Executive Summary  |   Portfolio  |   Guru Analysis  |   Watch List

Executive Summary August 7, 2009

The Economy

The economic picture has continued to get a bit brighter over the past two weeks, though the economy is still far from healthy.

One big sign that things have started to stabilize came in last week's gross domestic product numbers, which showed that the economy shrank at a 1.0% pace in the second quarter. The fact that U.S. economic output continues to decline isn't exactly great news. But when you consider the precipitous drops in GDP over the past several quarters -- -2.7% in last year's third quarter, -5.4% in the fourth quarter, and -6.4% in 2009's first quarter -- the second quarter numbers were an indication that we may be reaching a bottom.

Within the overall GDP figures were some interesting notes. The bulk of the decrease in the second quarter output came from weakness in consumer spending, which declined 1.2%. Business investment also fell, but the 8.9% drop was less than one-fourth of the second quarter's 39.2% plunge, and less than half the decline we saw in last year's final quarter. Keeping the numbers from being much worse: the government. Government consumption and spending jumped 5.6% in the quarter -- almost 11% at the federal level.

Just as the overall economy is slowly creeping back toward growth, so too is the manufacturing sector. Last week, the Institute for Supply Management said its manufacturing index rose to 48.9 from 44.8 the previous month, falling just a bit short of the 50 reading that is the dividing line between growth and contraction. The 48.9 figure is now comfortably ahead of the levels associated with a broader economic recession, however.

Construction spending, meanwhile, unexpectedly increased in June, the Commerce Department reported this week. The increase was helped by a 0.5% increase in residential construction, marking the second time in three months that residential construction spending increased, according to the Associated Press -- a sign that the housing market may be stabilizing. Another sign of housing stabilization came from the National Association of Realtors, which said this week that its Pending Home Sales Index rose in June for the fifth consecutive month, the first time that has occurred in six years. The index is up almost 7% since one year ago.

Of course, while signs of stabilization across the economy are encouraging given the free fall we experienced in late 2008 and early 2009, the overall picture remains troubling. While new claims for unemployment dipped more than expected in the most recent week, the total number of people filing for unemployment continues to climb (though at a slower pace), according to the latest government data -- and that doesn't include those whose benefits have run out but remain unemployed. July job loss data will be revealed today, and the overall unemployment rate is expected to rise slightly from the 9.5% June figure.

With unemployment that high, it's not surprising that consumer spending remains down. Retail sales fell 5.0 percent in July vs. the year-ago period, continuing a lengthy trend of year-over-year declines, according to the International Council of Shopping Centers. With consumer spending making up about two-thirds of the U.S. economy, that's a problem.

For the stock market, however, it's all about expectations. And over the past two weeks, companies have by and large continued to exceed expectations with their second-quarter earnings announcements. With three-quarters of S&P 500 companies having reported, positive surprises were outnumbering negative ones by five to one, according to Dow Jones Newswires (citing data from Brown Brothers Harriman). The companies averaged a 13% surprise to the upside.

The continued positive earnings surprises and better-than-expected GDP and manufacturing numbers helped the market continue its surge over the past fortnight. Since our last newsletter, the S&P 500 is up 2.1%, while the Hot List has gained 1.2%. For the year, the portfolio remains well ahead of the S&P, up 31.8% vs. the index's 10.4% gain. And since its inception more than six years ago, the Hot List is up 116.2%, while the S&P has returned -0.3%.

The portfolio is making some major changes this week, taking profits on six stocks and adding six new holdings. The new bunch is a diverse group, with three small-caps and three large-caps that span six different industries. For more details on the new holdings, see the "Newcomers to the Validea Hot List" section below.

The Economy & The Market: Dueling Data

The seeming disconnect between the stock market's continued rapid climb and the tiny steps forward that the economy is making has been pretty stark. After all, two of the more encouraging signs I mentioned above weren't even true forward steps -- the GDP and manufacturing numbers are signs that things haven't been getting worse as quickly as they were before, but they've still been getting worse nonetheless.

Given that, it's no wonder that many in the bearish camp are continuing to point to the economic weakness, high unemployment rate, sluggish consumer spending, and uneasy housing market as reasons to stay away from stocks.

What's critical to remember, however, is that while the stock market and economy are certainly intertwined, their relationship is not one of side-by-side running mates. And, more importantly, economic success today doesn't mean stock gains tomorrow; nor does economic struggle today mean stock woes tomorrow.

Take GDP. Market history is littered with examples of periods when strong GDP readings were followed by anything but strong stock returns. A few examples: In the late 1950s, the economy bounced back strong from the recession of 1957-1958, ending 1958 with back-to-back quarters of 9.7% GDP growth. When the year closed, the S&P 500 sat at about 55. With the economy about to put up two more big growth quarters in the first half of 1959 (+8.3% and +10.5%), early 1959 may in retrospect have seemed a good time to invest. But while the economy was booming, the market still hadn't crossed 60 by the year's midway point. A year after that, in mid-1960, it was just below 57.

The early 1970s provide what may be an even better example. In the first two quarters of 1972, the sluggish economy revived, posting GDP gains of 7.3% and 9.8%. But had you jumped into stocks in mid-1972, you'd have enjoyed just six months of moderate gains (about 12% in all) before entering one of the worst bear markets in history -- a bear whose first two quarters featured GDP readings of +10.6% and +4.7%.

One more example that unfortunately hits a bit closer to home: After a sluggish first quarter of 2007, GDP growth in the second and third quarters was a solid 3.2% and 3.6%. Had you jumped into the stocks immediately after the third quarter, however, you'd have entered the market just eight days before the start of the worst bear since the Great Depression.

Similarly, bull markets often begin amid periods of poor GDP readings. While the 1973-74 bear ended in October of '74, GDP growth didn't turn positive until the second quarter of 1975. And while the 1980-82 bear ended in August of '82, meaningful GDP growth didn't start until the first quarter of 1983.

Unemployment also often remains high -- or even increases -- in the first couple quarters of a bull market. Following the 1973-74 and 1980-82 bears -- the two downturns to which the current one is most often compared -- unemployment peaked well after the market turned upward. In the first case, a bull market began Oct. 3, 1974, and unemployment didn't peak until May 1975. In the second case, the bull run began Aug. 12, 1982, and the jobless rate didn't start declining until January 1983.

Now, all of this isn't to say that you shouldn't pay attention to the economy. But for an investor, to put a lot of weight on lagging indicators like GDP, which shows what has happened in the past three months (and in fact the lag is even longer by the time the numbers are announced) can be very counterproductive.

All of this also shows just how complicated and erratic the relationship between the economy and stock market can be -- sometimes, like in 1987, bull markets will start when GDP is indeed strong, and unemployment has already peaked; other times, like in 1974, it starts when GDP is negative, and unemployment has a ways to go before peaking.

In terms of the current market, such discrepancies show that the continued economic weakness is not by itself a reason to avoid stocks. But there's a broader point, too. The examples I've mentioned are yet another indication of how hard it is to time the market. You can analyze reams of economic data all you want, and you still could end up losing your shirt trying to jump in and out of the market based on GDP, unemployment, factory orders, or any other metric you can find.

For me, it thus always comes back to values and discipline -- the ability to find good values in the market regardless of economic conditions, and the discipline to stick with stocks through the inevitable ups and downs because, historically, they've been far and away the best investment vehicles out there. That will sometimes lead to short-term pain, as we saw last year. But over the long run, I believe this kind of systematic approach will pay off. While 2008 was the worst year for the Hot List and one of the worst years ever for stocks, the portfolio has already made up more than half of its '08 losses this year, and has more than doubled since its inception six years ago while the S&P has essentially been flat. Whatever the short term brings for the market or the economy, I expect that outperformance to continue over the long haul.

Editor-in-Chief: John Reese

Guru Investor Editor John Reese Announces Publication of New Book

The Guru Investor shows you how to implement the strategies of Wall Street legends like Warren Buffett, Peter Lynch and Benjamin Graham in your own portfolio.

Buy Your Copy Now!

The Fallen

As we rebalance the Validea Hot List, 6 stocks leave our portfolio. These include: The Dress Barn, Inc. (DBRN), Pfizer Inc. (PFE), Bj Services Company (BJS), Ceradyne, Inc. (CRDN), Lufkin Industries, Inc. (LUFK) and Oil States International, Inc. (OIS).

The Keepers

4 stocks remain in the portfolio. They are: Jos. A. Bank Clothiers, Inc. (JOSB), Frontier Oil Corporation (FTO), Chevron Corporation (CVX) and Fuqi International, Inc. (FUQI).

The Newbies

We are adding 6 stocks to the portfolio. These include: Astec Industries, Inc. (ASTE), Sociedad Quimica Y Minera (Adr) (SQM), Lloyds Banking Group Plc (Adr) (LYG), Marathon Oil Corporation (MRO), Capella Education Company (CPLA) and Allegiant Travel Company (ALGT).

Portfolio Changes

Newcomers to the Validea Hot List

Allegiant Travel Company (ALGT): This low-cost airline offers commercial stops in such major cities as Orlando, Phoenix, Las Vegas, and Los Angeles, as well as in a number of smaller cities across the U.S. All its flights are nonstop, and the firm also offers vacation package deals that include hotel stays, rental cars, and activities. In addition, Allegiant has charter services in the U.S., Mexico, Canada, and Cuba. The Las Vegas-based firm has a market cap of $833 million, and has taken in about $529 million in sales in the past year.

Allegiant gets high marks from the Guru Strategies I base on the writings of Peter Lynch, Joel Greenblatt, and Tom and David Gardner of The Motley Fool. To see why, check out the "Detailed Stock Analysis" section below.

Astec Industries, Inc. (ASTE): This Chattanooga, Tenn.-based firm makes equipment used in asphalt road building, pipeline and utility trenching, concrete plants, gas and oil drilling rigs, and wood processing, making it the type of company that could benefit from the government's infrastructure-focused stimulus package. It has a market cap of about $644 million, and has taken in about $827 million in sales in the past 12 months.

Astec gets approval from my Kenneth Fisher- and James O'Shaughnessy-based models. See the "Detailed Stock Analysis" section below to learn why those models are high on the stock.

Capella Education Company (CPLA): Based in Minneapolis, Minn., Capella is the parent of Capella University, a regionally accredited online school that offers graduate degree programs in business, information technology, education, human services, public health, public safety, and psychology, as well as bachelor's degree programs in business, information technology, and public safety. It has almost 30,000 students from all 50 states and 56 countries.

Capella has a market cap of $1.1 billion, and has taken in close to $300 million in sales in the past year. It gets strong interest from the strategy I base on the writings of Martin Zweig. Scroll down to the "Detailed Stock Analysis" section to find out why.

Lloyds Banking Group PLC (LYG): After its acquisition of HBOS PLC earlier this year, this London-based banking giant became the largest retail bank in the U.K., serving one in three people in the country. It is also involved in commercial banking and insurance. The firm has a market cap of about $44.7 billion, and has taken in more than $43 billion in sales in the past year.

Lloyds was hit hard like most financial firms during the credit crisis, but it has rebounded in recent months, and two of my strategies -- those I base on the writings of David Dreman and James O'Shaughnessy -- think it's a bargain. Find out why in the "Detailed Stock Analysis" section below.

Marathon Oil Corporation (MRO): This Houston-based integrated energy company has activities in the U.S., Canada, Angola, Equatorial Guinea, Gabon, Indonesia, Libya, Norway, and the U.K. It is the fourth-largest U.S.-based integrated oil firm, and the fifth-largest refiner. The $22.3 billion market cap company has brought in $61.9 billion in sales in the past year.

Marathon gets strong interest from three of my Guru Strategies, those I base on the writings of Peter Lynch, Joel Greenblatt, and James O'Shaughnessy. To find out why, see the "Detailed Stock Analysis" section below.

Sociedad Quimica y Minera de Chile S.A. (SQM): Based in Chile, SQM is involved in making specialty plant nutrition products, and is also the largest lithium producer in the world and a major iodine producer. It has offices in more than 20 countries, and has customers in 110 countries throughout Europe, America, Asia and Oceania. SQM has a market cap of $9.6 billion, and has trailing 12-month sales of $1.7 billion.

SQM gets approval from both my Peter Lynch-based strategy and my Momentum Investor approach. Scroll down to the "Detailed Stock Analysis" section to find out why.

News about Validea Hot List Stocks

Frontier Oil Corp. (FTO): On Aug. 6, Frontier announced second-quarter net income of $49.8 million, or 47 cents per share, down 16 percent from $59.3 million, or 57 cents per share, in the year-ago quarter, the Associated Press reported. Revenue was $1.1 billion, down 38 percent from $1.77 billion a year earlier. The results were impacted by decreased demand due to the recession, AP stated.

Fuqi International (FUQI): On Aug. 6, Fuqi reported second-quarter earnings of $0.45 per share, $0.14 better than estimates, according to Briefing.com. Revenues were up more than 50% to $100.8 million, beating estimates of $92.8 million. The firm also issued upside guidance for the third quarter and full year, Briefing.com reported. Shares jumped more than 12% for the day.

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

JOSB   |   FTO   |   FUQI   |   CPLA   |   ASTE   |   LYG   |   ALGT   |   SQM   |   MRO   |   CVX   |  

Jos. A. Bank Clothiers, Inc. (Jos. A. Bank) is a designer, retailer and direct marketer (through stores, catalog and Internet) of men's tailored and casual clothing and accessories. It sells all of its products exclusively under the Jos. A. Bank label through its 460 retail stores (as of January 31, 2009, which includes seven outlet stores and 12 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. Its products are targeted at the male career professional and emphasize the Jos. A. Bank brand of tailored and casual clothing and accessories. The Company's products, which range from the original Jos. A. Bank Executive collection to the more luxurious Jos. A. Bank Signature collection to the exclusive Jos. A. Bank Signature Gold collection. Jos. A. Bank operates through two segments: Stores and Direct Marketing.

Frontier Oil Corporation (Frontier) is an independent energy company engaged in crude oil refining and the wholesale marketing of refined petroleum products. The Company operates refineries (the Refineries) in Cheyenne, Wyoming and El Dorado, Kansas with a total annual average crude oil capacity of approximately 182,000 barrels per day (bpd). Frontier's Cheyenne Refinery has a permitted crude oil capacity of 52,000 bpd on a 12-month average. The Company markets its refined products primarily in the eastern slope of the Rocky Mountain region, which encompasses eastern Colorado (including the Denver metropolitan area), eastern Wyoming and western Nebraska (the Eastern Slope). The Cheyenne Refinery has a coking unit, which allows the refinery to process amounts of heavy crude oil for use as a feedstock. During the year ended December 31, 2008, heavy crude oil constituted approximately 76% of the Cheyenne Refinery's total crude oil charge.

Fuqi International, Inc. (Fuqi) is a designer of precious metal jewelry in China, developing, promoting, and selling a range of products in the Chinese luxury goods market. The Company's products consist of a range of styles and designs made from gold and other precious metals, such as platinum and Karat gold (K-gold). The Company also produce jewelry items that contain diamonds and other precious stones on a custom-order basis. Its design database contains over 30,000 products. The Company operates through its wholly owned subsidiary Fuqi International Holdings Co., Ltd. (Fuqi BVI) and its wholly owned subsidiary, Shenzhen Fuqi Jewelry Co., Ltd. (Fuqi China). As of December 31, 2008, the Company had 69 jewelry retail counters and stores in China.

Capella Education Company, is an online postsecondary education services company. Through its wholly owned subsidiary, Capella University (the University), the Company offers a variety of bachelor's, master's and doctoral degree programs primarily delivered to working adults. At December 31, 2008, Capella Education Company offered over 1,020 online courses and 22 academic programs with 111 specializations to approximately 26,800 learners. The Company also offers certificate programs, which consist of a series of courses focused on a particular area of study. In addition, Capella Education Company offers academic services, such as advising, writing and research services; administrative services, such as online class registration and transcript requests; library services; financial aid counseling and career counseling services.

Astec Industries, Inc. designs, engineers, manufactures and markets equipment and components used primarily in road building, utility and related construction activities. The Company's products are used in each phase of road building, from quarrying and crushing the aggregate to application of the road surface. The Company also manufactures certain equipment and components unrelated to road construction, including trenching, auger boring, directional drilling, gas and oil drilling rigs, industrial heat transfer equipment, whole-tree pulpwood chippers, horizontal grinders and blower trucks. In addition to equipment sales, the Company manufactures and sells replacement parts for equipment in each of its product lines. Dillman Equipment, Inc., a manufacturer of asphalt production equipment was acquired by Astec, Inc. in October 2008.

Lloyds Banking Group plc, formerly Lloyds TSB Group plc, is a United Kingdom-based financial services group providing a range of banking and financial services, primarily in the United Kingdom, to personal and corporate customers. The Company operates in three divisions: UK Retail Banking, Insurance and Investments, and Wholesale and International Banking. Its main business activities are retail, commercial and corporate banking, general insurance, and life, pensions and investment provision. The Company also operates an international banking business with a global footprint in 40 countries. Services are offered through a number of brands, including Lloyds TSB, Halifax, Bank of Scotland, Scottish Widows, Clerical Medical and Cheltenham & Gloucester. On January 16, 2009, Lloyds Banking Group plc acquired HBOS plc.

Allegiant Travel Company (Allegiant Travel) is a leisure travel company focused on transporting travelers in small cities to leisure destinations, such as Las Vegas, Nevada, Phoenix, Arizona, Orlando, Florida, Tampa/St. Petersburg, Florida and Ft. Lauderdale, Florida. It operates a low-cost passenger airline marketed to leisure travelers in small cities, allowing it to sell air travel both on a stand-alone basis and bundled with hotel rooms, rental cars and other travel related services.

Sociedad Quimica y Minera de Chile S.A. (SQM) is a producer of specialty plant nutrients. The Company is also engaged in the commodity fertilizer market through its subsidiary, Soquimich Comercial S.A. The fertilizers sold by this subsidiary include granular, water soluble and foliar products. SQM's products are derived from two natural resources found in Chile's Tarapaca and Antofagasta Regions: caliche ore and salar brines.

Marathon Oil Corporation is engaged in exploration, development and production activities in ten countries: United States, Angola, Canada, Equatorial Guinea, Gabon, Indonesia, Ireland, Libya, Norway and the United Kingdom. The Company's operations consist of four segments: exploration and production, oil sands mining, refining, marketing and transportation and integrated gas. Exploration and production explores for, produces and markets liquid hydrocarbons and natural gas. Oil sands mining mines, extracts and transports bitumen from oil sands deposits and upgrades the bitumen to produce and market synthetic crude oil and by-products. Refining, marketing and transportation, refines, markets and transports crude oil and petroleum products. Integrated gas, markets and transports products manufactured from natural gas, such as liquefied natural gas and methanol. Its wholly owned subsidiary include Speedway SuperAmerica LLC and Western Oil Sands Inc. (Western), Marathon Pipe Line LLC (MPL).

Chevron Corporation (Chevron) manages its investments in subsidiaries and affiliates, and provides administrative, financial, management and technology support to the United States and International subsidiaries that engage in fully integrated petroleum operations, chemicals operations, mining operations of coal and other minerals, power generation and energy services. Exploration and production (upstream) operations consist of exploring for, developing and producing crude oil and natural gas, and also marketing natural gas. Refining, marketing and transportation (downstream) operations relate to refining crude oil into finished petroleum products; marketing crude oil and the many products derived from petroleum, and transporting crude oil, natural gas and petroleum products by pipeline, marine vessel, motor equipment and rail car. In April 2009, Reliance Industries Limited bought back Chevron Corporation's 5% stake in Reliance Petroleum Limited.

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.


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.

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.