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|Executive Summary||April 13, 2012|
For the past several months, the economic data coming out of the U.S. has been painting one of the most positive pictures we've seen in quite a while. In the last two weeks, however, reminders have been popping up both at home and abroad of just what sorts of headwinds the economy is facing -- though for now, it is absorbing the blows and pushing forward.
At home, the biggest news has been somewhat disappointing jobs numbers. The private sector added 121,000 jobs in March, well below expectations and less than half of the average that were added in January and February. The unemployment rate, which is based on the separate survey of households (as opposed to the survey of businesses used to determine the number of new jobs), fell, however, to 8.2%. It marked the ninth straight month that the rate has declined or held steady, and the 8.2% figure is the lowest monthly reading in more than three years. The so-called "U-6" unemployment rate, meanwhile, which also includes discouraged workers who have given up looking for a job, also fell, from 14.9% in February to 14.5% in March. That's still quite high, but it does represent the lowest reading in more than three years.
Weekly unemployment claim figures were also somewhat disappointing. New claims rose about 3.5% in the week ending April 7, reaching their highest level since late January. Still, they are close to 9% below where they stood at this time last year. And continuing claims, the data for which lags new claims by a week, fell about 3%, hitting their lowest mark since July of 2008.
Good news, meanwhile, came from both the manufacturing and service sectors. The Institute for Supply Management's manufacturing index showed that the sector expanded for the 32nd straight month in March, and that it did so at an accelerating pace. Sub-indexes for new orders and employment also both stayed comfortably in expansion territory, with the employment sub-index making a pretty significant gain.
The service sector expanded for the 27th straight month in March, according to ISM. It did so at a slightly less rapid pace than it did in February, but the index was still very comfortably in expansion territory. And ISM's sub-indices for new orders and employment were both well in expansion territory.
A couple of the big factors weighing on the economy over the past fortnight have come from overseas. First, rising bond yields in Italy and Spain stoked fears that the European debt crisis could still infect U.S. financials. Second, weak import data coming out of China generated fears that a hard landing could be in the offing for the Asian giant. But on Thursday, yields in Italy and Spain moved a bit lower after an Italian bond auction, a good sign. And also on Thursday, new data showed that lending jumped in China in March, a sign that growth may actually be starting to rebound there.
Amid all of this, the S&P 500 returned -1.1% since our last newsletter, while the Hot List returned -3.2%. So far in 2012, the portfolio has returned 16.9% vs. 10.3% for the S&P. Since its inception in July 2003, the Hot List is far outpacing the index, having gained 164.2% vs. the S&P's 38.7% gain.
Data from a Different Angle
While economic data has been impressive over the past several months, some analysts have been questioning whether it has been impacted by external factors -- namely, problems in the way the government makes seasonal adjustments to its numbers. If you're not familiar with the general process, most government data comes in two forms -- the raw numbers, and seasonally adjusted figures, the latter of which takes into account the nature of the business cycle over the course of the year -- hiring, for example, picks up leading into the holiday season every year, so an increase in the raw number of jobs added in the fall months shouldn't be interpreted as a broader, lasting economic change. Seasonal adjustments account for that.
Perhaps the most notable group to raise questions about the seasonal adjustment process is the Economic Cycle Research Institute. It has said that after the sharp drop in the economy in the fourth quarter of 2008 and the first quarter of 2009, the algorithms used to determine the magnitude of seasonal adjustments began to view the data from those quarters "as a lasting change in seasonal patterns. So, according to these programs, data from Q4 and Q1 would be expected thereafter to be relatively weak, and therefore automatically adjusted upwards." The recent weakening of jobs data has thus raised some questions about whether the economic bounce we've seen over the past several months is as significant as it seems, or seasonal factors have skewed things.
Now, I would hope that the government's process for making seasonal adjustments would be robust enough to avoid a situation in which one or two anomalous quarters trip up the whole system. But given ECRI's track record, I think it's worth considering the possibility. First, however, I'd like to note that the mere fact that people are now debating whether the strong recent numbers are inflated is a good sign. Not all that long ago, the debate was whether the U.S. economy would fall into a depression; now that the data shows things have been improving significantly, the debate has shifted to the legitimacy of the numbers and the magnitude of the recovery. (There does seem to be a hint of bears grasping at straws here.)
But let's see what the data says. By using the unadjusted data and looking at year-over-year changes (i.e., this March vs. last March) rather than seasonally adjusted month-to-month figures, we can take out the seasonal factors. So let's take a look at the recent year-over-year changes in some key data points.
We'll start with employment. Here are the year-over-year gains in jobs since last April. Each monthly figure is the amount of jobs added to the economy since the same month one year earlier:
April 2011: +1.90 million
May 2011: +1.92 million
June 2011: +2.01 million
July 2011: +1.95 million
August 2011: +1.93 million
September 2011: +2.01 million
October 2011: +1.97 million
November 2011: +1.98 million
December 2011: +2.05 million
January 2012: +2.24 million
February 2012: +2.25 million
March 2012: +2.13 million
As you can see, while the pace dropped off a bit in March, job creation has accelerated over the past year, and the March gains were actually the third-most of the 12 months.
Now, on to initial claims for unemployment. Again, this is unadjusted data from the Labor Department. Since these weekly figures can be volatile, I've taken four-week blocks and averaged them out. So, for example, the first entry takes the average number of weekly new claims filed for the four weeks ending May 7, 2011, and compares that to the average number of new claims filed in the four corresponding weeks one year earlier.
Four Weeks Ending:
May 7, 2011: -24,069
June 4, 2011: -39,142
July 2, 2011: -40,824
July 30, 2011: -44,879
Aug. 27, 2011: -54,248
Sept. 24, 2011: -29,801
Oct. 22, 2011: -41,459
Nov. 19, 2011: -43,192
Dec. 17, 2011: -56,890
Jan. 14, 2012: -54,604
Feb. 11, 2012: -52,571
March 10, 2012: -31,098
April 7, 2012: -42,417
The data indicates that there have been some ups and downs in the rate of decline for new claims, though the overall picture has been a solid downward trend. The most recent four-week period is almost exactly at the average for all of those other periods I cited above (42,707). So while recent figures haven't been as strong as at other times during the past year, they are still very solid.
Next, let's look at industrial production, which is tracked by the Federal Reserve. The figures below show the rate of change for industrial production for each month versus the same month one year earlier.
March 2011: +5.47%
April 2011: +4.44%
May 2011: +3.18%
June 2011: +3.14%
July 2011: +3.41%
August 2011: +3.30%
September 2011: +3.47%
October 2011: +4.21%
November 2011: +4.04%
December 2011: +3.29%
January 2012: +3.25%
February 2012: +4.28%
The data shows that industrial production over the past year has increased at a slower pace than it did during the previous year. (From April 2010 through March 2011 the rate of increase was at least 5% every month.) That shouldn't be a surprise as an expansion ages, however. Usually, the economy gets a strong bounce at the beginning of an expansion, and then growth slows a bit as the expansion matures. That being said, notice that the most recent reading, from February, is the highest in nearly a year.
Finally, let's look at the U.S. consumer, via retail and food service sales data. Again, these are unadjusted numbers (from the Census Bureau), and the figures for each month represent the amount that sales increased over the same period a year earlier:
April 2011: +7.51%
May 2011: +7.94%
June 2011: +8.81%
July 2011: +6.36%
August 2011: +8.85%
September 2011: +8.72%
October 2011: +7.06%
November 2011: +6.95%
December 2011: +6.01%
January 2012: +6.10%
Here we can see that the rate of increase has generally been declining since last summer. But there was a bit of an uptick in January (the most recent month for which data is available), and the 6% to 7% annual growth we've seen over the past four months is a healthy range.
The metrics we looked at above are, of course, only a few of those used to analyze the economy. Still, they are important ones that give a look at three very important parts of our economy: the labor market, industrial production, and consumer spending. All in all, they paint a picture of an economy that, while perhaps not peaking, has been continuing to grow at a respectable pace -- and that's looking at the data in a way that sidesteps the seasonal adjustment process that some have brought into question.
Between that picture of respectable economic growth and the plethora of attractively valued stocks out there right now, I find this environment filled with opportunities. For example, the Hot List is adding two stocks this week, retailer Finish Line Inc. and for-profit education company Apollo Group. Finish Line has been growing earnings at a 28% pace over the long term, yet trades for about 13 times earnings and 0.8 times sales. It also has a PE-to-growth ratio below 0.5, no long-term debt, and a return on equity of 17%. Apollo Group, meanwhile, trades for just 8 times earnings, thanks to fear about the for-profit education industry. But it has an impressive 51% return on equity and long-term debt that is less than a quarter of its net current assets. These are the types of fundamentally sound stocks that have helped the Hot List take a big lead on the market this year, and which have helped it leave the market in the dust over the long haul, and the portfolio will continue to focus on them as we move deeper into 2012.
As we rebalance the Validea Hot List, 2 stocks leave our portfolio. These include: Caci International Inc (CACI) and Altisource Portfolio Solutions S.a. (ASPS).
8 stocks remain in the portfolio. They are: Forest Laboratories, Inc. (FRX), The Tjx Companies, Inc. (TJX), Cash America International, Inc. (CSH), Northrop Grumman Corporation (NOC), Coinstar, Inc. (CSTR), Advance Auto Parts, Inc. (AAP), Bridgepoint Education Inc (BPI) and Body Central Corp (BODY).
We are adding 2 stocks to the portfolio. These include: Apollo Group Inc (APOL) and Finish Line Inc (FINL).
Newcomers to the Validea Hot List
Apollo Group (APOL): Apollo owns the University of Phoenix and several other schools that offer undergraduate, master's, and doctoral degrees through both on-campus and online courses. The Phoenix, Ariz.-based firm has a $4.4 billion market cap and has taken in about $4.5 billion in revenue in the past year.
For-profit education companies have been dealing with several challenges over the past few years, not the least of which is the potential for increased government regulation of their operations. But my models think that Apollo should be getting more love from investors. It gets high marks from my Joel Greenblatt- and Peter Lynch-based models. To read more about the stock, scroll down to the Detailed Stock Analysis section below.
Finish Line Inc. (FINL): Based in Indianapolis, Finish Line is a mall-based retailer that sells athletic and casual footwear, as well as apparel and accessories. It has about 650 stores across the U.S. The firm has a $1.1 billion market cap, and has taken in about $1.4 billion in sales over the past year.
Finish Line gets high marks from 3 of my strategies, those I based on the writings of Peter Lynch, James O'Shaughnessy, and Martin Zweig. To read more about it, see the Detailed Stock Analysis section below.
News about Validea Hot List Stocks
Coinstar Inc. (CSTR): Coinstar shares surged after-market on Thursday, after the firm announced strong fourth-quarter results. Profit from continuing operations was $1.62 to $1.66 a share, the firm announced, citing preliminary results, according to Bloomberg. Sales were $567 million to $569.2 million. Analysts expected profit of 89 cents a share on sales of $538.6 million, according to Bloomberg. Shares were posting double-digit percentage gains in after-hours trading, eclipsing all time highs.
The Next Issue
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