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Executive Summary August 30, 2013

The Economy

The U.S. economy appears to have hit some bumps in the road, but it may well be just a short-term "pre-tapering" adjustment.

New home sales, for example, fell 13.4% in July, according to the Census Bureau. Mortgage rates, which have jumped over the past month or two amid expectations that the Federal Reserve will soon start tapering its massive stimulus efforts, were cited as a big reason for the decline. The longer-term trend is still a good one, though -- July sales were 6.1% above their year-ago pace, and median sale prices were 8.3% higher than they were a year ago.

Durable goods orders, which can also be impacted by rate increases, fell 7.3% in July, meanwhile, according to the Commerce Department. The decline was the largest in nearly a year for durable goods orders, which had risen in each of the three previous months. Orders for non-defense capital goods fell 3.3%, ending a streak of four straight monthly increases. While disappointing, we shouldn't draw too many conclusions, however. Durable goods orders can be extremely volatile from month-to-month; excluding the highly volatile transportation sector, orders were down just 0.6% for the month.

While new home sales were down, the housing market did offer some good news. Housing starts were up 5.9% in July, according to the Census Bureau. They are now about 21% above year-ago levels. Permit issuance for new construction, meanwhile, was up 2.7%, and is now about 17.5% above its year-ago level.

The latest jobs data also showed strong year-over-year gains. New claims for unemployment remained about the same over the past two weeks, but are 11.3% below where they were a year ago. Continuing claims were also pretty much flat, and are nearly 10% lower than they were a year ago.

Inflation picked up a bit in July, another Labor Department report showed -- a good sign. The Consumer Price Index rose 0.2% vs. June, and is now running at a reasonable 2.0% over the past year; core inflation (which excludes food and energy costs) also picked up slightly, though it is running at only about 1.7% over the past year. Unfortunately, wages didn't keep pace. Average hourly earnings slipped 0.1%, and average weekly hours worked declined 0.3%. When inflation is factored in, real weekly earnings fell 0.5% in July.

Oil prices have also made a big move upward, thanks to concerns about the conflict in Syria. Over a four-trading-day stretch ending Aug. 27, West Texas Intermediate crude prices jumped 5%. Moves in gas prices, which had been declining over the past month, usually lag crude price movements. We'll see how the crude surge impacts consumers at the pumps in the coming weeks and months.

Since our last newsletter, the S&P 500 returned -1.4%, while the Hot List returned -2.7%. So far in 2013, the portfolio has returned 22.5% vs. 14.9% for the S&P. Since its inception in July 2003, the Hot List is far outpacing the index, having gained 232.3% vs. the S&P's 63.7% gain.

The Sultan of Swat, Syria, and Storytelling

In baseball lore, few events are as celebrated as Babe Ruth's "called shot". The story goes like this: In the fifth inning of Game 3 of the 1932 World Series, Ruth came to the plate, and, while engaged in some serious back-and-forth jawing with Chicago Cubs players, pointed to Wrigley Field's centerfield bleachers as if to say, "That's where I'm hitting the next pitch." Then, incredibly, he did just that, crushing a home run that gave the Yankees the lead -- and Ruth's legend one of its signature moments.

There's just one small problem: The called-shot story may well be completely false -- over the years, plenty of eyewitnesses, including some of Ruth's teammates, have cast doubt on it. But once one reporter portrayed it that way, others followed, and soon the facts didn't really matter. Many, if not most, baseball fans simply accepted it as true.

That's not uncommon. As human beings, we want to believe in stories. In a world full of unpredictability and chaos, we look to stories to give us understanding, to give us a sense of order. (Barry Ritholtz recently had a great column on this on The Big Picture blog that I'd recommend checking out.) That's all well and good when it comes to a baseball legend. But in the investing world, putting stories ahead of facts is very dangerous. Since the 2008 financial crisis, for example, investors have been giving credence to a number of fear-filled stories. One of the most prominent: the tale of the tapped-out American consumer. According to this story, the housing market crash, stock market implosion, and near-collapse of the entire financial system dealt U.S. consumers a knockout blow in 2008, one from which they wouldn't be able to recover for years, perhaps even decades. Huge declines in consumer spending would mean years of struggle for the economy, and for retail firms in particular.

Like most tall tales, the tapped-out-consumer story was grounded in some truth -- Americans did cut back spending significantly amid the crisis, and they were overleveraged. But amid the fear-filled climate of 2008 and 2009, the tale spun a bit out of control, in part because it provided a great story arc -- after years of overspending and living high on the hog, Americans were getting their comeuppance. Forget Gucci handbags and Prada shoes; citizens of the most powerful country in the world would soon be on the verge of scavenging for food and weaving clothing out of leaves and branches. What drama!

Who knows -- had a few things gone differently, perhaps that scenario would have played out. But it didn't. Consider these facts: While they trended downward from December 2007 to April 2009, real personal consumption expenditures have been on the rebound ever since, and are now 4.7% above that December 2007 peak. Retail sales, meanwhile, are 11.8% above their November 2007 peak. And after climbing above 14% in mid-2007, Americans' collective debt service ratio (the ratio of outstanding mortgage and consumer debt to disposable personal income) has fallen to 10.32% in the fourth quarter of 2012 and 10.49% in this year's first quarter. Those two most recent readings are the lowest the ratio has been at any time since 1980.

Still, the tapped-out-consumer story lingers. And that's good. Because when the story and the facts diverge, opportunities are created. Some of the Hot List's biggest winners over the past few years -- such as Jos. A. Bank Clothiers (+78.2% in 2009) -- were unloved retail stocks, and my Guru Strategies are still finding great value in the retail apparel industry. In fact, it's one of the top-ranked industry in the market according to my Validea Industry Index, which ranks industries based on a composite of growth and value factors.

The tapped out consumer story is an example of the pundits and talking heads getting the story wrong. But for investors, there's danger in another type of storytelling as well -- that which involves stories that sound important, but, from investing perspective, just don't really matter that much.

The crisis in Syria looks like a good example of that. In recent days we've seen lots of headlines about the impact that potential US involvement in Syria could have on stocks. To be sure, many investors have probably sold shares just because fear has started to fill the headlines. But while Syria no doubt matters from a number of perspectives -- political, strategic, and, of course, humanitarian -- the likelihood is that for investors, the crisis won't end up mattering all that much.

In fact, in a recent column, MarketWatch's Mark Hulbert said that, historically, the market has suffered only minor losses because of geopolitical crises, and has rebounded quite quickly in many cases. He references a 1989 study performed by economics professors David Cutler of Harvard, James Poterba of MIT, and Larry Summers, who is now in the running to be the next Federal Reserve chief. In it, the professors examined how the stock market fared on 49 days in history when major geopolitical events occurred, such as the Kennedy assassination and Pearl Harbor bombing.

"They came up with little evidence that non-economics events had a big effect on the stock market," Hulbert writes. "On average, across all 49 events on their list, the S&P 500 moved just 1.46%, less than one percentage point more than the 0.56% that prevailed on all other days. Because of this small difference, the professors concluded that there's 'a surprisingly small effect of non-economic news' on the stock market."

What's more, the Syrian crisis isn't even an out-of-nowhere event like Pearl Harbor or the JFK assassination. As Hulbert notes, it has been building for years now; even the idea of American intervention isn't new, though it has come more to the forefront in recent weeks. Investors have known that US intervention has been a possibility for months, even years now. A good deal of the risk had probably been getting baked into the price of stocks since the start of the crisis.

That's not to say that if the US does intervene in Syria, it won't cause short-term problems for stocks. In the short term, emotions rule, and stocks might go through some declines. But if they do, it's just as likely that they will bounce back quickly, with little damage, if any, to your long-term returns -- despite what the headlines may be saying. In fact, disciplined investors who have some extra cash to deploy may even end up profiting from any short-term declines, which could generate some great buying opportunities.

Bottom line: If you need a "story" fix, pick up a good book or turn on a spine-tingling, heart-string-tugging, or edge-of-your seat movie. When it comes to investing your money, however, the only story you should focus on is the one that a company's fundamentals and financials are telling.

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: Inter Parfums, Inc. (IPAR), Overstock.com, Inc. (OSTK), Valero Energy Corporation (VLO) and Williams-sonoma, Inc. (WSM).

The Keepers

6 stocks remain in the portfolio. They are: Usana Health Sciences, Inc. (USNA), Amtrust Financial Services, Inc. (AFSI), Bridgepoint Education Inc (BPI), Lear Corporation (LEA), Hollyfrontier Corp (HFC) and Hci Group Inc (HCI).

The Newbies

We are adding 4 stocks to the portfolio. These include: Jpmorgan Chase & Co (JPM), Ross Stores, Inc. (ROST), Joy Global Inc. (JOY) and Stamps.com Inc. (STMP).

Portfolio Changes

Newcomers to the Validea Hot List

Ross Stores, Inc. (ROST) : California-based Ross is a discount clothing apparel and home goods retailer, which operates under the Ross Dress for Less and dd's DISCOUNTS names. It has taken in about $9.1 billion in sales in the past year.

Ross, which has a $14.8 billion market cap, gets approval from my Peter Lynch- and Warren Buffett-based models. To read more about it, see the "Detailed Stock Analysis" section below.

Stamps.com Inc. (STMP): This California-based company ($650 million market cap) allows customers to pay for and print postage for a variety of letters and packages online. The 16-year-old firm gets solid marks from several of my models, including my Peter Lynch- and Motley Fool-based strategies. For more on the stock, see the "Detailed Stock Analysis" section below.

Joy Global Inc. (JOY): This Milwaukee-based mining equipment provider ($5.2 billion market cap) has taken in more than $5 billion in sales in the past year. It's a favorite of my Peter Lynch-, Benjamin Graham-, and Joel Greenblatt-based models. To read more about it, see the "Detailed Stock Analysis" section below.

JPMorgan Chase & Co. (JPM): New York City-based Chase is involved in investment banking, financial services for consumers and small businesses, commercial banking, financial transaction processing, asset management and private equity. The firm, which has $2.4 trillion is assets, fared better than most big banks during the 2008-09 financial crisis, though its past few years have not been without problems. My Peter Lynch- and James O'Shaughnessy-based models think it's time to give this unloved megacap ($190 billion) a look, though. To read more about it, see the "Detailed Stock Analysis" section below.

News about Validea Hot List Stocks

Williams-Sonoma Inc. (WSM): On Aug. 28, Sonoma reported second-quarter profit of $48.9 million, or 49 cents a share, up about 13% from $43.4 million, or 43 cents a share, a year earlier, The Wall Street Journal reported. Revenues were up 12% to $982.2 million. Total same-store sales rose 8.4%; the company had been projecting gains in the 4% to 6% range, the Journal said. Sonoma also upped its full-year earnings projection to between $2.69 to $2.79 a share on $4.26 billion to $4.34 billion in revenue, from $2.67 to $2.77 in per-share earnings and $4.22 billion to $4.3 billion in revenue. The Hot List is selling the stock on today's rebalancing, as other stocks' fundamentals have surpassed Sonoma's fundamentals.

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

USNA   |   BPI   |   HCI   |   STMP   |   ROST   |   JPM   |   JOY   |   LEA   |   AFSI   |   HFC   |  

USANA Health Sciences, Inc. develops and manufactures science-based nutritional and personal care products. The Company has operations in 15 markets worldwide, where it distributes and sells its products by way of direct selling. The Company reports operations in two geographic regions: North America and Asia Pacific, which is further divided into three sub-regions; Southeast Asia/Pacific, Greater China, and North Asia. North America includes the United States, Canada, Mexico, and direct sales from the United States to the United Kingdom and the Netherlands. Southeast Asia/Pacific includes Australia, New Zealand, Singapore, Malaysia, and the Philippines; Greater China includes Hong Kong, Taiwan and China; and North Asia includes Japan and South Korea. The Company's customer base consists of two types of customers: Associates and Preferred Customers. As of December 31, 2011, the Company had 222,000 active Associates and 64,000 active Preferred Customers worldwide.

Bridgepoint Education, Inc. (Bridgepoint) is a provider of postsecondary education services. The Company's academic institutions include Ashford University and University of the Rockies. Its institutions deliver programs primarily online, as well as at their traditional campuses. As of December 31, 2011, the Company had 86,642 total students enrolled in its institutions. Bridgepoint's institutions conduct ongoing faculty and student assessment processes and provide a range of student services. The Company is also focused on developing new technologies, such as through Waypoint Outcomes, Constellation, and the development of its institutions' mobile learning platforms. The Company has developed Constellation to replace third party textbooks with digital course materials. Constellation materials are displayed in a browser-based platform. In January 2012, Bridgepoint introduced Thuze.

HCI Group Inc, formerly Homeowners Choice, Inc., is a holding company. The Company, through its subsidiaries, is engaged in the property and casualty insurance business. Through Homeowners Choice Property & Casualty Insurance Company, Inc. (HCPC) and subsidiaries, primarily Homeowners Choice Managers, Inc. (HCM), Southern Administration, Inc., Claddaugh Casualty Insurance Company, Ltd., and its subsidiary, HCPCI Holdings LLC, it provides property and casualty homeowners' insurance, condominium-owners' insurance and tenants' insurance to individuals owning property in Florida. Its subsidiaries also include TV Investment Holdings LLC, which owns and operates a marina facility located in Florida; Unthink Technologies Private Limited. During the year ended December 31, 2011, it organized TV Investment Holdings LLC, HCI Holdings LLC and HCI Technical Resources, Inc.

Stamps.com Inc. is a provider of Internet-based postage solutions. The Company's customers use its service to mail and ship a variety of mail pieces, including postcards, envelopes, flats and packages, using a range of United States Postal Service (the USPS) mail classes, including First Class Mail, Priority Mail, Express Mail, Media Mail, Parcel Post, and others. Its customers include individuals, small businesses, home offices, medium-size businesses and enterprises.

Ross Stores, Inc., along with its subsidiaries, operates two brands of off-price retail apparel and home fashion stores. As of January 28, 2012, the Company operated a total of 1,125 stores, of which 1,037 were Ross Dress for Less (Ross) locations in 29 states, the District of Columbia, and Guam, and 88 were dd's DISCOUNTS stores in seven states: 48 in California, 19 in Texas, 12 in Florida, four in Arizona, two in Georgia, two in Nevada, and one in Maryland. Ross focuses on customers primarily from middle income households, while dd's DISCOUNTS focuses on customers from more moderate income households. During the fiscal year ended January 28, 2012 (fiscal 2012), it opened 59 new Ross stores and closed ten existing stores. During fiscal 2011, it opened 21 new dd's DISCOUNTS stores. The average approximate dd's DISCOUNTS store size is 23,900 square feet. In April 2011, it purchased a 449,000 square foot warehouse for packaway storage in Riverside, California.

JPMorgan Chase & Co. (JPMorgan Chase) is a financial holding company. The Company is a global financial services firm and a banking institution in the United States, with global operations. The Company is engaged in investment banking, financial services for consumers and small businesses, commercial banking, financial transaction processing, asset management and private equity. JPMorgan Chase's principal bank subsidiaries are JPMorgan Chase Bank, National Association (JPMorgan Chase Bank, N.A.), and Chase Bank USA, National Association (Chase Bank USA, N.A.). JPMorgan Chase's activities are organized into four business segments, as well as Corporate/Private Equity. The Company's consumer business is the Consumer & Community Banking segment. The Corporate & Investment Bank, Commercial Banking, and Asset Management segments consists of the Company's wholesale businesses.

Joy Global Inc. is a manufacturer and servicer of high productivity mining equipment for the extraction of coal and other minerals and ores. The Company's equipment is used in mining regions throughout the world to mine coal, copper, iron ore, oil sands, and other minerals. The Company's underground mining machinery segment (Joy Mining Machinery) is a manufacturer of underground mining equipment for the extraction of coal and other bedded minerals and offers service locations near mining regions worldwide. The Company's surface mining equipment segment (P&H Mining Equipment) is a producer of surface mining equipment for the extraction of ores and minerals and provides operational support for many types of equipment used in surface mining. During the fiscal year ended October 28, 2011, the Company completed the acquisition of LeTourneau. On December 30, 2011, it acquired approximately 41.1% of Int'l Mining Machinery Holdings Limited's common stock to 69.2%.

Lear Corporation is a tier 1 supplier to the global automotive industry. The Company supplies its products to automotive manufacturers with automotive seat systems and related components, as well as electrical distribution systems and related components. The Company has two segments: seating and electrical power management systems (EPMS). The seating segment includes seat systems and related components, such as seat frames, recliner mechanisms, seat tracks, seat trim covers, headrests and seat foam. The EPMS segment includes electrical distribution systems for traditional powertrain vehicles, as well as for hybrid and electric vehicles. As of December 31, 2011, it had 20 joint ventures located throughout Asia, as well as five in North America, two in Europe and Africa and one with operations in all three regions.

Amtrust Financial Services, Inc. is a holding company. The Company is a multinational specialty property and casualty insurer focused on generating consistent underwriting profits. The Company operates in four segments: small commercial business, specialty program and personal lines reinsurance. In January 2013, the Company acquired First Nonprofit Companies, Inc. In February 2013, its subsidiary acquired Car Care Plan (Holdings) Limited from Ally Insurance Holdings, Inc. In April 2013, it acquired Sequoia Insurance Company and its subsidiaries, Sequoia Indemnity Company and Personal Express Insurance Company. In May 2013, the Company acquired Mutual Insurers Holding Company (MIHC) and MIHC's subsidiary, First Nonprofit Insurance Company.

HollyFrontier Corporation (HollyFrontier), formerly Holly Corporation, is a petroleum refiner, which produces light products, such as gasoline, diesel fuel, jet fuel, specialty lubricant products, and specialty and modified asphalt. HollyFrontier operates in two segments: Refining and Holly Energy Partners, L.P. (HEP). The Refining segment includes the operations of its El Dorado, Tulsa, Navajo, Cheyenne and Woods Cross Refineries and NK Asphalt. The HEP segment involves all of the operations of HEP. As of December 31, 2011, it operated five refineries having a combined crude oil processing capacity of 443,000 barrels per day that serve markets throughout the Mid-Continent, Southwest and Rocky Mountain regions of the United States. The Company merged with Frontier Oil Corporation (Frontier), on July 1, 2011. On November 9, 2011, HEP acquired from the Company certain tankage, loading rack and crude receiving assets located at its El Dorado and Cheyenne Refineries.

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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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.