Five-Month Review of Bill's 2006 Extravaganza of Predictions
(Guest Commentary - June 8, 2006)
Dear Subscribers and Readers,
For those who were waiting for Bill Rempel's guest commentary this month he is finally back (he was having connectivity problems last week). But before we go on and look at Bill's review of his picks earlier this year, this author wants to quickly comment on the latest sell-off in both U.S. and global equities.
As this author has mentioned many times before, many of the world's emerging markets have been getting highly speculative since the beginning of this year especially the Indian and Russian markets. Since the early May highs, both markets have been the worst performing markets in the world with both being down 20% since that time. Just like commodities, emerging markets should continue to underperform going forward, given a continuing decline in global liquidity, and an upcoming U.S. mid-cycle consumer slow-down.
Speaking of commodities, a recent World Gold Council Report outlined that jewelry demand for gold decreased 22% on a year-over-year basis during the first quarter of 2006, as gold's parabolic rise was too much even for emerging China and India. Of all sources of demand growth, the demand from ETF investment grew the most as the tonnage demanded rose 23% to a record high of 108.7 tonnes. But ETF investors are notoriously fickle, and a positive demand coming from ETFs could quickly turn into a negative outflow if investors start dumping their gold ETFs. Moreover, mining companies further de-hedged 160 tonnes of production from their hedge books during the first quarter which exceeded the total amount of de-hedging done during 2005 and most likely contributed a significant portion of the spike in gold prices. Bottom line: The current bull market in gold for this cycle is over (at least for the next couple of years) even though this author believes that the secular bull market in gold is still intact. At this point, this author would not even think about a long trade on gold until it hits the $550 level.
As for U.S. equities, conditions are now oversold enough such at I believe we will most likely get an intermediate term bottom sometime in the next two weeks. As I posted in our discussion forum, the best scenario for the bulls right now would be for the indices to get a washout either today or tomorrow, with an accompanying NYSE ARMS reading of 2 or over and another VIX spike of 10% or over. This will give us a NYSE 10-day ARMS reading of over 1.43 and a 21-day reading of over 1.35 which would represent the most oversold NYSE ARMS readings since October 2004 and August 2004, respectively. This oversold reading in the NYSE ARMS Index is also being confirmed by other technical and sentiment readings such as the Rydex Cash Flow Ratio, the McClellan Summation Index, the equity put/call ratio, and the AAII and Investors Intelligence Readings. In fact, the AAII bulls-bears % differential has just flashed two weekly -19% readings in a row. Such oversold readings in the AAII survey haven't been since April 2005. Meanwhile, the readings coming out of the Investors Intelligence Survey have gotten even more oversold, as the latest weekly bulls-bears% differential reading of 8.7% represents the most oversold reading since April 2003!
Should we get some kind of washout over the next two days, this author will be going 100% long in our DJIA Timing System for an inevitable retest of the early May highs. Please note, however, that this author is still bearish for most of this year, but in the meantime, the markets are giving us a very oversold condition that I believe will be very tradable on the long side (at least in the major market indices and some ETFs).
Now, let's go on to Bill's commentary!
Without further ado, following is biography of Bill:
Bill Rempel (aka nodoodahs) is an active poster on the MarketThoughts forum as well as a few others around the web. Bill is a regular, monthly guest commentator on our website (see Gannett a Stand-out in the Newspaper Industry for his last individual stock commentary). Bill graduated from Caddo Magnet High School (a high school for nerds) in back in 1985 and proceeded to learn the hard way when he drank his way out of a scholarship to Tulane later that year. After a few years of sweating for a living, he decided to go back to school, and graduated from LSU-Shreveport in 1995 with a Bachelors in Mathematics - all the while working the overnight shift stocking shelves in a grocery store.
Post-college, Bill has been in the P&C insurance industry as an actuary, product manager, and pricing manager. Bill and his wife Millie are amateur investors with a variety of holdings, but they prefer to buy and hold value investments. In typical "value" style, they live cheap, driving old cars and preferring to save or invest instead of buying fancy "stuff." Bill currently maintains an excellent investment blog (which he tries to update daily) at Nodoodahs.com.
Disclaimer: This commentary is solely meant for education purposes and is not intended as investment advice. Please note that the opinions expressed in this commentary are those of the individual author and do not necessarily represent the opinion of MarketThoughts LLC or its management.
It's time for a five-month review of the stocks first mentioned in my 2006 Extravaganza of Predictions.
Now that we've had some time for dividends to filter through the works somewhat, I'll use the returns on index-tracking ETF's for comparison. All the returns are based on a close to close, December 30, 2005 through June 7, 2006 period.
The SPY tracks the S&P 500 index, and it is this index that I watch most often, and against which I intended to compare the 48 stocks that I reviewed. At the end of 2005 when I made my picks,, my prediction for the S&P 500 was as follows:
The 52-week model for the S&P 500 is currently reading in the 6th decile. The 6th decile is neutral in the sense that it suggests an average 52-week return. Median and average returns for this reading are 13.4% and 11.7% vs. standard median and average returns of 12.4% and 11.8%. The 6th decile implies a 79% chance of gains, with about a 52% chance of above-average gains, and a still-hefty 13% chance of ending the year down more than 10% from where we are today. Overall, the model output suggests a U.S. stock market year that is somewhat typical and not anything to be especially excited about or afraid of.
My models don't include the return from any dividends, only the index value itself. The SPY has returned a mere 1.1% since December 30th, and is actually down from a maximum total return of 6.5% just about a month ago.
By way of comparison, the DIA, which mirrors the Dow Jones Industrial average, has returned 3.0% since that time and had at one point a total return of 9.7%. Of course, a significant chuck of this was due to GM's smoke-and-mirrors act over the last quarter [Henry's note: I still believe GM will go bankrupt within the next 12 months]
The QQQQ, which mirrors the NASDAQ, is currently in the red to the tune of 4.8%, although it did have a 6.9% return at one point in 2006.
With the major indices down from their highs, a mildly bullish end-of-year prediction sounds like it's in jeopardy. While the market could have experienced a top, this author thinks the current condition in the markets is a consolidation phase caused by new interest rate expectations, and I think new leadership will emerge by July. But from where? Good question ...
In the interest of disclosure, I must remind you that this message and its predecessors are expressions of opinion made by an amateur investor. I have been and still am long many of the stocks that I mention positively, and have been and may still be short many of the stocks I mention negatively. Do your own due diligence, and may the BooYah be with ya! Another note on returns I used the Yahoo!Finance feature of "adjusted close," which adjusts previous closing amounts for splits and dividends. Therefore the adjusted close on the table may not match the actual close on December 30 , 2005 if the stock paid a dividend or had a split since that time.
I mentioned twelve large cap (over $5 billion) stocks that I thought had potential to outperform the broader market over the course of 2006. As a whole, an equal-weighted portfolio comprised of these twelve stocks has returned 4.1%, which beats the SPY, the DIA, and trounces the QQQQ. Individually, eight of the twelve beat the SPY; six of twelve beat the DIA; and ten of twelve beat the QQQQ.
How did they do it? Well, they didn't do it through parabolic increases! In true "value" fashion, they did it by slowly chipping away gains. None of these stocks returned even 17% so far, but only three failed to make a gain.
There were twelve smaller-cap stocks mentioned as potential values, and these also performed well compared to the broader market. As a whole, an equal-weighted portfolio comprised of these twelve stocks has returned 3.2%, which beats the SPY and trounces the QQQQ, but is about even the DIA. Individually, six of the twelve beat the SPY; four of twelve beat the DIA; and ten of twelve beat the QQQQ.
The results here had much greater volatility than the large-cap stocks, as you might expect, having both a 20% gainer and a 20% loser. Incidentally, the 20% loser was at one point a 20% winner! Tiny little Nash-Finch, a grocery supplier, got their brains kicked in on April 27 when they widely missed estimates. A trailing stop loss could've saved you only a little pain. Check the red arrows on the chart below! The space between them is your paper loss on the day your stop kicks you out. Of course, if you bought in at the close of December 30th and had a trailing stop, you'd be in a profit on this position reference the green arrow for buy in and the lower red arrow for where a conditional trade would have triggered. However, the group was structured as a one-year buy-and-hold, so the entire 19.4% loss on NAFC is counted against this group.
A full five of the twelve have failed to make a positive return at this point. One of those has come roaring back from a whopping near 30% down to about breakeven! You see, Sanderson Farms was mistakenly diagnosed with a fatal case of "bird flu," but it appears they had only a common cold.
A little more controversial was my list of large caps poised to under-perform. Three of the contentious picks were India/outsourcing plays, and I'm happy to say that I'm two-out-of-three on those, with only Cognizant posting a gain (and what a gain!) since December 30, 2005. Other picks which prompted some critiques were Genentech, a winner for me, and Starbucks, a loser for me. Oh, bother. Oh, and don't forget Google, whose inclusion on this list had many people asking about my sanity (it's still missing, thanks for asking).
As a whole, an equal-weighted portfolio comprised of these twelve stocks has returned 0.8%, which only manages to beat the QQQQ, which is interesting, because some of these stocks contributed in large part to the QQQQ's decline! Only four of these stocks have posted increases over the last five months, and those four have all outperformed the major indices. However, they haven't been able to lift the portfolio of twelve. Several of these presented really good short opportunities that I was able to get a piece of.
The last group of stocks selected was a real learning experience for me. The lesson was not dissimilar from one of Newton's Laws, something on the order of "a stock that's in motion will tend to remain in motion!" In review of many of the academic papers on momentum that are listed on the MarketThoughts discussion forum, it is plain that a lot of money could be made by finding profitless, overvalued stocks that are flying high, and buying them with some mechanical money-management rule. Maybe I'll write more on that later let's see how it's turning out thus far.
As a whole, an equal-weighted portfolio comprised of these twelve stocks has returned 0.3%, which only beats the QQQQs. It also had the most variation in returns, from 72.8% to +39.3%! However, this group was LEADING the comparison at two months in! What happened?
In one case, the Feral Death Admin..., er, the Federal Drug Administration, made its mark. Interestingly, this was only a short opportunity if you were in a position before the news occured. After the news, long was the way to be for this stock. While Threshold Pharma may have a 72.8% return for the comparison, it has subsequently returned +14.2% since its downfall. Oh, bother.
Sometimes a short opportunity can become a long opportunity.
In another example, if you shorted BIDU down from the get-go with a 10% trailing stop, you'd have ridden down 28.2% and been kicked out in February with a 20% gain. For the whole period, BIDU is actually up 39.3%. In essence, it's practically doubled since its lows! What a ride!
Rackable Systems looks like a loser on this list, because it gained 25.2% since mention. However, at one point in April this dog was up 92.9%! Catching even part of a 35.1% downslide in a month-and-a-half wouldn't have been bad.
This is a day-by-day comparison of the portfolio performance for all four sets, combined with the index-tracking ETF's total returns. This chart includes the return from dividends and assumes equal-weighted portfolios. It's plain to see why value stocks tend to hold up better in times of market decline than more speculative issues.
Good luck and happy investing!