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Executive Summary January 21, 2011

The Economy

The economic picture keeps on improving, with even the most troublesome area of the economy -- the labor market -- showing improvement as we head into 2011.

According to the Labor Department's most recent monthly report, the economy added 103,000 jobs in December, a figure that looks even better when you consider that the numbers for October and November were revised higher by a total of 70,000. It was the third straight month of job growth -- and, contrary to popular belief, it's not government hiring that's driving the growth; it's the private sector, which actually had positive job growth in every month of 2010, according to the Labor Department.

The unemployment rate fell in December from 9.8% to 9.4%, the biggest drop since the start of the recession. And the "U-6" measure of unemployment -- which also includes those who have given up looking for a job -- fell from 17.0% to 16.7%.

One interesting note from the report is that the overall number of unemployed people dropped by 556,000 in December, even though less than a fifth of that number of jobs were added. Looked at another way, the number of people who were not in the labor force jumped by more than 430,000. It doesn't, however, appear that that was due to discouraged workers dropping out of the labor force -- the U-6 figure is intended to pick up discouraged workers who want a job but have stopped looking, and that declined. Next month's report may give a clue as to whether the big increase of those not in the labor force was simply an anomaly, of if there is something significant behind it.

Thus far in January, the employment numbers continue to be positive. According to the Labor Department's latest weekly report (for the week ending Jan. 8), continuing claims for unemployment fell to their lowest level since October 2008. New claims, meanwhile, are in the low 400,000s, well below where they were for most of 2010.

In other areas, the economy continues to show improvement. Industrial production increased 0.8% in December, according to a new Federal Reserve report. A big part of the increase came from the utilities sector, thanks to colder-than-expected winter weather that led to higher heating bills, but the manufacturing and mining sectors also showed solid growth. Overall, industrial production ended the year at its highest level since August 2008, as did capacity utilization.

Retail sales also continued to look good, rising 0.6% in December, according to the Commerce Department. While many pundits have proclaimed the U.S. consumer dead, the December figure represented a new high, topping the previous high that was set in November 2007, just before the "Great Recession" hit. For the full year, sales rose 6.6%, the fastest pace in 11 years.

Fourth-quarter earnings reports, meanwhile, have been rolling in, and the results are mixed. Good news came from the tech sector, with bellwethers Apple and IBM posting very strong results. The retail sector also had some big winners, with Sears Holdings and Tiffany & Co. both upping their earnings forecasts. In the financial sector, reports were mixed, with Citigroup and Goldman Sachs putting up disappointing numbers, U.S. Bancorp beating expectations, and Wells Fargo meeting expectations.

Some good news also came from the housing market. The National Association of Realtors reported that existing-home sales jumped 12.3% in December, reaching their highest level since May, back when the new-homebuyer tax credit was still in effect. Sales prices fell, however, to their lowest level since February.

One issue to keep an eye on is inflation. While so-called "core" inflation has remained tame, food and energy prices -- which aren't included in the core figure, but are certainly core expenses for Americans -- have been rising fairly sharply. In December, home heating oil producer prices surged 12.3%, fresh and dry vegetable prices jumped 22.8%, and fresh fruits and melons surged 15.4%. Food prices have been climbing for several months, as shortages due to weather conditions have many analysts worried about a food shortage in 2011. If fuel and food prices keep on climbing and are passed on to consumers, it could put a crimp in the consumer spending rebound, as well as corporate profits.

Overall since our last newsletter, the S&P 500 returned 0.5%, while the Hot List returned 2.5%. For the year, the portfolio stands at 2.0% vs. 1.8% for the S&P. Since its inception in July 2003, the Hot List is far outpacing the index, having gained 175.2% vs. the S&P's 28.0% gain.

Staying Small

Last newsletter, I wrote about "closet indexers" -- funds that purport to be actively managed but which really act as index funds -- and how you can't beat the market by owning it. Many of the best opportunities lie outside the major indices (like the S&P 500 or Dow Jones Industrial Average), where a myriad of good stocks can fly under the radar. On today's rebalancing, the Hot List is again showing a commitment to scouring all areas of the market, adding two smaller stocks that aren't members of the S&P 500 or the Dow.

The first is Atwood Oceanics, a Houston-based offshore oil drilling firm with a $2.4 billion market cap. Atwood has been a big winner for one of my most stringent -- and most successful -- strategies, the model I base on the writings of the late Benjamin Graham. Atwood's shares were hit hard by the fear surrounding the oil spill in the Gulf of Mexico in April, and my Graham-based portfolio picked it up in early September, right around when it hit bottom. Since then it's up more than 40%. Atwood isn't nearly as well known as some of the bigger oil drillers, but it has an excellent balance sheet -- its current ratio is 3.85 and it has more net current assets than long-term debt, a key criterion Graham used. Its small size and relative anonymity have also helped it fly under the radar of many investors. While big oil services firms like Halliburton or Schlumberger trade for 25 or 26 times earnings, Atwood trades for just 10 times three-year average earnings.

The other new addition to the Hot List is a small-cap that has also been hot but remains an under-the-radar pick: Ariad Pharmaceuticals. Ariad is a biotech that makes drugs used to treat very aggressive types of cancer. It's not getting a ton of love from Wall Street, trading for only about 8 times earnings, but it has caught the eye of my Joel Greenblatt-based model. Ariad boasts an impressive 193% return on capital and a strong 13.8% earnings yield, making it the 19th-most-attractive stock in the market, according to this model.

Ariad and Atwood replace two stocks that were added to the portfolio last month. As of yesterday afternoon, one -- Cash America International -- was up about 3%, while the other -- Fossil, Inc. -- was down about 3%.

Sentiment-al Thoughts

Lately, there's been a lot of talk about how "optimistic" investors have become. And, to be sure, sentiment seems to be better than it was a year ago, and it's dramatically better than it was two years ago.

For a contrarian investor -- and, because of its value tilt, the Hot List does tend to have a strong contrarian streak -- the question is, has sentiment gotten too bullish? After all, in the past 11 years we've seen two bubbles burst as sentiment grew to unreasonably high levels.

Professional investors do seem to be bullish. In fact, according to a recent Bank of America-Merrill Lynch survey, fund managers are as bullish as they've been since July 2007, with a net 55% of asset allocators saying they are 'overweight' global equities. (The "net" 55% figure means that's the spread between the percentage of those who are overweight stocks and the percentage of those who are underweight.)

There have also been indications that individual investors have made a major bullish turn. On the American Association of Individual Investors' Sentiment Survey, for example, the spread between the percentage of respondents who are bullish and the percentage who are bearish has favored the bearish side by at least 20 percentage points for nine straight weeks -- the first time that has happened in more than six years.

On the surface, that might seem to be a troubling statistic. But there are some important caveats to consider when looking at these numbers. For one thing, the AAII survey measures what investors say -- not what they do. For another, there is no discussion of magnitude. That is, a person who is ever-so-slightly bullish is counted the same as someone who has emptied the bank account, sold the house, and dumped every last penny they have into the market. (The same goes for the BOA/Merrill survey of fund managers.)

Because of that, I think it may be more instructive to look at fund flow data to determine just how much bullishness is out there. There are a variety of groups that track fund flows, but one that is particularly useful is Lipper, Inc., which tracks not only the flows in and out of mutual funds, but also those in and out of exchange-traded funds, which have become a major tool for individual investors.

Looking at the latest Lipper data, the sentiment picture doesn't seem nearly as bullish as those other number indicate. In fact, for U.S. stocks, it's downright bearish. In December, net inflows to stock and mixed equity mutual funds were just over $11 billion, according to Lipper. That's a solid increase, but by no means an indication of overwhelming bullishness. (Back in January 2007, by comparison, net inflows were more than $38 billion.)

What's more, domestic funds actually detracted from that $11.1 billion total; U.S. domestic mutual funds had outflows of $10.9 billion for the month. World equity funds had inflows of $12.5 billion, while mixed equity funds (which contain both stocks and other assets) and sector equity funds also had significant inflows.

ETFs were a different story. Overall net inflows to stock and mixed equity ETFs were $18.4 billion in December, with $14.4 billion of that coming from U.S. domestic equity ETFs.

When we combine the mutual fund and ETF data, we thus see that a net of about $29.5 billion flowed into stock and mixed equity funds in December -- but that only $3.5 billion of that went toward U.S. domestic funds. That's not even enough to make up for the $3.8 billion that flowed out of U.S. domestic equity mutual funds and ETFs in November. (Also, keep in mind that the BOA/Merrill survey asked managers whether they were bullish on global equities, not U.S. equities.

For the Hot List, that's a good sign. Sentiment has improved recently, but it doesn't seem to be close to really troublesome levels for U.S. stocks. And, while the Hot List has keyed on a number of foreign firms and American Depository Receipts in recent years, it remains predominantly invested in U.S. companies. Currently, for example, it holds three foreign companies, and two of them -- Europe-based Telefonica and Sanofi-Aventis -- are from a region that many investors have actually been avoiding.

On the other side of the coin, it's possible that some other parts of the world have gotten a bit frothy; emerging markets, for example, have seen major inflows in the past year. But when it comes to those regions, the Hot List's value bias should be particularly useful. Because it focuses on so many valuation metrics -- the price/book, price/earnings, price/cash flow, and price/divided ratios to name a few -- it should be able to avoid the really overhyped stocks in those regions.

The bottom line is that, overall, despite the talk of "frothy" sentiment, it looks like a sizeable wall of worry remains in place for U.S. equities. In the short term, of course, anything can happen. But from a long-term perspective, I think the U.S. market remains in good position, with sentiment in check, strong corporate earnings underpinning the market's gains, and numerous individual stocks still looking quite attractive.

 
Editor-in-Chief: John Reese










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The Fallen

As we rebalance the Validea Hot List, 2 stocks leave our portfolio. These include: Cash America International, Inc. (CSH) and Fossil, Inc. (FOSL).

The Keepers

8 stocks remain in the portfolio. They are: Telefonica S.a. (Adr) (TEF), Millicom International Cellular Sa (Usa) (MICC), Raytheon Company (RTN), Aeropostale, Inc. (ARO), Sanofi-aventis Sa (Adr) (SNY), Tower Group, Inc. (TWGP), Gamestop Corp. (GME) and Dollar Tree, Inc. (DLTR).

The Newbies

We are adding 2 stocks to the portfolio. These include: Ariad Pharmaceuticals, Inc. (ARIA) and Atwood Oceanics, Inc. (ATW).

Portfolio Changes



Newcomers to the Validea Hot List

Ariad Pharmaceuticals (ARIA): Based in Cambridge, Mass., Ariad is a biotech firm that develops small-molecule drugs to treat aggressive cancers for which current therapies are inadequate. The firm recently announced that its ridaforolimus drug, which is being developed in collaboration with Merck, had a successful Phase 3 trial for patients with metastatic soft-tissue or bone sarcomas. Ariad is a small-cap ($800 million), and it has taken in about $180 million in sales in the past year.

Ariad gets strong interest from the Guru Strategy I base on the writings of Joel Greenblatt. To read more about it, check out the "Detailed Stock Analysis" section below.

Atwood Oceanics (ATW): Like many offshore oil drillers, Atwood shares were hit particularly hard after the big Gulf of Mexico oil spill. But they've bounced back strong, climbing back to around their pre-spill levels. The Bureau of Ocean Energy Management's chief also recently said new permits for drilling in the Gulf should be issued in the first half of this year, a good sign. Even if they aren't, Houston-based Atwood has operations all around the globe, and increased both earnings and sales in its 2010 fiscal year despite the temporary ban on drilling in the Gulf. The $2.4-billion-market-cap firm has taken in about $650 million in sales in the past year.

Atwood gets strong interest from both my Benjamin Graham- and Peter Lynch-inspired strategies. See the "Detailed Stock Analysis" section below to learn more about the stock.



News about Validea Hot List Stocks

Telefonica SA (TEF): Telefonica was one of two firms awarded the first private licenses to provide cell phone service in Costa Rica. Telefonica had the highest bid, at $95 million, and received the best of the available licenses, Reuters reported. If approved by Costa Rica's president, the awards could be granted in two weeks and the private cell service could begin in September, according to Reuters.

Sanofi-Aventis SA (SNY): Sanofi and Genzyme's merger talks are heating up again. According to The Wall Street Journal, the firms have been discussing ways to structure a deal that would eventually value Genzyme at about $80 per share. The sides are discussing the option of using a "contingent value right", which usually goes into effect after an acquired company meets sales or regulatory goals, to push the price up toward that $80 figure, the Journal reports. Sanofi's previous $69 a share tender offer for the biotech firm expires on Jan. 21.



The Next Issue

In two weeks, we will publish another issue of the Hot List, at which time we will take a closer look at my strategies and investment approach. If you have any questions, please feel free to contact us at hotlist@validea.com.



Current Portfolio






Detailed Stock Analysis

Disclaimer: The analysis is from Validea's selection and interpretation of content from the guru's book or published writings, and is not from nor endorsed by the guru. See Full Disclaimer

ARO   |   MICC   |   TEF   |   RTN   |   TWGP   |   ARIA   |   SNY   |   GME   |   DLTR   |   ATW   |  



Aeropostale, Inc. is a mall-based specialty retailer of casual apparel and accessories. The Company designs, markets and sells its own brand of merchandise principally targeting 14 to 17 year-old young women and young men. The Company also sells Aropostale merchandise through its e-commerce Website, www.aeropostale.com. During the fiscal year ended January 30, 2010 (fiscal 2009), the Company launched P.S. from Aeropostale, which offers casual clothing and accessories focused on elementary school children between the ages of 7 and 12. During fiscal 2009, the Company completed the closure of its 14 store Jimmy'Z concept. Jimmy'Z Surf Co., Inc., a wholly owned subsidiary of Aeropostale, Inc., was a contemporary lifestyle brand targeting young women and men aged 18 to 25.





Millicom International Cellular S.A. (Millicom) is a global mobile telecommunications operator. The Company also operates fixed telephony, cable and broadband businesses in five countries in Central America. As of December 31, 2009, the Company had 14 mobile operations in 14 countries focusing on emerging markets in Central America, South America, Africa and Asia. Millicom operates its mobile businesses in El Salvador, Guatemala and Honduras in Central America; in Bolivia, Colombia and Paraguay in South America; in Chad, the Democratic Republic of Congo, Ghana, Mauritius, Rwanda, Senegal and Tanzania in Africa; and in Laos in Asia. In November 2009, the Company announced that it has completed the sale of its Cambodian operations to The Royal Group. In October 2009, the Company announced the sale of Tigo (Private) Limited, its Sri Lanka operation, to Etisalat.





Telefonica SA (Telefonica) together with its subsidiaries and investees operates in the telecommunications, media and contact center industries. Telefonica basic purpose is the provision of all manner of public or private telecommunications services, including ancillary or complementary telecommunications services or related services. The Company operates in three business areas: Telefonica Spain, Telefonica Latin America and Telefonica Europe. During the year ended December 31, 2009, Telefonica Moviles Espana, SAU, a wholly owned subsidiary of the Company completed the sale of its 32.18% stake in Medi Telecom, SA. In January 2010, the Telefonica Group, through its wholly owned subsidiary, Telefonica Europe plc completed the acquisition of JAJAH.





Raytheon Company, together with its subsidiaries, develops products, services and solutions in defense markets; sensing, effects, command, control, communications and intelligence (C3I), and mission support, as well as the cybersecurity and homeland security markets. The Company serves both domestic and international customers, principally as a prime contractor on a portfolio of defense and related programs for government customers. It operates in six business segments Integrated Defense Systems (IDS), Intelligence and Information Systems (IIS), Missile Systems (MS), Network Centric Systems (NCS), Space and Airborne Systems (SAS) and Technical Services (TS). In October 2009, the Company acquired BBN Technologies Corp. and related entities. In November 2010, the Company acquired Trusted Computer Solutions, a company that delivers a portfolio of cross-domain, operating system and network security solutions.





Tower Group, Inc. (Tower), through its subsidiaries, offers a range of commercial, personal and specialty property and casualty insurance products and services to businesses in various industries and to individuals. The Company operates in three segments: Brokerage Insurance, Specialty Business and Insurance Services. On February 5, 2009, Tower acquired CastlePoint Holdings, Ltd. (CastlePoint). On February 27, 2009, the Company and its subsidiary, CastlePoint, completed the acquisition of HIG, Inc. (Hermitage), a property and casualty insurance holding company. On October 14, 2009, the Company completed the acquisition of the renewal rights to the workers compensation business of AequiCap Program Administrators, Inc. (AequiCap), an underwriting agency. On November 13, 2009, it acquired Specialty Underwriters Alliance, Inc. (SUA). In July 2010, Tower Group, Inc. acquired the Personal Lines Division of OneBeacon Insurance Group, Ltd.





ARIAD Pharmaceuticals, Inc. (ARIAD) is a biopharmaceutical company focused on the discovery and development of drugs to provide therapeutic intervention in treating human diseases at the cellular level. The Company's lead cancer product candidate, ridaforolimus, is an internally discovered, potent inhibitor of the protein mTOR. mTOR acts as a central regulator of protein synthesis, cell proliferation, cell cycle progression and cell survival. Its second product candidate, AP24534, is an investigational, pan BCR-ABL inhibitor that has potential applications in various hematological cancers and solid tumors and is wholly owned by the Company. Its third product candidate, AP26113, is an investigational anaplastic lymphoma kinase (ALK), inhibitor that has the potential to regulate multiple cancer pathways and to be used in the treatment of certain patients with various cancers, including non-small cell lung cancer, lymphoma and neuroblastoma.





Sanofi-Aventis is a pharmaceutical group engaged in the research, development, manufacture and marketing of healthcare products. The Company's business includes two main activities: pharmaceuticals and human vaccines through sanofi pasteur. The Company is also present in animal health products through Merial Limited (Merial). In its pharmaceutical activity, the Company specializes in six therapeutic areas: diabetes, oncology, thrombosis and cardiovascular, central nervous system (CNS), and internal medicine. The global portfolio of sanofi-aventis also consists of a range of other pharmaceutical products in Consumer Health Care (CHC) and other prescription drugs, including generics. It offers vaccines in five areas: pediatric combination vaccines, influenza vaccines, adult and adolescent booster vaccines, meningitis vaccines and travel and endemic vaccines. In October 2010, Siegfried Holding AG sold its PulmoJet Inhalation Project to the Company.





GameStop Corp. (GameStop) is a retailer of video game products and personal computer (PC) entertainment software. The Company sells new and used video game hardware, video game software and accessories, as well as PC entertainment software, and related accessories and other merchandise. As of January 30, 2010, the Company operated 6,450 stores in the United States, Australia, Canada and Europe, primarily under the names GameStop and EB Games. GameStop also operates the electronic commerce Website www.gamestop.com and publish Game Informer, a multi-platform video game magazine in the United States based on circulation, with approximately 4 million subscribers. During the fiscal year ended January 30, 2010 (fiscal 2009), GameStop operated its business in four segments: United States, Canada, Australia and Europe.





Dollar Tree, Inc. (Dollar Tree) is an operator of discount variety stores offering merchandise at the fixed price of one dollar. At January 30, 2010, the Company operated 3,806 discount variety retail stores. Approximately 3,650 of these stores sell substantially all items for one dollar or less. The remaining stores, operating as Deal$, sell items for one dollar or less but also sell items for more than one dollar. Dollar Tree's stores operate under the names of Dollar Tree, Deal$ and Dollar Bills.





Atwood Oceanics, Inc., along with its subsidiaries, is engaged in the international offshore drilling and completion of exploratory and developmental oil and gas wells. The Company's operations include nine offshore mobile drilling units located in five regions: offshore Southeast Asia, offshore Africa, offshore Australia, offshore South America and the Mediterranean Sea. During the fiscal year ended September 30, 2010 (fiscal 2010), the Company had a utilization rate of 88%. Its offshore drilling equipments include semisubmersible rigs, jack-up drilling rigs, semisubmersible tender assist rigs and submersible drilling rigs. The Company obtains the contracts, under which it operates its units either through individual negotiation with the customer or by submitting proposals in competition with other contractors. In October 2010, the Company entered into turnkey construction agreements with PPL Shipyard PTE LTD to construct two Pacific Class 400 jack-up drilling units.





Watch List

The Watch List contains the highest scoring stocks according to our guru consensus system that are not currently in the Hot List portfolio. We provide this list both for informational purposes and for investors who are not comfortable with a portfolio of ten stocks.





Disclaimer


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Validea is not registered as a securities broker-dealer or investment advisor either with the U.S. Securities and Exchange Commission or with any state securities regulatory authority. Validea is not responsible for trades executed by users of this site based on the information included herein. The information presented on this website does not represent a recommendation to buy or sell stocks or any financial instrument nor is it intended as an endorsement of any security or investment. The information on this website is generic by nature and is not personalized to the specific situation of any individual. The user therefore bears complete responsibility for their own investment research and should seek the advice of a qualified investment professional prior to making any investment decisions.

Performance results are based on model portfolios and do not reflect actual trading. Actual performance will vary based on a variety of factors, including market conditions and trading costs. Past performance is not necessarily indicative of future results. Individual stocks mentioned throughout this web site may be holdings in the managed portfolios of Validea Capital Management, a separate asset management firm founded by Validea.com founder John Reese. Validea Capital Management, which is a separate legal entity and an SEC registered investment advisory firm, uses, in part, the strategies on the web site to select stocks for its clients.