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Executive Summary July 9, 2010

The Economy

The economic news has been quite mixed since our last newsletter -- not as good as it had been in previous months, but perhaps not as bad as the market and media are indicating.

A good example came from the manufacturing sector. The Institute for Supply Management's latest Report on Business stated that the group's manufacturing activity index fell in June to 56.2, down from 59.7 in May. But while the drop was met with some fear, the index still indicates that the manufacturing sector is expanding, and it's doing so at a good pace. Anything above a reading of 50 is a sign of expansion in the sector, and the 56.2 reading for June indicates that, while the sector expanded more slowly than it did in May, it still grew in June at a faster rate than it did in any month of 2009.

Like its manufacturing index, ISM's service sector index stayed comfortably in expansion territory in June, though it also dropped from its May level. It registered 53.8, a higher reading than at any time in 2009.

The ISM data also offered some positive employment news. The employment sub-index of its manufacturing index registered 57.8 in June -- down from May levels but still way above the 49.8 mark that signals growth in manufacturing employment. The service sector employment sub-index, meanwhile, fell slightly to 49.7 in June, indicating a very slight contraction.

The Labor Department's latest jobs report, meanwhile, showed private sector growth, but not as much as many had hoped for. Overall, nonfarm payrolls shed 125,000 jobs in June. But that included about 225,000 temporary Census jobs that were lost. In the private sector, 83,000 jobs were added. There were some other discouraging signs in the report, however. The number of people "marginally attached" to the workforce -- those who wanted and were available for work, and had looked for a job sometime in the prior 12 months (but not in the four weeks before the survey) -- jumped from about 2.2 million in May to 2.6 million in June. Among that group, the number of "discouraged workers" -- those who aren't looking for work because they believe no jobs are available -- grew from about 1.1 million in May to 1.2 million in June. If you factor in those 1.2 million workers, the unemployment rate would be north of 10%.

There was some decent employment news this week, however, as new claims dropped to their lowest level in about two months. Still, the overall job market has a ways to go before it can be considered healthy.

Consumers, meanwhile, seem to have gotten a fresh dose of fear. The Conference Board reported that its consumer confidence index tumbled more than 15% in June. While the index is still more than twice as high as its early 2009 lows, the 52.9 reading in June was well below the target of 90 that usually indicates a stable economy. Retail sales, which took a sizeable dip in May, do appear to have rebounded in June, though. They increased 3.1%, according to Thomson Reuters, though the Census Bureau has yet to release its official results. The consumer is critical for the U.S., with consumer spending making up about two-thirds of the country's economy.

Finally, the housing market remains a big question mark. The latest S&P/Case-Shiller data (for April) showed that home prices rose close to 1% vs. March, and were up almost 4% over their year-ago levels. But it's unclear what impact of the expiration of the government's homebuyer tax credit program will have going forward. The National Association of Realtors reported that pending home sales plunged in May by 30%, as many homebuyers had rushed to make their purchases in the previous couple months to be eligible for the tax credits. That boosted sales in prior months, but left something of a void in the market in May. As we move further from the tax credit expiration, we should get a better idea of how the housing market will fare without those government tax credit carrots dangling before buyers.

The market hasn't responded well to the economic news since our last newsletter. The S&P 500 has returned -0.3%, while the Hot List has returned -0.8%. For the year, the portfolio stands at -7.6% vs. -4.0% for the S&P. Since its inception in July 2003, the Hot List is far outpacing the index, having gained 122.8% vs. the S&P's 7.0% gain.

A Diverse Quartet

The Hot List is shaking things up today on its regular monthly rebalancing, selling four of its holdings and replacing them with four that are now garnering higher scores on my guru-based models.

The departing stocks include one longer-term holding, Aeropostale, that has fared quite well. The teen retailer is up about 35% since joining the portfolio back in November, on the back of continued strong profits and sales results amid a tough climate for retailers.

The other three departing stocks haven't fared as well. Sanofi-Aventis has been pretty much flat since joining the portfolio on June 11, as has Ares Capital since the Hot List picked it up on March 19. But flat hasn't been a bad thing to be lately -- the broader market has been in the red since the portfolio picked up each of those stocks. The fourth departing stock, Clearwater Paper, has struggled since joining the portfolio two rebalancings ago. It was down about 18% as of Thursday afternoon.

The newcomers to the portfolio are quite a mix. There's a large-cap aerospace & defense giant (Raytheon Company); a large-cap hard drive and digital space power (Western Digital); and two smaller stocks, one an India-based metals and mining firm (Sterlite Industries) and the other a Brazil-based producer of sugar and ethanol products (Cosan Limited).

The changes to the Hot List mean that eight different sectors are now represented in the 10-stock portfolio. There are three holdings with market caps of about $1 billion or less; four that are in the $2.5 billion-$3.0 billion range; and three that have caps of about $7 billion or more.

That diversity seems to be an indication of the broader market climate. Bargains aren't just popping up in a couple maligned areas; shares of strong companies are selling at bargain prices across most of the market. And a big reason, I believe, is that fear -- not fundamentals -- has been doing a good portion of the market-moving in the past couple months.

To be sure, some of the data that has been coming in in recent weeks isn't as good as it had been earlier in the recovery; some is flat-out disappointing. But as I noted above, in some cases -- like the manufacturing sector -- things are still improving at a very nice pace. Many investors, however, aren't seeing it that way.

Last newsletter, I discussed several of the behavioral biases humans are prone to that lead them to make poor investment decisions. Among them were "anchoring" -- when one bases one's expectations on facts that are no longer relevant -- and "recency bias" -- the penchant for people to extrapolate the recent past into the future. Right now, it seems to me that investors are suffering from a bit of both, anchoring their expectations on the 2008 crash since that is the most recent downturn they've faced. Back then, stocks tumbled. But instead of bouncing back as they do in a typical bear market or correction, they kept tumbling, and tumbling, and tumbling, as we endured a bear market of historical proportions.

Given how trying that bear market was, and how recent it was, it's no surprise that investors are looking at the current correction and fearing that it's just the start of another big plunge. But it's important to look at the facts, and the facts are that the market is currently quite different than it was heading into the 2008 crash. For one thing, companies -- the entities behind the stocks that make up the market -- were leveraged to the hilt back then. In the year-and-a-half since, financial firms have written off billions of dollars in bad debt. Non-financials have streamlined operations, preparing for what some had feared would be a second Great Depression, and now boast record-high cash levels. There are still problems, to be sure -- some financials are still holding plenty of bad debt, for example. But all in all, Corporate America is far better off than it was leading up to the 2008 crash.

Valuations are also better today than they were as the 2008 crash hit. Heading into the third quarter of 2008, the S&P 500 traded for about 18.4 times trailing 12-month operating earnings, and more than 24 times as-reported trailing 12-month earnings. Today, it sells for about 15.5 times TTM operating earnings, and about 16.6 times as-reported TTM earnings.

Many investors are ignoring those facts. They've been pulling piles of money out of the market in recent weeks. After putting cash back into stocks in each of the first four months of 2010, investors pulled a net of almost $25 billion out of equity mutual funds in May, and preliminary figures show the outflows continued in June, according to Investment Company Institute. And U.S. funds were hit much harder than foreign equity funds.

Sentiment has continued to tumble even as stock valuations have gotten more and more attractive. On June 17, the American Association of Individual Investors sentiment survey showed that 42.5% of respondents were bullish, and only 30.7% were bearish. By July 8, the bullish figure had dropped to 20.9% and the bearish figure was up to 57.1%. The former was the lowest the bullish reading has been since the group's March 5, 2009 report; the latter was the highest the bearish reading has been since the same date. Of course, just two trading days after that report, the market took off on its dramatic rally.

That's not surprising. The market often turns when things look bleakest, and fear is running rampant. That's what so many of the gurus I follow knew. David Dreman has written extensively about buying unloved stocks, or being bullish in times of outright crisis. Warren Buffett has said that the time to be greedy is when others are fearful. And Peter Lynch has said having the stomach to stay disciplined during emotional times is critical to making money in stocks. So while others will focus on the fear and hype surrounding the recent downturn, the Hot List will continue to focus on the facts and figures. And right now, they show that there are plenty of good values out there. Those who pass up the bargains now will likely wish they hadn't later.

 
Editor-in-Chief: John Reese










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The Fallen

As we rebalance the Validea Hot List, 4 stocks leave our portfolio. These include: Aeropostale, Inc. (ARO), Sanofi-aventis Sa (Adr) (SNY), Ares Capital Corporation (ARCC) and Clearwater Paper Corp (CLW).

The Keepers

6 stocks remain in the portfolio. They are: Jos. A. Bank Clothiers, Inc. (JOSB), Oshkosh Corporation (OSK), Astrazeneca Plc (Adr) (AZN), China Automotive Systems, Inc. (CAAS), Healthspring, Inc (HS) and Aixtron Ag (Adr) (AIXG).

The Newbies

We are adding 4 stocks to the portfolio. These include: Western Digital Corp. (WDC), Raytheon Company (RTN), Sterlite Industries India Limited (Adr) (SLT) and Cosan Limited (CZZ).

Portfolio Changes



Newcomers to the Validea Hot List

Cosan Limited (CZZ): This Brazil-based company is involved in the production and trading of sugar and ethanol. Its ethanol products are used in fuel, lubricants, paints, and cosmetics, while its sugars are sold to retail stores, wholesalers, and food manufacturers. Its operations also include about 1,500 service centers and convenience stores in Brazil.

Cosan has a market cap of about $2.8 billion and has taken in more than $8 billion in sales in the past year. It gets high marks from an interesting tandem of strategies -- my Martin Zweig-based growth model, and my David Dreman-inspired contrarian approach. To read more about the stock's fundamentals, see the "Detailed Stock Analysis" section below.

Raytheon Company (RTN): This Massachusetts-based aerospace & defense firm provides state-of-the-art electronics, products, and services in a variety of areas, including integrated defense systems, missile systems, space and airborne systems, and intelligence and information systems. It also provides a variety of mission support services. It has a market cap of about $18.6 billion, and has taken in more than $25 billion in sales in the past year.

Raytheon, which gained 14% while in the Hot List for a one-month stint last fall and another 2.5% while in the portfolio for another one-month stay earlier this year, gets approval from my Joel Greenblatt-, Peter Lynch- and Kenneth Fisher-based models. The "Detailed Stock Analysis" section below has more on the firm.

Western Digital Corp. (WDC): This California-based firm is a leader in the hard drive and digital storage business. The 40-year-old company has a market cap of about $7.2 billion, and has raked in more than $9 billion in sales in the past year. It gets approval from my Peter Lynch-based model, and high marks from several other of my strategies. For more on the stock, see the "Detailed Stock Analysis" section below.

Sterlite Industries India Ltd. (SLT): Based in Mumbai, Sterlite is India's largest non-ferrous metals and mining company. Its primary businesses involve aluminum, copper, zinc, lead, and commercial energy. Over the past year, the company has taken in more than $4 billion in sales.

The $2.9-billion-market-cap company gets approval from my Peter Lynch- and Kenneth Fisher-based models. To read more about it, scroll down to the "Detailed Stock Analysis" section below.



News about Validea Hot List Stocks

Oshkosh Corp. (OSK): Oshkosh announced on June 30 that its defense division has received a $600 million order for tactical trucks and cargo trailers for the U.S. Army, the Associated Press reported. As part of the deal, Oshkosh will build 1,900 new and refurbished Heavy Expanded Mobility Tactical Truck A-4 vehicles, and more than 530 Palletized Load System trailers, AP stated.

Raytheon Company (RTN): Raytheon has received U.S. Navy contracts totaling $368 million to manufacture Standard Missile-6 systems over a three-year period. The SM-6 is an extended-range anti-air warfare missile system that is used against aircraft, unmanned aerial vehicles, and anti-ship cruise missiles. Raytheon will deliver the first missiles in early 2011.



The Next Issue

In two weeks, we will publish another issue of the Hot List, at which time we will examine one of my individual Guru Strategies in greater depth. 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

JOSB   |   AZN   |   RTN   |   HS   |   OSK   |   WDC   |   CZZ   |   SLT   |   AIXG   |   CAAS   |  



Jos. A. Bank Clothiers, Inc. (Jos. A. Bank) is a designer, manufacturer, retailer and direct marketer (through stores, catalog and Internet) of men's tailored and casual clothing and accessories. The Company sells substantially all of its products exclusively under the Jos. A. Bank label through its 473 retail stores (as of January 30, 2010, which includes seven outlet stores and 13 franchise stores) located throughout 42 states and the District of Columbia in the United States, as well as through the Company's nationwide catalog and Internet (www.josbank.com) operations. Jos. A. Bank operates through two segments: Stores and Direct Marketing. The Company's Stores segment consists of its 453 Full-line Stores. The Company opened 14 stores (and closed one store) during the fiscal year ended January 30, 2010 (fiscal 2009). The Company's Direct Marketing segment consists of its Internet and catalog channels.





AstraZeneca PLC (AstraZeneca) is a biopharmaceutical company. The Company focuses on the discovery, development and commercialization of prescription medicines for six areas of healthcare. Its six areas of healthcare includes cardiovascular, gastrointestinal, infection, neuroscience, oncology, and respiratory and inflammation. The Company's products include Crestor, Nexium, Synagis, Seroquel, Arimidex and Symbicort. The Company owns and operates a range of research and development (R&D), production and marketing facilities worldwide.





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.





HealthSpring, Inc. (HealthSpring) is a managed care organization with a primary focus on Medicare, the federal government-sponsored health insurance program for United States citizens aged 65 and older, qualifying disabled persons and persons suffering from end-stage renal disease. As of December 31, 2009, the Company operated coordinated care Medicare Advantage plans in Alabama, Florida, Illinois, Mississippi, Tennessee, and Texas. As of January 1, 2010, it also commenced operations of Medicare Advantage plans in three counties in Northern Georgia. As of December 31, 2009, the Company's Medicare Advantage plans had over 189,000 members. The Company also offers prescription drug benefits in accordance with Medicare Part D to its Medicare Advantage plan members, in addition to providing other medical benefits (MA-PD) plans. It also offers prescription drug benefits nationally on a stand-alone basis in accordance with Medicare Part D (PDP).





Oshkosh Corporation (Oshkosh) is a designer, manufacturer and marketer of a range of specialty vehicles and vehicle bodies, including defense trucks, access equipment, fire & emergency vehicles and concrete mixers and refuse collection vehicles. The Company operates in four business segments: defense, access equipment, fire & emergency, and commercial. It manufactures defense trucks under the Oshkosh brand name, and is a manufacturer of severe-duty heavy- and medium-payload tactical trucks for the United States Department of Defense (DoD). The Company is also the manufacturer of aerial work platforms under the JLG brand name. Under the Pierce brand name, the Company manufactures fire apparatus assembled on both custom and commercial chassis. The Company manufactures aircraft rescue and fire fighting (ARFF) and airport snow removal vehicles under the Oshkosh brand name and ambulances under the Medtec brand name.





Western Digital Corporation (WD) designs, develops, manufactures and sells hard drives. The Company sells its products worldwide to original equipment manufacturers and original design manufacturers for use in computer systems, subsystems or consumer electronics devices, and to distributors, resellers and retailers. Its hard drives are used in desktop computers, notebook computers, and enterprise applications, such as servers, storage area networks and video surveillance equipment. Additionally, its hard drives are used in CE applications, such as digital video recorders, and satellite and cable set-top boxes. WD also sells its hard drives as stand-alone storage products and integrates them into finished enclosures, embedding application software and offering the products as WD-branded external storage appliances. In July 2010, Western Digital Corporation acquired the magnetic media sputtering operations of Hoya Corporation and Hoya Magnetics Singapore Pte. Ltd.





Cosan Limited (Cosan) is a Brazil-based company that its principally engaged is the control of the stake in Cosan SA Industria e Comercio (Cosan SA). Cosan SA along with its subsidiaries are principally engaged in the production and trade of sugar and ethanol, cogeneration of energy produced from cane sugar, extracted from its own plantations and acquired from third parties, as well as distribution of fuels and lubricants. Cosan SA's activities are also integrated into the activities of its indirect subsidiaries Provider Cosan Operadora Portuaria SA, Teacu Armazens Gerais SA e TEAS - Terminal Exportador de Alcool de Santos SA, which comprise mainly logistical support and export of sugar and ethanol of Cosan SA. Cosan SA through its subsidiary Cosan SA Fuels and Lubricants operates 40 bases for distributing fuel and lubricants in Brazil.





Sterlite Industries (India) Limited is a non-ferrous metals and mining company. The Company's primary businesses include aluminum, copper, zinc and lead, and commercial energy. The Company's principal operations are located in India. The subsidiary of the Company is Hindustan Zinc Limited (HZL). HZL products include refined zinc metal, refined lead metal, silver, cadmium and sulphuric acid. The Company's subsidiaries include Sesa Goa Limited, The Madras Aluminium Company Limited, Konkola Copper Mines Plc, Sesa Industries Limited and Dempo Mining Corporation Private Limited. As of March 31, 2010, it also operated a copper mine in Australia. As of March 31, 2010, the Company's copper production was 334,174 tons. As of March 31, 2010, the Company's zinc and lead production was 768,620 tons. As of March 31, 2010, the Company's aluminum production was 268,425 tons.





AIXTRON AG (AIXTRON) is a provider of deposition equipment to the semiconductor industry. The Company's technology solutions are used by a range of customers worldwide to build advanced components for electronic and opto-electronic applications based on compound, silicon, or organic semiconductor materials. Such components are used in displays, signaling, lighting, fiber optic communication systems, wireless and mobile telephony applications, optical and electronic storage devices, computing, as well as a range of other leading-edge technologies. AIXTRON's business activities include developing, producing and installing equipment for coating semiconductor materials, process engineering, consulting and training, including ongoing customer support. AIXTRON supplies to customers both full production-scale material deposition systems and small scale systems for Research and Development (R&D) use and small-scale production use.





China Automotive Systems, Inc. (China Automotive) is a holding company and has no significant business operations or assets other than its interest in Great Genesis Holdings Limited (Genesis). Through Genesis, the Company manufactures power steering systems and other component parts for automobiles. All operations are conducted through eight Sino-foreign joint ventures in China and a wholly owned subsidiary in the United States. The Company has business relations with more than 60 vehicle manufacturers, including FAW Group and Dongfeng Auto Group, automobile manufacturers in China; Shenyang Brilliance Jinbei Co., Ltd., light vehicle manufacturer in China; Chery Automobile Co., Ltd, state-owned car manufacturer in China, and Xi'an BYD Auto Co., Ltd and Zhejiang Geely Automobile Co., Ltd., car manufacturers.





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


The names of individuals (i.e., the 'gurus') appearing in this report are for identification purposes of his methodology only, as derived by Validea.com from published sources, and are not intended to suggest or imply any affiliation with or endorsement or even agreement with this report personally by such gurus, or any knowledge or approval by such persons of the content of this report. All trademarks, service marks and tradenames appearing in this report are the property of their respective owners, and are likewise used for identification purposes only.

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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.