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Executive Summary February 14, 2014

The Economy

Economic news has been a bit disappointing over the past couple weeks, but it appears the frigid wintry weather much of the country has experienced is at least partly to blame.

Manufacturing activity, for example, increased for the eighth straight month in January, according to the Institute for Supply Management, but it did so at a significantly slower pace than it did in December. The New Orders sub-index dropped sharply, though it remained in expansion territory, and employment conditions improved but at a slower pace than they did the previous month. Prices jumped, meanwhile, while inventories, customer inventories, and backlogs of orders all contacted. But a number of survey respondents specifically cited the snowstorm-fraught conditions as a reason for the sluggishness, making it hard to draw any big conclusions from the monthly report.

On the bright side, ISM's non-manufacturing report showed that the service sector expanded in January for the 48th straight month, and it did so at a slightly faster pace than it did in December. New order growth accelerated slightly, as did improvement in employment conditions, which remain very solid, according to the report. Prices did increase to a fairly high level, so that may be something to keep an eye on in both the manufacturing and service sectors.

As for the job market, the Labor Department's latest report showed that the private sector added 142,000 jobs in January, up from 89,000 the previous month but well shy of November's 272,000 figure. There was good news in several aspects of the report though. The unemployment rate fell a tenth of a percentage point to 6.6%, while the number of people not on the labor force declined by about 350,000 amid annual population control adjustments. And the "U-6" unemployment rate -- a broader figure that includes discouraged workers who've given up their job searches and part-time workers seeking full-time employment -- fell by 0.4 percentage points to 12.7%. It has fallen a full percentage point over the past three months, a great sign.

Consumer data wasn't great, however. Real disposable personal income fell 0.2% in December, according to a new government report. Real personal consumption expenditures rose 0.2%, meaning that Americans were dipping into their savings to finance purchases. The personal savings rate thus fell 0.4 percentage points to 3.9%. While not alarmingly low, that is one of the lower monthly figures we've seen since the end of the Great Recession.

Since our last newsletter, the S&P 500 returned 2.0%, while the Hot List returned 0.1%. So far in 2014, the portfolio has returned -8.8% vs. -1.0% for the S&P. Since its inception in July 2003, the Hot List is far outpacing the index, having gained 232.0% vs. the S&P's 82.9% gain.

Correction Dissection

Heading into 2014, many prognosticators were saying they expected the stock market to enter into correction mode at some point during the year. And after the first month or so of the new year, we certainly seem headed in that direction. Through early February, the S&P 500 was down nearly 7%, creeping closer to the 10% mark that defines a correction.

Since then, stocks have rebounded pretty nicely. We may have dodged a correction, but who knows. As I always say, in the short term, no one really knows where the market is headed. Sooner or later, however, you can bet that we will have a correction. And given that it's been quite a while since we had one (the last official correction came in the spring and summer of 2011) it's a good time to examine just what a correction means, and how to respond to one. After all, the longer you go without experiencing one, the more daunting and dramatic they can feel when they do hit.

First, a bit of background information on the nature of corrections historically. Josh Brown of The Reformed Broker blog provides a great deal of it in his "Field Guide to Stock Market Corrections" (which uses data from Dow Jones, Morningstar, and Bloomberg). According to Brown, in the post-World War II era corrections have been more than twice as common as bear markets, with 27 corrections having occurred and 12 bear markets (which involves a peak to trough decline of at least 20%) having transpired. On average, the market has declined 13.3% during those 27 corrections, over an average span of a little more than three months.

So, how does the current market environment match up against all those historical figures? Well, since the bull market started in March 2009, we've had two or three corrections, depending on how you look at it. The first occurred a little over a year into the bull, and lasted for 69 trading days, resulting in a decline of 16% or so -- fairly typical by historical standards. The second started about a year after the first, and was more than twice as long, lasting 154 trading days. It involved a loss of a little over 19%, very nearly bringing us into bear market territory before the market resumed its upward trend in early October 2011. The third correction is a bit debatable. Like the first two corrections (and the bull market itself) it hit in the late winter/early spring, beginning in early April 2012. It lasted a little under 60 days, and involved a decline of (this is where the debatable part comes in) 9.94%. So technically, it was not an official correction, but for all intents and purposes it had a very similar impact as a legitimate correction.

Since then, we've been in rally mode for most of 20 months, with the S&P 500 rising about 43%. That's bigger than average rally -- bull market rallies in between corrections on average have run for 221 trading days and involved a gain of 32%, according to Brown. But while it's above average, it's far from anomalous. In the post war era, corrections have tended to be somewhat bunched up. In fact, 25% of the corrections since World War II occurred in the 1970s, while another 20% occurred from 2000-2010, Brown notes. Meanwhile, from the start of the bull market that began in 1982 up through the 1987 market crash, only one correction occurred, and between that crash and the peak of the bull market that ended in 2000, there were only two corrections. The point here, I think, is that corrections don't simply occur because it's "been a while" since we've had one. Just as you might have two corrections within a one-year span, so too can you go several years without having one.

Okay, so now that we have a good historical grounding for how corrections have behaved, the big question is, what do we do when one hits? For me, when looking for guidance, I always turn to the gurus -- those rare investors who succeeded over lengthy periods of time. And, pretty much without fail the gurus I follow don't ever try to time or sidestep a correction. In fact, I can't recall one of them ever advising such an approach. In a recent Forbes column, for example, Ken Fisher noted that many commentators are expecting a correction in 2014. "No one consistently predicts corrections or ever has, so that's a risk always best ignored," he said. Back in 1996, in an interview with PBS's Frontline, Peter Lynch talked about corrections and bear markets. "If you're in the market, you have to know there's going to be declines. And they're going to cap and every couple of years you're going to get a 10 percent correction. That's a euphemism for losing a lot of money rapidly," he said. "That's what a 'correction' is called. And a bear market is 20-25-30 percent decline. They're gonna happen. When they're gonna start, no one knows. If you're not ready for that, you shouldn't be in the stock market. I mean stomach is the key organ here. It's not the brain. Do you have the stomach for these kind of declines?"

Then there's Warren Buffett. In their book The New Buffettology, Mary Buffett and David Clark write that "Warren knows very well that if the bull market has not yet 'bubbled', these corrections and panics will be short-lived and present great buying opportunities," adding that "Warren believes that corrections and panics are perfect buying opportunities for the selective contrarian investor." I agree. Corrections aren't time to flee -- they're time to buy.

It's not just the gurus upon whose approaches I base my strategies. Listen to other top strategists with strong track records -- fund managers like Donald Yacktman, David Herro, or Bill Nygren -- and you won't hear them talking about how to forecast a correction or sidestep one. You hear them talk about value, long-term thinking, and discipline. In fact, sometimes you hear the gurus talk about how they hope to see a correction, both for a buying opportunity and as a way to knock excess positive sentiment out of the market. Indeed, in his book Winning on Wall Street, the late, great Martin Zweig said that the lack of a market correction for some time was part of why he correctly forecasted the 1987 market crash. "What bothered me were the similarities to 1929, 1946, and 1962," he wrote. "The familiar pattern was gross overvaluation in P/Es and yields along with straight-up price movement which lacks a major correction for years and which had produced doubles or a lot more in the Dow." Walls of worry are good for bull markets. When sentiment gets too high, you run into situations where investors start piling on the bandwagon, which can lead to valuations getting far out of whack, which can lead to major crashes -- like '87.

Nevertheless, while the greatest investors in history view corrections as a normal --and necessary -- part of market life, most investors don't heed their advice. Look no further than the last month. As the market fell and correction talk increased, flows into domestic equity mutual funds fell sharply, according to the Investment Company Institute. In the week ending January 15, a net of $4.2 billion flowed into such funds, according to ICI. The next week, the figure fell to $2.5 billion; the week after that it was $1.9 billion; and in the most recent week flows were actually negative at -$1.6 billion. Then, almost as if on cue, the market unexpectedly reversed and left those who had bailed expecting a correction wishing they hadn't.

In the end, the discomfort of investing through corrections (and bear markets for that matter) is the price you pay for reaping the long-term benefits of stocks, which have been the greatest investment vehicle of all time. It's hard, to be sure. We are emotional creatures, and when our money is involved, those emotions can get set off quickly and ferociously, often to our detriment. That's why it's so important to listen to those who have had success in the past. While the specifics of the market are ever changing and ever evolving, I don't think the core tenets -- like the psychology involved in dealing with short-term losses -- change. And, throughout history, the most successful investors I know of have stuck to their long-term approaches -- if not become more bullish -- during downturns. That's why, despite a rough start to 2014 for the market and, even more so, for the Hot List, we'll continue to stick to our long-term strategy, regardless of whether a correction is around the corner or not.

Editor-in-Chief: John Reese

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The Fallen

As we rebalance the Validea Hot List, 3 stocks leave our portfolio. These include: Alliance Fiber Optic Products Inc (AFOP), The Tjx Companies, Inc. (TJX) and Lear Corporation (LEA).

The Keepers

7 stocks remain in the portfolio. They are: Agco Corporation (AGCO), Usana Health Sciences, Inc. (USNA), Cnooc Limited (Adr) (CEO), Bofi Holding, Inc. (BOFI), Lukoil (Adr) (LUKOY), Hollyfrontier Corp (HFC) and Hci Group Inc (HCI).

The Newbies

We are adding 3 stocks to the portfolio. These include: Ross Stores, Inc. (ROST), Parexel International Corporation (PRXL) and Trueblue Inc (TBI).

Portfolio Changes

Newcomers to the Validea Hot List

PAREXEL International Corporation (PRXL): This Massachusetts-based biotech firm operates in 76 locations with more than 15,000 employees in 50 countries worldwide. It provides expertise in clinical research, medical communications, consulting, and advanced technology products and services to the pharmaceutical, biotechnology, and medical device industries, with offerings that range from clinical trials management, to data management, to biostatistical analysis, to epidemiology, and beyond.

PAREXEL ($3 billion market cap) gets strong interest from my James O'Shaughnessy-inspired growth model, and high marks from my Momentum Investor and Martin Zweig-based models. To read more about its fundamentals, scroll down to the "Detailed Stock Analysis" section below.

Ross Stores, Inc. (ROST): This former Hot List favorite is a California-based 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 $10 billion in sales in the past year.

Ross, which has a $15 billion market cap, gets approval from my Peter Lynch- and Warren Buffett-based models. For more on the stock, see the "Detailed Stock Analysis" section below.

TrueBlue Inc. (TBI): Tacoma, Wash.-based TrueBlue provides temporary blue-collar staffing services to a variety of industries, including construction, manufacturing, transportation, aviation, waste, hospitality, retail, and renewable energy. It operates about 700 branches in all 50 states, Puerto Rico and Canada, and has taken in about $1.7 billion in sales over the past 12 months.

TrueBlue ($1 billion market cap) gets strong interest from my Peter Lynch- and James O'Shaughnessy-based models. To read more about its fundamentals, check out the "Detailed Stock Analysis" section below.

News about Validea Hot List Stocks

BofI Holding, Inc. (BOFI) : BofI announced second fiscal quarter (ended December 31) net income of $13.2 million -- a record -- up 34.7% over net income of $9.8 million for the year-ago quarter. Earnings attributable to BofI's common stockholders were $13.1 million or $0.91 per diluted share, up 38.6% from $9.4 million or $0.70 per diluted share for the year-ago quarter. Core earnings, which exclude the after-tax impact of gains and losses associated with the firm's securities portfolio, were up 36.8% to $13.8 million.

USANA Health Sciences (USNA): USANA reported fourth-quarter earnings per share of $1.41, beating estimates of $1.37, according to the Motley Fool website. Sales rose 10.5% to $186.3 million, which also topped expectations. The firm also delivered solid guidance for 2014, forecasting revenue of $790 to $810 million and EPS of $5.80 to $5.95. Both figures were well above analysts estimates of $750.5 million in sales and per-share profit of $5.63.

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   |   TBI   |   HCI   |   PRXL   |   ROST   |   LUKOY   |   HFC   |   BOFI   |   CEO   |   AGCO   |  

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.

TrueBlue, Inc. (TrueBlue) is a provider of temporary blue-collar staffing services. The Company has a network of 691 branches in all 50 states, Puerto Rico and Canada, which supply its customers with temporary workers. It operates as Labor Ready for general labor, Spartan Staffing for light industrial services, CLP Resources for skilled trades, PlaneTechs for aviation and diesel mechanics and technicians, and Centerline Drivers for dedicated and temporary drivers to the transportation and distribution industries. In June 2013, Trueblue Inc acquired the assets of Crowley Transportation Services. On September 30, 2013, the Company acquired The Work Connection (TWC).

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.

PAREXEL International Corporation (PAREXEL) is a biopharmaceutical services company, providing a range of expertise in clinical research, medical communications, consulting, and advanced technology products and services to the worldwide pharmaceutical, biotechnology, and medical device industries. It operates it three segments: Clinical Research Services (CRS), PAREXEL Consulting and Medical Communications Services (PCMS) and Perceptive Informatics, Inc. (Perceptive). The Company's product and service offerings include clinical trials management, observational studies and patient/disease registries, data management, biostatistical analysis, epidemiology, health economics / outcomes research, pharmacovigilance, medical communications, clinical pharmacology, patient recruitment, post-marketing surveillance. In May 2013, PAREXEL International Corp acquired the entire share capital of HERON Group Ltd.

Ross Stores, Inc. is an off-price apparel and home fashion chain in the United States, with 1,091 locations in 33 states, the District of Columbia and Guam. The Company operates two brands of off-price retail apparel and home fashion stores: Ross Dress for Less (Ross) and dd's DISCOUNTS. It offers designer apparel, accessories, footwear, and home fashions for the entire family at everyday savings of 20% to 60% off department and specialty store regular prices. As of February 2, 2013, it operated 108 dd's DISCOUNTS stores in eight states. dd's DISCOUNTS features brand apparel, accessories, footwear, and home fashions for the entire family at everyday savings of 20% to 70% off moderate department and discount store regular prices.

NK Lukoil OAO (Neftyanaya Kompaniya LUKOIL OAO or NK LUKOIL OJSC) is a Russia-based integrated oil and gas company. The Company is engaged in the business of oil exploration, production, refining, marketing and distribution. It is an owner of refineries, gas processing, petrochemical plants and gas stations network located in Russia, Eastern and Western Europe, as well as Africa. The Company's petroleum products are sold in the Russian Federation, the Commonwealth of Independent States (CIS) countries, Eastern and Western Europe, Asia and the United States. NK Lukoil OAO operates through numerous subsidiaries and affiliated companies. In April 2013, the Company acquired a 100% of Samara-Nafta ZAO and completed acquisition of CJSC Kama-Oil. In June 2013, it sold a 99.57% stake in Lukoil Odes'kyi NPZ PAT. The Company's major shareholder is NKO ZAO NRD with a stake of 91.60%. In December 2013, it consolidated a 100% stake in ISAB Srl.

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.

BofI Holding, Inc. is a holding company for BofI Federal Bank, a diversified financial services company. The Bank operate its bank from a single location in San Diego, California, serving approximately 40,000 retail deposit and loan customers across all 50 states. As of June 30, 2012, it had total assets of $2,386.8 million, loans of $1,799.7 million, mortgage-backed and other investment securities of $483.0 million, total deposits of $1,615.1 million and borrowings of $547.2 million. It distributes its deposit products through a range of retail distributions channels, and its deposits consist of demand, savings and time deposits accounts. It distributes its loan products through its retail, correspondent and wholesale channels, and the loans it retains are primarily first mortgages secured by single family real property and by multifamily real property.

CNOOC Limited is an investment holding company. The Company, along with its subsidiaries, is a producer of offshore crude oil and natural gas and an independent oil and gas exploration and production company. Its subsidiaries are engaged in exploration, development, production and sales of oil and natural gas. It has three segments: independent operations, operations under joint arrangement and trading business. The Company has four producing areas in offshore China, which include the Bohai Bay, Western South China Sea, Eastern South China Sea and East China Sea. It also has oil and gas assets in Indonesia, Iraq, Australia, Africa, North America and South America. As of December 31, 2012, its subsidiaries included CNOOC China Limited, CNOOC International Limited, China Offshore Oil (Singapore) International Pte Ltd and others.

AGCO Corporation (AGCO) is a manufacturer and distributor of agricultural equipment and related replacement parts globally. The Company sells a range of agricultural equipment, including tractors, combines, self-propelled sprayers, hay tools, forage equipment and implements. It also manufactures and distributes grain storage and handling equipment systems, as well as protein production systems. Its products are recognized in the agricultural equipment industry and are marketed under a range of brands, including Challenger, Fendt, Massey Ferguson and Valtra. The Company distributes its products through a combination of approximately 3,100 independent dealers and distributors in more than 140 countries. In September 2013, Grain Systems, Inc. (GSI), a global brand of the Company announced that it has purchased Johnson System Inc. (JSI), manufacturer of catwalks, towers and support structures based in Marshall, Michigan.

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.

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