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.
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%.
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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** Validea Capital Management is a separate investment advisory firm managed by Validea.com founder John Reese.
Thre information above in not intended as personal investment advice and should not be interpreted as such.
As we rebalance the Validea Hot List, 2 stocks leave our portfolio. These include:
Cash America International, Inc. (CSH)
Fossil, Inc. (FOSL).
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)
Dollar Tree, Inc. (DLTR).
We are adding 2 stocks to the portfolio. These include:
Ariad Pharmaceuticals, Inc. (ARIA)
Atwood Oceanics, Inc. (ATW).
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 email@example.com.