ‘the tell’ that the market has gotten ahead of itself. And if we grow too fast, potentially the greatest risk is an unraveling of the recovery due to the economy’s vulnerability to rising interest rates. But don’t make the mistake of thinking that equities are not the place to be. On the contrary, the equity market may provide one of the few outlets for preserving wealth. To date, cost cutting has driven corporate profits, but it will require a pick-up in underlying demand to drive profit growth in the future. Valuation seems reasonable given the profit recovery and expected profit growth (easy YoY comparisons). The key will be whether that anticipated future growth materializes. Fund flow and small investor sentiment data indicate there are still a lot of small investors sitting out the rally. With confidence in the recovery spreading, it seems likely that these hesitant investors will be reeled in from the sidelines. The market right now is a ship without an anchor probing resistance in search of a valuation level. Many an investor has been burned standing in the way of this steamroller. Potential positive catalysts going forward are coordinated moves to address global imbalances, banks increasing their lending again, and a realization that the recovery is self-sustaining. However, prudence points to caution. The Fed has the difficult task of trying to stick the monetary landing, while our elected leaders have to come up with the courage to address our structural imbalances. Looking forward, we should expect more volatility and more compressed market cycles, as the choppy waters of stimulus exit meet the rough seas of secular headwinds.
Portfolio Review
The Stewardship Partners US SMID Cap BRI strategy composite – gross returned 4.70% in the first quarter, but underperformed the S&P 1000 benchmark by 4.24% over the period. Much of the relative underperformance was due to a large underweight position in the outperforming Consumer Discretionary and Consumer Staples sectors, and an overweight position in the underperforming Technology sector. In addition to the portfolio’s skew toward growth companies, stock selection and cash served as drags on performance relative to the benchmark. At this point we continue to maintain an overweight exposure to Technology, and Healthcare, with underweight exposure to Financials, Consumer Discretionary, Consumer Staples, and Utilities. Outperforming stocks during the quarter were Health Grades (HGRD), CapitalSource (CSE), Petmed Express (PETS), SEI Investments (SEIC), ICON PLC (ICLR), and MF Global (MF). Underperforming names were Investment Technology Group (ITG), Superior Energy (SPN), FLIR Systems (FLIR), and Yamana Gold (AUY). During the quarter we increased the portfolios equity exposure adding Nutrisystem (NTRI) in the Consumer Discretionary space, Arris Group (ARRS) in the Telecom/Technology sector, and Assurant, Inc. (AIZ) in the Financial services sector. In the current environment we are privy to companies with strong, liquid balance sheets, weak relative performance, leading market franchises, solid historic operating results, and manageable valuations. We employed the inverse ETF option in Tactical accounts in the middle of January and removed them in early February, adding nearly 1% in additional performance for Tactical accounts. We recently enacted the tactical option again at the end of the quarter, reducing equity exposure from 92% to 85% in Tactical accounts.
Outlook
Much has happened since I outlined my underlying view in the inaugural commentary, but not a lot has changed. There is still much to worry about, and much to be worried about. Psychological resistance to the recovery is giving way to a growing confidence, as investors come in from the cold. Momentum from the rising market, acceptable valuations, and 0% interest rates continue to encourage risk taking. The incessant upward movement of the market creates an unhealthy expectation, setting up potential disappointment. And so, at this point we continue to be cautious, wary that the longer term outlook is still cloudy, and that the lion’s share of the ‘easy money’ has already been made. As such, I am reluctant to chase the market, given how much it has run, how I think its trajectory will flatten, and how there are questions regarding the transition to self-sustaining growth.
This commentary represents the opinions of its author as of 4/12/10, and may change based on market and other conditions. The author’s opinions are not intended to forecast future events, guarantee future results, or serve as investment advice.
The Stewardship Partners US SMID Cap BRI strategy composite – gross returned 4.70% in the first quarter, but underperformed the S&P 1000 benchmark by 4.24% over the period. Our defensive posture, underperformance in stock selection, and underweighting of cyclical sectors, all served as a drag on relative performance.
Market Review – Still Climbing
It remained the best of times for small-mid cap investors in the first quarter, as the market continued to climb a wall of worry. The SMID cap sector, as captured by the S&P 1000 index, rose by 8.94% during the first quarter of 2010. The S&P 400 index (mid caps) rose 9.09%, while the S&P 600 index (small caps) rose 8.61%. The market extended its gains and momentum from 2009 into the new year. However, all was not a straight line, as the market took a tumble in January, before staging a recovery to finish the quarter up more than 14% from its February low. Growing confidence in the sustainability of the recovery, surging earnings, strong momentum, and low interest rates continue to underpin market strength. Although mid caps and small caps provided a similar return over the period, they did so via different routes. The leading sectors in the mid cap space were Consumer Discretionary (13.46%), Materials (12.95%), Health Care (12.34%) and Consumer Staples (11.46%). While the leading sectors in the small cap realm were Consumer Discretionary (19.46%), Financials (8.50%) and Health Care (8.05%). Value trumped growth by handy margins in both the mid and small cap sectors (15.08% to 11.42%, and 20.7% to 8.05% respectively). Sector laggards among mid caps were Utilities (1.08%), Telecom (3.6%), and Energy (3.7%). Sector laggards among small caps were Telecom (-12.19%), Materials (0.43%), and Utilities (1.25%). Of note, the SMID cap sector continued to outperform the large cap sector, highlighting the bullish predisposition of the market.
Recovering Balance Sheets, Recovering Psyches
It is becoming clearer that we are in the midst of a cyclical recovery, and there is little in the near term outlook to derail that process. Bolstered by exceptional monetary and fiscal policy, growth is spreading, weak sectors are stabilizing, and confidence is growing. However, recovery is fragile and we are still dealing with the de-leveraging effects of a balance sheet recession. The question remains as to whether the economy is robust enough to pass the baton from the public sector to the private sector, and when it will transition from recovery to expansion. The test is likely to come in 2011. Further down the road, it will be the middle-class who get squeezed on all sides (higher taxes, rising living costs, increasing interest rates, and higher energy costs). Having risen more than 75% off its lows, the market has already signaled high hopes for the future. But market history and common sense caution that there is less margin for error after such a move, and that the trajectory will flatten. And it is worrying when everyone seems to be on the same side of the trade. For those concerned about the risks, waiting for another collapse may be a little premature. Normally the pre-conditions for collapse (or in this case re-lapse) require high valuations, increasing leverage, and a reasonable period of stable growth in order to breed the complacency necessary to ignore risks. But with everyone focused on the risks, the likelihood that they will morph into reality is reduced. That does not mean however, that we will continue on the moon shot ride. When good news translates to bad news, then that may be ‘the tell’ that the market has gotten ahead of itself. And if we grow too fast, potentially the greatest risk is an unraveling of the recovery due to the economy’s vulnerability to rising interest rates. But don’t make the mistake of thinking that equities are not the place to be. On the contrary, the equity market may provide one of the few outlets for preserving wealth. To date, cost cutting has driven corporate profits, but it will require a pick-up in underlying demand to drive profit growth in the future. Valuation seems reasonable given the profit recovery and expected profit growth (easy YoY comparisons). The key will be whether that anticipated future growth materializes. Fund flow and small investor sentiment data indicate there are still a lot of small investors sitting out the rally. With confidence in the recovery spreading, it seems likely that these hesitant investors will be reeled in from the sidelines. The market right now is a ship without an anchor probing resistance in search of a valuation level. Many an investor has been burned standing in the way of this steamroller. Potential positive catalysts going forward are coordinated moves to address global imbalances, banks increasing their lending again, and a realization that the recovery is self-sustaining. However, prudence points to caution. The Fed has the difficult task of trying to stick the monetary landing, while our elected leaders have to come up with the courage to address our structural imbalances. Looking forward, we should expect more volatility and more compressed market cycles, as the choppy waters of stimulus exit meet the rough seas of secular headwinds.
Portfolio Review
The Stewardship Partners US SMID Cap BRI strategy composite – gross returned 4.70% in the first quarter, but underperformed the S&P 1000 benchmark by 4.24% over the period. Much of the relative underperformance was due to a large underweight position in the outperforming Consumer Discretionary and Consumer Staples sectors, and an overweight position in the underperforming Technology sector. In addition to the portfolio’s skew toward growth companies, stock selection and cash served as drags on performance relative to the benchmark. At this point we continue to maintain an overweight exposure to Technology, and Healthcare, with underweight exposure to Financials, Consumer Discretionary, Consumer Staples, and Utilities. Outperforming stocks during the quarter were Health Grades (HGRD), CapitalSource (CSE), Petmed Express (PETS), SEI Investments (SEIC), ICON PLC (ICLR), and MF Global (MF). Underperforming names were Investment Technology Group (ITG), Superior Energy (SPN), FLIR Systems (FLIR), and Yamana Gold (AUY). During the quarter we increased the portfolios equity exposure adding Nutrisystem (NTRI) in the Consumer Discretionary space, Arris Group (ARRS) in the Telecom/Technology sector, and Assurant, Inc. (AIZ) in the Financial services sector. In the current environment we are privy to companies with strong, liquid balance sheets, weak relative performance, leading market franchises, solid historic operating results, and manageable valuations. We employed the inverse ETF option in Tactical accounts in the middle of January and removed them in early February, adding nearly 1% in additional performance for Tactical accounts. We recently enacted the tactical option again at the end of the quarter, reducing equity exposure from 92% to 85% in Tactical accounts.
Outlook
Much has happened since I outlined my underlying view in the inaugural commentary, but not a lot has changed. There is still much to worry about, and much to be worried about. Psychological resistance to the recovery is giving way to a growing confidence, as investors come in from the cold. Momentum from the rising market, acceptable valuations, and 0% interest rates continue to encourage risk taking. The incessant upward movement of the market creates an unhealthy expectation, setting up potential disappointment. And so, at this point we continue to be cautious, wary that the longer term outlook is still cloudy, and that the lion’s share of the ‘easy money’ has already been made. As such, I am reluctant to chase the market, given how much it has run, how I think its trajectory will flatten, and how there are questions regarding the transition to self-sustaining growth.
This commentary represents the opinions of its author as of 4/12/10, and may change based on market and other conditions. The author’s opinions are not intended to forecast future events, guarantee future results, or serve as investment advice.
Friday, April 23, 2010
What I'm Looking For
I'm looking for a tell that this leg of the rally is done, and a timeout is likely to ensue.
My best guess is to watch the compression of returns between small-mid caps and large caps. When you see the SMID caps treading water and the large caps playing catch-up (especially if it is in a hurry), then there is a good chance a reversal is not that far away. Panicked buying is always a good sign.
The rationale for this is the fact that the SMIDs have led this rally from the beginning (SMID is up 17% YTD v 9% for the S&P 500 - a carryover from 2009). When their leadership begins to falter, then that is a sign the market is losing steam, and a more cautious tone is taking hold.
Within the SMIDs, consumer discretionary and financials have been the leaders this year (up 30% and 18% respectively). So watch them closely for an early sign of slippage.
My best guess is to watch the compression of returns between small-mid caps and large caps. When you see the SMID caps treading water and the large caps playing catch-up (especially if it is in a hurry), then there is a good chance a reversal is not that far away. Panicked buying is always a good sign.
The rationale for this is the fact that the SMIDs have led this rally from the beginning (SMID is up 17% YTD v 9% for the S&P 500 - a carryover from 2009). When their leadership begins to falter, then that is a sign the market is losing steam, and a more cautious tone is taking hold.
Within the SMIDs, consumer discretionary and financials have been the leaders this year (up 30% and 18% respectively). So watch them closely for an early sign of slippage.
Thursday, April 15, 2010
Entering Fat Pitch Territory
It is so hard to sell this market because you feel foolish and get steamrolled daily (that's a pretty bad combo). The price action is entering crazy territory. If we are really lucky, we will get a blow-off top which will set up a true fat pitch - S&P 1300 would be close to that mark. You can either sell into it, or keep your powder dry and go for the perfect timing play.
The market has overshot significantly on this upside bounce. Selling into ongoing strength is going to work. There is way too much happiness. Way too much comfort with the market. When you can't find anyone to say a bad thing about the market or the future, it is time to take a contrary position. You know you're in a bull market when good news/bad news/no news, it just keeps going up.
The market is acting as though the future is pure plain sailing. This leg is overdone, and it is time to book profits and go to the sideline.
The market has overshot significantly on this upside bounce. Selling into ongoing strength is going to work. There is way too much happiness. Way too much comfort with the market. When you can't find anyone to say a bad thing about the market or the future, it is time to take a contrary position. You know you're in a bull market when good news/bad news/no news, it just keeps going up.
The market is acting as though the future is pure plain sailing. This leg is overdone, and it is time to book profits and go to the sideline.
Thursday, April 1, 2010
And you thought I got it wrong
Okay. Confession time. I'm not really bearish on the prospects for the next 5-10 years. In fact, I am downright BULLISH. I have just been playing the devil's advocate this whole time to provide a little perspective.
It was obvious to me that the financial crisis and credit crunch were not real. They were just a product of a pathologically manic-depressive human emotion meter. A simple, but mistaken, loss of confidence. A figment of the imagination.
As quickly as it came, it was always going to go away. Duh! Any fool could see that.
Everything is fine. In fact, it is better now than at anytime that I can remember. You only have to look at the stock market to see that. And you need to remember that the stock market doesn't lie. It is an unbiased predictor of what the future holds.
For anyone willing to listen. All is right, and all will be right. We have a lot of catching up to do to get back to where we ought to be. S&P 2000 is the only fair value level given the pretense of economic damage. The firings were all a knee jerk reaction and they'll just as sooner hire everybody back again. Banks will open up their check books again, because they have significantly undervalued assets on their balance sheets. Houses will be worth what they should be worth, and equity withdrawal is likely to resume. The only thing that won't and shouldn't change is zero percent interest rates. With inflation below 2% and likely to stay there. There is no reason for short rates to rise and every reason for long rates to fall a lot further. Profit margins should expand as demand comes around and revenues increase. Because there is so much operating leverage in the corporate sector, EPS growth will be off the charts. No cyclicality, no normalization, only growth in the forecast. Concerns over public sector borrowing are pure make believe. The State has capacity to take on much more debt without so much as a flinch.
So sit down, buckle up and get ready for the ride of your life. We're getting on the gravy train.
It was obvious to me that the financial crisis and credit crunch were not real. They were just a product of a pathologically manic-depressive human emotion meter. A simple, but mistaken, loss of confidence. A figment of the imagination.
As quickly as it came, it was always going to go away. Duh! Any fool could see that.
Everything is fine. In fact, it is better now than at anytime that I can remember. You only have to look at the stock market to see that. And you need to remember that the stock market doesn't lie. It is an unbiased predictor of what the future holds.
For anyone willing to listen. All is right, and all will be right. We have a lot of catching up to do to get back to where we ought to be. S&P 2000 is the only fair value level given the pretense of economic damage. The firings were all a knee jerk reaction and they'll just as sooner hire everybody back again. Banks will open up their check books again, because they have significantly undervalued assets on their balance sheets. Houses will be worth what they should be worth, and equity withdrawal is likely to resume. The only thing that won't and shouldn't change is zero percent interest rates. With inflation below 2% and likely to stay there. There is no reason for short rates to rise and every reason for long rates to fall a lot further. Profit margins should expand as demand comes around and revenues increase. Because there is so much operating leverage in the corporate sector, EPS growth will be off the charts. No cyclicality, no normalization, only growth in the forecast. Concerns over public sector borrowing are pure make believe. The State has capacity to take on much more debt without so much as a flinch.
So sit down, buckle up and get ready for the ride of your life. We're getting on the gravy train.
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