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|Executive Summary||June 8, 2012|
Growth has slowed over the past month or so, but the U.S. economy is continuing to inch forward -- though that has been little consolation for jittery investors who remain fixated on Europe's debt crisis.
Several economic reports have demonstrated this trend of slowing -- but still present -- growth. The most notable, and for many the most disappointing, came in the May jobs report. According to the Labor Department, the private sector added 82,000 jobs in May on a seasonally adjusted basis, the second straight month that the figure has been under 100,000. The unemployment rate rose slightly to 8.2%, while the "U-6" unemployment rate (which also takes into account discouraged workers who have given up looking for a job) rose to 14.8% from 14.5%. If we look at the raw job growth numbers rather than the seasonally adjusted figures, however, the picture wasn't as bad. Compared to the same month a year earlier, the economy added 1.98 million jobs. That's below the pace we saw in the first three months of this year, but up slightly from April and right around the 12-month average.
New weekly unemployment claims have held fairly steady since our last newsletter. They are more than 12% lower than they were a year ago. Continuing claims have also held fairly steady, and sit more than 11% below their year-ago level.
The manufacturing sector offered better news. While its growth also slowed in May, the sector was still comfortably in expansion territory, according to the Institute for Supply Management, marking the 34th straight month it has expanded. The group's new orders sub-index grew at an accelerating rate, reaching its highest mark in over a year, which could be a good sign looking forward. The prices producers paid also dropped sharply during the month, reaching their lowest level of 2012.
The service sector also expanded in May, the 29th straight month it has grown, according to ISM. It did so at a slightly faster pace than it did in April. The service sector new orders sub-index rose during the month, but the employment sub-index took a hit, falling to its lowest level in 2012.
The much-maligned housing market, meanwhile, continue to offer a mixed bag. Pending home sales fell 5.5% (seasonally adjusted) in April (vs. March), though they were nearly 15% higher than they were a year earlier (using unadjusted numbers). The S&P/Case-Shiller Home Price indices also showed that the average U.S. home price dropped about 2% in the first quarter vs. last year's fourth quarter, though when adjusted for seasonal variations, they actually rose 1.1%. Still, the raw number was 2% below where it was a year ago, and marks a new post-housing crisis low. Housing starts did increase 2.6% in April vs. March, according to the latest report from the Census Bureau, but building permit issuance for privately owned housing units fell 7% (seasonally adjusted). Housing starts are more than 30% above their year-ago levels, while permit issuance is more than 22% above where it was a year ago at this time, so we're still far ahead of where we were a year ago.
Overseas Greece and the European debt crisis continue to dominate the headlines. Greece, unable to form a governing coalition after its recent elections, will hold another vote on June 17. Many are expecting the vote to be something of a referendum on whether Greeks want to remain in the Eurozone, or exit. Investors will no doubt be watching closely.
Since our last newsletter, the S&P 500 returned -0.4%, while the Hot List returned -1.7%. So far in 2012, the portfolio has returned 5.6% vs. 4.6% for the S&P. Since its inception in July 2003, the Hot List is far outpacing the index, having gained 138.7% vs. the S&P's 31.4% gain.
For the past several weeks, investors -- who already had Europe's debt woes on their minds -- have become fixated on the continent. The headlines are dominated by the latest news about Greece's debt crisis, its political turmoil, and, of course, the question of whether it will exit the Euro -- and what that means for the global economy and financial markets. Signs of trouble on the Greece front trigger significant, broad-based sell-offs; signs that a resolution won't be too chaotic trigger broad-based rallies. All in all, the news has been mostly negative, so the market has flirted with "correction" territory (i.e., a 10% decline from previous highs) in recent days.
When I listened to interviews with Donald Yacktman and Whitney Tilson -- two strategists with strong track records who I respect quite a bit -- this week, however, they weren't fixated on Greece. And in discussing their strategies and outlooks, day-to-day news coming out of Europe seemed to play little role.
In fact, Yacktman, whose flagship fund ranks in the top percentile in its category over the past five and ten years according to Morningstar (and the second percentile over the past 15 years), stressed the importance of not getting hung up on the short term. Asked by WealthTrack's Consuelo Mack what had made his fund so successful, he said, "I think more than anything it's a combination of objectivity and horizon time. We're very patient. We're very long-term investors. Horizon time is a huge part of that. I know there are a lot of people who would like to buy certain investments that they look [at] as good value for their clients, but they're worried that they won't look good for the next quarter or the next year and that they might get fired because of that. And so this longer horizon time, we're just willing to stay there, because we know that [the investing approach] will stand the test of time."
Yacktman said his value-focused approach is like "buying beach balls being pushed underwater and the water level is rising". Logic dictates that at some point, the external pressure won't be enough to keep the ball down, and it will shoot back out of the rising water -- and the longer it takes and the farther down it goes, the bigger the bounce will be, he says. I'd add that exactly when the bounce will occur is never really certain (nor is it guaranteed), but Yacktman seems to be saying that if you are confident in the ball's buoyancy -- or a stock's fundamentals -- you can wait for the bounce and reap the benefits. With stocks, however, many investors don't have the patience, and they end up selling while their picks are "underwater".
Tilson is another investor who does have the patience to wait for the ball to bounce, and it's no doubt a part of why he's been so successful. Asked in a CNBC interview when he cuts his losses on holdings that fall in the short term, he responded, "We don't. If we still have conviction in the stocks we hold, we selectively add to them, and that's what we've been doing. (Incidentally, that's essentially what the Hot List does. In addition to revamping its holdings at each rebalancing, our system also brings the existing holdings back to or near an equal weighting. So if a particular holding falls, but its fundamentals and financials remain strong enough for it to stay in the portfolio, the Hot List will buy more shares of it on the rebalancing date to bring it back around that 10% weighting.)
Tilson says short-term volatility isn't something to fear, but something to take advantage of. "We've sort of got a strong stomach for volatility," he said. "We deliberately -- we think as other investors flee volatility, that's the time we're willing to wade into the most out-of-favor stocks because that's where the bargains are."
What Yacktman and Tilson both possess -- and what so many investors lack -- is perspective. It's harder and harder to have a sense of it in today's world of high-speed Internet and smartphones and 24-hour financial television, but that makes it all the more critical. If you think you can stay ahead of the high-frequency traders and other pros when it comes to short-term market movements, I wish you luck. I think it's far more likely that it will lead to a continual cycle of buying high and selling low.
Right now, those who are focused on the short term are consumed with the incessant day-to-day speculation about whether growth will continue or recession will hit, and whether a new bear market has arrived the bull market will continue. Amid all that, nearly four years after the 2008 market meltdown and global financial crisis, it still at times seems as though the financial world is balanced on the edge of a knife. Every day without resolution leads to a growing sense of fear; every downturn is seen as a possible "beginning of the end".
But when you step back and consider the bigger picture, you see that what's going on -- lengthy economic turmoil -- is not unusual if you understand the historical context. Consider the work of Kenneth Rogoff and Carmen Reinhart, who have done perhaps the most extensive research on past financial crises. In examining about 15 pre-2007 financial crises across the globe, Reinhart and Rogoff said in a 2008 paper that on average real house prices fell for six years before rebounding. In very few cases did the declines last less than five years. Unemployment, meanwhile, increased on average for nearly five years by an average of 7 percentage points. Real public debt jumped 86% on average in the three years after the crises.
In other words, it takes time -- for most investors, an uncomfortable amount of time -- to recover from a financial crisis. While the 2008 crisis seemed to explode in a furious instant when Lehman Brothers collapsed, the conditions that led to it were a long time in the making. Credit and housing bubbles inflated over years and years, spurred by low interest rates, before they popped. Recovering from such periods thus also takes several years. There is no magic pill that the Federal Reserve or anyone else can administer to change that. And during these years of recovery there will be (and obviously have been) major ups and downs. It's a bit like an earthquake; after a big one hits, aftershocks inevitably follow as the tectonic plates work to slide into their new alignment. The aftershocks themselves can be quite large and fear-inducing. (While Europe's crisis is very different in nature from the U.S.'s 2008 crisis, it is in many ways related, born of an atmosphere of reckless spending and easy money that pervaded much of the developed world. You could thus say that, while different, it is indeed an aftershock from the 2008 crisis.) But eventually, the plates will find their new equilibrium, and order is restored. Unfortunately, in a financial crisis, this process takes place over a period of several years.
If you realize and accept that, you can deal with those ups and downs in a more constructive way. Others will get stuck in the cycle of bailing on stocks every time the lingering debt worries at home or abroad flare up, and then jumping back in along with everyone else when the hopeful signs emerge. But you -- like Yacktman and Tilson -- can focus on what really matters over the long run: value and fundamentals. You can buy good stocks that others have dumped too hastily, and you can avoid the overpriced safe-havens that investors flock to in fear-filled times.
That's easier said than done, of course. But it's what just about every one of the highly successful investment gurus I follow has done. From Benjamin Graham to Peter Lynch to Warren Buffett to Joel Greenblatt, they almost universally stress the need to focus on the long term, stay disciplined, and make rational, value-based decisions. With its quantitative strategies and methodical rebalancing process, I've designed the Hot List to do all of those things. Whatever strategy you use, you should be sure that it incorporates those tenets. In the short term, it will be difficult and at times painful. But in the long run, it will tilt the odds of success well in your favor, and that's what really matters.
As we rebalance the Validea Hot List, 3 stocks leave our portfolio. These include: Finish Line Inc (FINL), Apollo Group Inc (APOL) and Advance Auto Parts, Inc. (AAP).
7 stocks remain in the portfolio. They are: The Tjx Companies, Inc. (TJX), Coinstar, Inc. (CSTR), Lkq Corporation (LKQ), Stamps.com Inc. (STMP), Mwi Veterinary Supply, Inc. (MWIV), Discover Financial Services (DFS) and Solarwinds Inc (SWI).
We are adding 3 stocks to the portfolio. These include: Guess?, Inc. (GES), World Acceptance Corp. (WRLD) and Altisource Portfolio Solutions S.a. (ASPS).
Newcomers to the Validea Hot List
World Acceptance Corp. (WRLD): Based in Greenville, S.C., World Acceptance ($937 million market cap) specializes in small, short-term loans, and has close to 1,000 offices in the southern and central U.S., and Mexico. Its loans are generally under $3,000 and have durations of less than 24 months, and much of its business comes from repeat customers.
World Acceptance gets approval from my Peter Lynch- and Warren Buffett-based models. See the "Detailed Stock Analysis" section below to learn more about the stock.
Altisource Portfolio Solutions S.A. (ASPS): This Luxembourg-based company provides real estate mortgage portfolio management and related technology products, as well as asset recovery and customer relationship management services. It serves government agencies, lenders, servicers, investors, mortgage bankers, credit unions, financial services companies and hedge funds across the U.S. It has a $1.5 billion market cap, and has increased earnings per share in each of the past six years. The stock gets strong interest from my Martin Zweig-based strategy. To read more about it, see the "Detailed Stock Analysis" section below.
Guess?, Inc. (GES): Los Angeles-based Guess makes trendy apparel, denim, handbags, watches, footwear and other related consumer products. It directly operates about 500 retail stores in the United States and Canada and 264 retail stores in Europe, Asia and Latin America. Its licensees and distributors operate more than 800 more retail stores outside of the U.S. and Canada.
Guess gets strong interest from my Peter Lynch- and Benjamin Graham-based models. See the "Detailed Stock Analysis" section below to learn more about the stock.
News about Validea Hot List Stocks
The TJX Companies (TJX): TJX reported that same-store sales increased 8% in May. That was well above the 5.1% estimate by analysts surveyed by Retail Metrics Inc., according to Bloomberg. TJX shares have held up much better than the broader market during the recent market declines, spending most of the past two months in the black while the S&P 500 is well in the red.
The Next Issue
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