Monday, March 7, 2011

Investment Report - March 2011: Opportunistic Levered

After a disappointing January, February was a welcome return to outperforming the market. The model returned 6.17% versus the 3.2% of the SP500. The market remained strong even in the face of Middle East turmoil and continuous calls that the market is overbought. Certainly the returns have been strong since the beginning of September, but a review of the first year of this model and market has only gained roughly 20% over that time period. While thats a great return for the 13 month life of this model, it isn't anything excessive considering the massive market drop during the financial crisis. Also investors need to consider that corporate profits are returning to the peak levels of 2007 all while the SP500 is still some 250 points below the all time high of 1,576. In that context the market appears cheap and has plenty of room to run.

Definitely cognizant that the market needs a breather or even a minor 5% or so correction. Though market participants need to understand that a 10% correction even from late February highs of 1,344 would leave the market close to 1,200. A level some 25% below the peak back in 2007 even as the corporate profit levels reach back to the highs.

Added Long Exposure
In that context with corporate profits soaring and the Fed extremely cheap, this model used the late February weakness to add back long exposure. Freeport McMoRan Copper & Gold (FCX) was added back to the model while three new stocks were added. ICICI Bank (IBN), ChinaCache (CCIH), and Radware (RDWR) were added. The main theme of adding FCX, IBN, and CCIH was to increase exposure to the emerging markets. Exposure had been reduced to the sector over the last few months as it has fallen out of favor. By February the valuations had become too inexpensive to pass up with all three stocks down nearly 20% from recent highs. CCIH was down 50% from its highs reached after its very successful IPO providing for an apparent bargain.

RDWR on the other hand was added to gain more exposure to the fast growing network and cloud computing space. The main thrust of the trade being to add back exposure after selling Terremark Worldwide (TMRK) in January following its purchase by Verizon Communications (VZ).

Top Performers
Ironically the top performer was a stock just added towards the end of the month. CCIH had a whopping 27% gain in less then a week. CCIH is the Akamai (AKAM) of China and has enormous potential but the departure of the COO has placed the future in doubt providing an opportune risk/reward entry point.  Also after a weak few months, the China markets have started to heat up providing for an attractive entry point to US listed China stocks at their lows. Most market commentators have apparently missed the run up as the focus remains on the violence in Libya and potential protests in oil rich Saudi Arabia. A strong domestic Chinese market typically leads the US  market by several months.

Two tech stocks had good months. Even with the chorus mostly claiming that tech was overbought and expensive, Riverbed Tech (RVBD) enjoyed a 15% gain and Limelight Networks (LLNW) was up 11%.

The other top 5 performers were Atwoods Oceanics (ATW) with a 12.6% gain and Sears Holdings (SHLD) up 10.5%. ATW is a deepwater driller so not too surprising that it had a good month with oil spiking and the prospects for drilling offshore much more attractive now that the investment community has been reminded that the risks of a accident on an oil rig is less then the political stability in most oil producing countries.

Bottom Performers
AerCap Holdings (AER) had the worst month as the airplane lessor was impacted by the spiraling costs of oil and the fears of reduced travel demands. Although AER isn't nearly as impacted as the market always believes, they tend to trade violently during these time periods. The company has extremely long leases with a diverse group of airlines and the continual increase in demand for global travel will always override these minor setbacks. Not to mention, AER has a relatively young fleet of fuel efficient planes that are in higher demand as oil prices rise. The company survived the financial crisis with minimal impacts so investors shouldn't be so quick to sell this stock.

The remaining weak performers were mostly due to concerns over higher inflation in emerging markets or a reduction of work form the turmoil in the Middle East. Puda Coal (PUDA), Cephalon (CEPH), and ICICI Bank (IBN) were all down between 4-5%. Not great results but not horrible considering the top performers were up 10%+ highlighting the volatility of stocks in general and further demonstrating how even a diversified portfolio that had good absolute and relative returns for the month had some weak individual stocks.

Largest Position
The combination of Massey Energy (MEE) and Alpha Natural Resources (ANR) remains the largest position in the model by far. MEE alone has the largest weighting at 9.33%. Over time this combined position will be reduced as the model aims to keep all positions below 10%. The significant drop of ANR following the mostly stock buyout agreement with MEE lead to the decision to keep both stocks for now. Metallurgical coal remains in high demand due to emerging market growth and reduced supplies because of the Australia floods. The ANR/MEE combination makes for a global powerhouse in the met coal area and a very attractive investment option. Regardless some stock will be sold into strength to reduce exposure.

Conclusion
The market began March with numerous concerns and some relative weakness providing numerous opportunities. Investors in general continue to focus too much on the returns off the market bottom two years ago and not enough on the returns since the market top less then four years ago. The picture remains long term bullish when looking at the complete picture as opposed to chopping off a small corner to fit an investment thesis.

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