Tuesday, June 7, 2011

Investment Report - June 2011: Opportunistic Levered

May was a very rough month for the Opportunistic Levered model. It severely underperformed the market as China specifically and emerging growth stocks in general were hit much harder than the overall market. This trend will likely continue into June, but eventually will provide great upside potential as most of the stocks in these areas remain extremely cheap.

Expanded Track Record
Recently the track record was expanded back to January 30, 2009 adding a little over a year to the previous record. As one can see, the model can be very volatile, but the end result has been very good for anybody that remains invested. Sometimes an investor has to accept wild price swings in order to make long term gains. It is not uncommon for top stocks to drop more than 25% before eventually rebounding to higher prices. At times it can be worthwhile to cash out to avoid losses such as the recent sell of Limelight Networks (LLNW). The sell limited losses without incurring material capital gains impacts as the stock was sold within the general range of the purchase price. Other times though, a sell could trigger a large capital gains event that would reduce any benefits of protecting short term losses. In those cases the volatility is worth it. Ideally this model will hold winners for multiple years as the story plays out.

Market Review
The market in general has been weak as it ended May on a rare five week losing streak. Individual emerging growth stocks were just crushed in many cases. The fears abound regarding a double dip recession, even though, the likelihood according to the New York Fed is less than 1%. This is due to the very positive Treasury Spread or yield curve as can be seen in this chart. Recessions just don't happen unless the Fed reduces liquidity causing short term interest rates to move higher than long term rates. In addition, the earnings yield on the SP500 stocks remains higher than the yield on the 10 year Treasury bond suggesting investors obtain a higher yield in stocks.

China
The Chinese stocks in this model continue to get crushed even after a horrible April. In hindsight, selling and waiting for the fraud fears to settle would've been a better move. Both ChinaCache (CCIH) and Lihua International (LIWA) remain extremely undervalued as fear prevails in this sector. It appears more panic than reality as this point as both companies have been vetted by numerous analysts. Puda Coal (PUDA) remains halted as the company continues to investigate the alleged illegal transfer by the Chairman. The subsequent $12 buyout off is also being reviewed by the special committee and remains a legitimate option with the potential for a higher offer. Several indications exist that the Chairman is raising cash selling other investments suggesting a real opportunity to reclaim the money and maybe even profit from this stock. Time will tell as these Management Buyouts in China remain hit and miss. At the end of the day, these companies could obtain higher valuations as time passes and the scrutiny subsides leaving the cream of the crop to rise. The situation reminds us of the financial crisis where all stocks were crushed without discrimination. Now the remaining strong companies have higher earnings and trade at higher valuations than prior to the crisis. This too could happen to the China stocks that survive the fraud scare.

Weak Economy or Japan Induced Slowdown?
The growing consensus seems to be that the global economy and especially the US is moving towards a severe slowdown if not a double dip recession as mentioned above. On the contrary, any slowdown seems directly related to reductions in the supply chain from the Japan disaster in March. The auto sector had significant hits in March and April, but it appears that the sector will be on the mend in June as even Toyota (the most impacted auto company) rebounds to 90% production rates.

Several stocks including Manitowoc (MTW), U.S. Steel (X), and Freeport McMoRan (FCX) were added to the model to benefit from global growth and the rebuild in Japan. While the theme has been slow to play out, the recent rebound in copper gives us confidence that the recovery is now underway in a meaningful way. Dr. Copper bottomed out in mid May and has continued to rally into June providing strong evidence of growing demand.

Conclusion
Stocks remain cheap. The Fed remains accommodative regardless of whether QE2 ends in June. Market psychology is slowly turning from bullish to very bearish.  The combination suggests staying fully long with limited hedges as the opportunity ahead could match the rally off the 2009 lows.


Disclosure: Long all stocks mentioned in personal and client portfolios unless otherwise stated. Please review the disclaimer page. 

No comments: