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Executive Summary June 19, 2015

The Economy

While housing and industrial reports have been mixed since our last newsletter, excellent jobs numbers and strong consumer data are indicating that the economy is continuing to gain steam.

The private sector added 262,000 jobs during May, the Labor Department said, with total nonfarm payrolls rising by 280,000. Average hourly wages also made a nice jump, rising 0.3%. The number of people not in the workforce fell by more than 200,000, another good sign. The unemployment rate rose slightly to 5.5%, while the broader "U-6" rate (which unlike the headline number takes into account those working part-time who want full-time work, and discouraged workers who have given up looking for a job) was steady at 10.8%, the lowest it has been since before the financial crisis exploded in September 2008.

The consumer is also showing signs of life. For the second time in three months, retail sales surged, jumping 1.2%, according to a new report from the Census Bureau. Despite the big monthly jump, sales were just 1.0% higher than they were in the year-ago period, however.

After jumping in April, housing starts pulled back in May, falling 11.1%, according to the Census Bureau. They are about 5% above year-ago levels, however. Permit issuance for new construction jumped nearly 12%, and is about 21% above where it stood a year ago. That bodes well for construction activity going forward.

Industrial production fell for the sixth straight month, declining 0.2% in May, according to a new Federal Reserve report. April's loss was revised to 0.5% from initial estimates of 0.3%, while March's results were revised to flat (from -0.3%). For May, manufacturing output was down 0.2%, while mining output dropped 0.3%. Utility output, which tends to be driven by seasonal factors, rose 0.2%.

Gas prices are continuing to climb, though the pace has slowed. A gallon of regular unleaded on average cost $2.80 as of June 16, up from $2.70 a month earlier, according to AAA. That's still 23.5% below where it was a year ago.

Since our last newsletter, the S&P 500 returned 1.2%, while the Hot List returned 1.7%. So far in 2015, the portfolio has returned 10.9% vs. 3.0% for the S&P. Since its inception in July 2003, the Hot List is far outpacing the index, having gained 258.8% vs. the S&P's 112.0% gain.

Portfolio Update

The Hot List has been continuing its strong 2015, with 7 of the portfolio's 10 holdings in the black since our last newsletter, as of mid-morning trading on Thursday.

The biggest winner was manufacturer Chart Industries (GTLS), which was up more than 7%. A couple catalysts may have been at work. First, Chart does a lot of work in the oil and gas industry, so rebounding oil prices may have helped its stock. Second, in early June, the firm agreed to acquire vaporizer manufacturer Thermax, Inc., in a deal expected to be accretive to future earnings within the first twelve months. Investors may have been continuing to adjust their expectations for Chart for the coming year.

Another strong performer was Taiwan-based semiconductor firm Silicon Motion Technology Corp. (SIMO), which was up 6.3%. There didn't seem to be a specific catalyst for Silicon Motion over the past fortnight. The stock has been exhibiting strong momentum for several weeks now, and bullish technical analysis factors may have been in play.

It was also a solid two weeks for South African petrochemical firm Sasol Ltd. (SSL). In addition to being helped by the oil price rebound, Sasol also got good news from the Competition Appeal Court of South Africa, which overturned a decision to fine the firm for overcharging customers for chemicals. The Competition Tribunal of South Africa in June 2014 fined Sasol 534 million rand ($43.5 million) in a case related to excessive pricing of polypropylene and propylene between 2004 and 2007, Bloomberg Business reported. Sasol shares were up 4.2% since our last newsletter.

On the downside, shares of Universal Insurance Holdings (UVE) were down 5.8%. Universal had a lot going on over the past couple weeks -- the firm repurchased over $5 million of its own shares, wrote its first homeowners policy in Pennsylvania, and received licensing approvals to do business in Minnesota and Michigan as it continues to expand. It's unclear whether investors were viewing the firm's expansion as a negative, or if some other factor was at work in the decline.

All in all, the Hot List's performance remains very encouraging, with the portfolio far ahead of the S&P 500 both this year and over the long term. In two weeks, we will rebalance the portfolio, and check back in on how the current holdings are faring.

 
Editor-in-Chief: John Reese












Guru Spotlight: David Dreman

While most investors were heading for the hills in late 2008 and early 2009, Warren Buffett was diving into the market, putting billions of dollars of cash to work and penning an op-ed for The New York Times entitled, "Buy American. I Am". James O'Shaughnessy was writing about a "generational opportunity" in the market. Kenneth Fisher was saying that investors needed to "get a grip" on their fears.

Buffett, O'Shaughnessy, and Fisher were not advising people to buy stocks during what turned out to be one of the greatest buying opportunities in decades because they had some sort of "6th sense" about when the market would turn. They were doing so because they understood investor psychology. They knew that, as Buffett puts it, the best time to be greedy is when others are fearful. And that means that, during crises, you should be looking for bargains, not the exit door.

One guru who has done extensive research into this notion is David Dreman. Dreman, perhaps more than any other guru I follow, is a student of investor psychology. And at the core of his research is the belief that investors tend to overvalue the "best" stocks -- those "hot" stocks everyone seems to be buying -- and undervalue the "worst" stocks -- those that people are avoiding like the plague. In addition, he also believed that the market was driven largely by how investors reacted to "surprises", frequent events that include earnings reports that exceed or fall short of expectations, government actions, or news about new products. And, he believed that analysts were more often than not wrong about their earnings forecasts, which leads to a lot of these surprises.

When you put those factors together, you get the crux of Dreman's contrarian philosophy. Surprises happen often, and because the "best" stocks are often overvalued, good surprises can't increase their values that much more. Bad surprises, however, can have a very negative impact on them. The "worst" stocks, meanwhile, are so undervalued that they don't have much further down to go when bad surprises occur. But when good surprises occur, they have a lot of room to grow. By taking a "contrarian" approach -- i.e. targeting out-of-favor stocks and avoiding in-favor stocks -- Dreman found you could make a killing.

Because Dreman took advantage of the overreactions of others, he found that one of the best times to invest was during a crisis. "A market crisis presents an outstanding opportunity to profit, because it lets loose overreaction at its wildest," he wrote in Contrarian Investment Strategies: The Next Generation. "People no longer examine what a stock is worth; instead, they are fixated by prices cascading ever lower." He goes on to say, "Buy during a panic, don't sell."

In his book, Dreman provides a table that shows what he calls "11 major postwar crises." These include the Berlin blockade, Korean War, Kennedy assassination, Gulf of Tonkin crisis, 1979-1980 oil crisis, and 1990 Persian Gulf War. He shows how, one year after all but one (the Berlin Blockade, when the market dropped), the market was up between 22.9 percent and 43.6 percent, except for a 7.2 percent rise after the Gulf of Tonkin crisis. The average gain was 25.8 percent. Two years after the crisis, the average gain was 37.5 percent. It's worth noting that following the September 11 terrorist attacks, which occurred after Dreman wrote Contrarian Investment Strategies, it took just one month for the S&P 500 to climb back to pre-September 11 levels. And of course, we know how strongly the market rebounded after the 2008-09 financial crisis, despite the "this time it's different" cries from the pundits.

Taken from Contrarian Investment Strategies: The Next Generation (Simon & Schuster, 1998)

Screen Shot 2015-06-17 at 11.58.54 AM



In fact, looking back on the financial crisis, Dreman's writings in Contrarian Investment Strategies seem particularly prescient. Consider what he had to say about the collective mindset of investors and the media when a crisis hits: "The event triggering the crisis is always considered to be something entirely new; nothing in our experience shows us how to cope with the current catastrophe. 'Sell, sell, sell,' the savants chorus. 'No matter how low prices have fallen, they are destined to go lower yet.' In each case, the crisis is the major news of the day. Legions of experts are interviewed, most making dour forecasts of structural damage to the nation. A common theme is 'things will never be the same again.' Because the nation, if not the world, is focused on the crisis, the media is in its glory. A crisis sells newspapers, builds ratings, and peddles advertising." Dreman said that "It is through this rout of panicky investors -- who as they rush past you shout how awful conditions are up ahead -- that you must resolutely advance."

Sound familiar? Even though Dreman wrote Contrarian Investment Strategies a decade before the financial crisis, 2008-09 played out just as you might have expected if you had read the book. It's the same old song, just a different verse: Bad news often gives the market the jitters, only to have it recover when the bad news turns out not to be as devastating as first feared. The savvy investor can take advantage of that knowledge.

I would be remiss if I did not note that Dreman himself was hit hard during the financial crisis. He doubled down on many of the big financials after they plunged, only to see them collapse further. His mistake, I believe, was that he trusted that the numbers on these firms' balance sheets were legitimate, when in many cases the companies had huge office-balance-sheet liabilities. If you are going to make big bets on particular companies, you have to be sure that the numbers on which you are basing your decisions are comprehensive and accurate.

That being said, the broader point of Dreman's research and writings is, I believe, a timeless one. When crises hit and the masses are fleeing the market, you should be on the lookout for the bargains they leave behind -- just make sure you're thorough and careful as you do so.



News about Validea Hot List Stocks

Lumber Liquidators Holdings, Inc. (LL): The embattled flooring firm has fired Chief Merchandising Officer William Schlegel, the Associated Press reported on June 15. Schlegel served four years in the position. He will be replaced by Chief Marketing Officer Marco Pescara, who will hold both roles, AP said. Pescara has been with Lumber Liquidators for nine years.

Universal Insurance Holdings, Inc. (UVE): Universal announced on June 10 that it repurchased 200,000 of its shares from Ananke Catastrophe Investments Limited, an affiliate of Nephila Capital Ltd., in a privately negotiated transaction, at an average price of $25.38 per share.



The Next Issue

In two weeks, we will publish another issue of the Hot List, at which time we will rebalance the portfolio. 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

AFSI   |   JLL   |   HRTG   |   LL   |   GTLS   |   SAFM   |   UVE   |   SIMO   |   TBI   |   SSL   |  



Amtrust Financial Services, Inc., (AmTrust) is a provider of property and casualty insurance. The Company operates in four business segments: small commercial business, Specialty Risk and Extended Warranty, specialty program and personal lines reinsurance. Small Commercial Business segment provides workers' compensation to small businesses. The Company's Specialty Risk and Extended Warranty segment provides coverage for consumer and commercial goods and custom designed coverages. The Company's Specialty Program segment provides workers' compensation, package products, general liability, commercial auto liability, excess and surplus lines programs and other specialty commercial property and casualty insurance. The Company subsidiaries include: Technology Insurance Company, Inc. (TIC), Rochdale Insurance Company (RIC), AmTrust Insurance Company of Kansas, Inc. (AICK), AmTrust Lloyd's Insurance Company of Texas (ALIC), Oryx Insurance Brokerage, Inc. and TMI Solutions, LLC.





Jones Lang LaSalle Incorporated (JLL) is a financial and professional services firm specializing in real estate. The Company operates through four business segments. JLL provides real estate services through three business segments: the Americas, Europe, the Middle East and Africa (EMEA), and Asia Pacific. JLL's fourth business segment is LaSalle Investment Management (LaSalle). The Company provides a range of integrated property, project management and transaction services locally, regionally and globally through its Americas, EMEA and Asia Pacific operating segments. The Company manages its investment management business globally as LaSalle. The Company provides a range of real estate services to real estate owners, occupiers, investors and developers for a range of property types. The Company offers its products and services under the JLL, LaSalle Investment Management and Tetris brands.





Heritage Insurance Holdings, Inc., formerly Heritage Insurance Holdings, LLC., is a property and casualty insurance holding company. Through Its subsidiary, Heritage Property & Casualty Insurance Company (Heritage P&C), the Company provides personal residential insurance for single-family homeowners and condominium owners in Florida. The Company is vertically integrated and control or manage substantially all aspects of insurance underwriting, actuRoboto analysis, distribution and claims processing and adjusting. As of March 31, 2014, it had approximately 140,000 policies in force, approximately 89% of which were assumed from Citizens. As of March 31, 2014, Citizens had approximately 940,000 insurance policies, of which approximately 690,000 were personal residential policies.





Lumber Liquidators Holdings, Inc. (Lumber Liquidators) is a retailer of hardwood flooring, and hardwood flooring enhancements and accessories in North America. The Company's product categories include Solid and Engineered Hardwood; Laminate; Bamboo, Cork and Vinyl Plank, and Moldings and Accessories. The Company sells its products primarily to homeowners or to contractors on behalf of homeowners. The Company offers wood flooring under18 brand names, led by Bellawood, a collection of solid and engineered hardwood flooring, bamboo flooring, moldings and accessories. The Company also offers a range of flooring enhancements and installation accessories, including moldings, noise-reducing underlay and tools. It offers around 400 different flooring product stock-keeping units. As of February 23, 2015, Lumber Liquidators operated around 354 stores located in 46 states of the United States and nine store locations in Canada.





Chart Industries, Inc. (Chart) is a diversified global manufacturer of engineered equipment engineered equipment for the industrial gas, energy, and biomedical industries. Chart's equipment and engineered systems are primarily used for low-temperature and cryogenic applications. The Company operates in three segments: Energy & Chemicals (E&C), Distribution & Storage (D&S), and BioMedical. The Company's products include vacuum insulated containment vessels, heat exchangers, cold boxes and other cryogenic components. The Company's E&C and D&S segments manufacture products used primarily in energy-related and industrial applications, such as the separation, liquefaction, distribution and storage of hydrocarbon and industrial gases. Through its BioMedical segment, it supplies cryogenic and other equipment used in the medical, biological research and animal breeding industries.





Sanderson Farms, Inc. is a poultry processing company which is engaged in the production, processing, marketing and distribution of fresh and frozen chicken and other prepared chicken items. In addition, the Company is engaged in the processing, marketing and distribution of prepared chicken through its wholly owned subsidiary, Sanderson Farms, Inc. (Foods Division). It produces a range of processed chicken products and prepared chicken items. It sells ice pack, chill pack, bulk pack and frozen chicken, in whole, cut-up and boneless form, under the Sanderson Farms brand name to retailers, distributors, and casual dining operators in the south-eastern, south-western, north-eastern and western United States and to customers who resell frozen chicken into export markets. During the fiscal year ended October 31, 2013 (fiscal 2013), it processed 452 million chickens, or over 3.0 billion dressed pounds.





Universal Insurance Holdings, Inc. (UIH), with its wholly owned subsidiaries, is a vertically integrated insurance holding company performing all aspects of insurance underwriting, distribution and claims. The Company's offers homeowners' insurance through the Insurance Entities, Universal Property & Casualty Insurance Company (UPCIC) and American Platinum Property and Casualty Insurance Company (APPCIC). Substantially all aspects of insurance underwriting, distribution and claims processing are performed by the Company's subsidiaries. UPCIC, a wholly owned subsidiary of the Company, is a writer of homeowners insurance in Florida and has commenced its operations in North Carolina, South Carolina, Hawaii, Georgia, Massachusetts, Maryland, Delaware, and Indiana. APPCIC, also a wholly owned subsidiary, writes homeowners multi-peril insurance on Florida homes valued in excess of $1 million, which are limits and coverages currently not targeted through its affiliate UPCIC.





Silicon Motion Technology Corporation is a Taiwan-based holding company. The Company develops microcontroller ICs for NAND flash storage devices and specialty RF ICs for mobile devices. The Company designs, develops and markets, low-power semiconductor solutions to OEMs and other customers in the mobile storage and mobile communications markets. For the mobile storage market, the Company's key products are microcontrollers used in solid state storage devices such as SSDs, eMMCs and other embedded flash applications, as well as removable storage products. For the mobile communications market, the Company's key products are handset transceivers and mobile TV IC solutions. The Company's products are used in smartphones, tablets, and industrial and commercial applications.





TrueBlue, Inc. (TrueBlue), is a provider of specialized workforce solutions, helping clients improve growth and performance. The Company provides staffing, recruitment process outsourcing, and managed service provider solutions. The Company operates through two reportable segments, Staffing Services and Managed Services. The Company offers on-premise temporary blue-collar staffing together with outsourced service offerings in recruitment process outsourcing (RPO) and managed services provider (MSP) solutions. On-premise staffing is sourcing, screening, recruiting and management of the contingent labor workforce at a customer's facility. RPO is high-volume sourcing, screening, and recruiting of permanent employees for all industries and jobs. MSP solutions manage its customer's overall contingent labor program including vendor selection, vendor performance management, vendor compliance monitoring and risk management, and reducing vendor costs.





Sasol Limited (Sasol) is a South Africa-based international integrated energy and chemicals company. The Company develops and commercializes technologies, builds and operates facilities to produce a range of product streams, including liquid fuels, high-value chemicals and low-carbon electricity. The Company's operations are organized into three focused business clusters: South African Energy Cluster; International Energy Cluster and Chemical Cluster. The South African Energy Cluster is involved in coal mining, gas production, synfuels manufacturing and oil refining. The International Energy Cluster manages the Company's oil and gas business outside South Africa. The Chemical Cluster is involved in making polymers, solvents, olefins and surfactants and other chemicals.
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.




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