Climbing the Wall – April 2014 Alpha Select Update

Climbing_the_Wall_of_Worry_-_Google_SearchAlpha Select – April 2014 Update

*Alpha Select – MTD (-0.11%) YTD +2.80%
**S&P 500 – MTD +0.62% YTD +2.53%
* Net of Fees
** Includes Dividends

By David Nelson

After starting off the month with a push to all-time highs markets quickly headed south and by mid-month were down close to 4%. Even confirmed bulls like me started to waffle especially in the face of a continued sell-off in growth stocks. The S&P beat us this month but we are still modestly ahead of the index year to date net of all fees.

 I wrote about the coming rotation in last month’s article, The Worm Has Turned. I believe we have pushed the valuation envelope too far as Growth at the Right Price morphed into Growth at Any Price.

The good news is the market so far is successfully deflating some of these bubbles as investors look beyond the revenue line, placing more emphasis on the bottom line.

Concerns

IDU_SPY_-_SharpCharts_Workbench_-_StockCharts_com_-_Google_Chrome1st on my list is the out-performance of the utility sector since the start of the year. Utilities were last year’s laggard but are outperforming year to date. Remember this is a performance chart which represents the performance of the S&P Utility ETF (IDU) vs. the S&P ETF (SPY). When the line is moving higher utilities are outperforming. As you can see we had a similar move in the first part of last year that ended as soon as the FED first mentioned the Taper. A move into utilities is clearly defensive as investors wrestle with weak economic data.

The second is a similar chart comparing the performance of the Russell 2000 small cap index with the S&P 100 Large Caps. Since early March the Russell has underperformed their Big Cap brothers and is another sign of investor concern and unease.

_RUT__OEX_-_SharpCharts_Workbench_-_StockCharts_com_-_Google_Chrome
The chart of the S&P (SPX) has been bouncing back and forth across the 50 day moving average all year. Technical analysts are becoming worried about the potential of a head & shoulder pattern developing. We need to see the SPX break to new all-time highs to take that off the table.

SPX_2014_04_30

Finally the NY Stock Exchange Bullish Percent Index is sitting in a column of O’s. This also needs to reverse.
_BPNYA_-_2014_04_30

The Economy

We’re still wrestling with the overhang of 1st quarter blues and the weak data that many economists believe was the result of bad weather. We’re not going to have the weather put in July when companies start to report Q2 earnings. It’s important to see data soon confirming that Q1 was really all about the weather.

Buybacks Were the Low Hanging Fruit

CapexContinued low interest rates, buybacks and higher dividends were the low hanging fruit for management to drive investor returns. A rise in Capex (Capital Expenditures) is the key for the next leg of the bull market. As the year unfolds I still expect to see this metric continue to move higher. The chart below from Goldman Sachs economic team shows US Industrial & Construction Capex is well below historic norms.

The Capex debate rages on with passionate arguments being made from both sides. Mike Santoli from Yahoo Finance in a recent article interviewed Jason Trennert of Strategas Research Partners. Jason points out, companies spending a higher percentage of their revenue for capex have underperformed the market and that trend has remained in place since 2008. He goes on to say that buybacks and debt pay down have been more richly rewarded.

I believe 2014 will be the transition year. Companies that don’t spend on their future ultimately turn into IBM. Products, innovation and research are what drive long term performance.

The Fed

There were few surprises in yesterday’s FOMC meeting. As expected they continued the taper taking out an additional $10 Billion with bond purchases now sitting at $45 Billion. At this pace bond purchases should end by October. They talked about the effects of weather in Q1 but it seems clear they need more data to arrive at any concrete conclusions.

Earnings

We are jumping over a lowered bar this earnings season but for the most part I’m pleased with the reports coming from our Alpha Select Stocks. Trinity (TRN), Precision Drilling (PDS), Gilead (GILD), Delta (DAL), Suncor (SU) and Apple (AAPL) came in well above expectations. Raytheon (RTN), Royal Caribbean, (RCL) were both disappointing and have been removed from the portfolio.

The Good the Bad & the Ugly

Realized Returns

One of the oldest positions in the Alpha Select portfolios JP Morgan Chase (JPM) was sold just before their report earlier this month locking in a 48% return. (JPM) has been falling in the model for months and the long awaited increase in NIM (Net Interest Margins) I was looking for has yet to materialize. The banking sector as a whole is probably not going to give the best bang for the buck right now.

Helmerich & Payne (HP) and Google (GOOG) were also sold before their reports locking in +28% & +12.8% respectively. (HP) was a valuation call and in (GOOG) we were just stopped out when it broke key technical levels. I find myself increasingly uncomfortable with the (GOOG) dual class structure. If we return it will be with (GOOGL) shares which have voting rights.

In the realized loss column Lockheed Martin (LMT), Aetna (AET) and Coca Cola Enterprises (CCE) were sold with (-5.6%), (-5.6%) and (-4.9%) losses respectively. All three were technical stops having breached levels of support. There were a few other names with realized returns between +2% and (-2.9%).

Unrealized

Our repurchase of Gilead (GILD) delivered the biggest return this month and is up +13.5% since the buy a few days before reporting a block buster number. I’ve talked about Gilead’s controversial $1000 dollar a pill Sovaldi which offers a cure for Hepatitis C several times in the media. My article on the subject which appeared on Seeking Alpha generated significant interest. More important than what I wrote were the comments of those with the disease. Doctors also weighed in on the subject. With rare exception most the comments were positive in support of Gilead’s pricing.

Apple (AAPL) was number 2 with a bullet finishing the month up close to +10% on the heels of a big earnings beat. The interesting story here is that Apple was probably the company most portfolio managers including yours truly were worried about going into their earnings report.

Energy was a big performer this month with our two recent purchases Suncor (SU) and Precision Drilling (PDS) leading the way. Both delivered on earnings with Suncor (SU) up +7.8% since our purchase earlier in the month. Precision (PDS) was up +8.6% in April and +19.5% from inception in March.

This month’s candidates for the Bad Team included SCI Corp (SCI), Discover (DFS) and Coviden (COV) down (-5.6%), (-3.9%) and (-2.9%) respectively

To make Team Ugly you have to be down over 10%. Fortunately no one made the roster.
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Jobs

April’s Job numbers will be reported on Friday with consensus around 200k. The recent ADP numbers support that view so anything less will be viewed negatively.

Markets and Alpha Select are slightly below trend to reach the target I established earlier this year. Obviously there is a lot of info here to digest so please feel free to give me a call or email if you have any questions.