No Place to Hide – Alpha Select Update July 2014

Climbing_the_Wall_of_Worry_-_Google_SearchAlpha Select – July 2014 Update

*Alpha Select – MTD (-2.94%) YTD +6.81%
**S&P 500 – MTD (-1.51%) YTD +5.52%
* Net of Fees
** Includes Dividends

By David Nelson, CFA

Yesterday’s Sell-Off Was Different

Yesterday’s decline started off as an ordinary pullback but quickly morphed into something more serious by day’s end. The key that something bigger was taking place was that virtually every asset class was negative on the day. U.S. Stocks, International Stocks, Bonds, Gold and Oil were all down. In other words there was no place hide. This was an institutionally driven sell-off with firms reducing exposure.

Strategists and traders spent most of yesterday trying to figure out which events or factors were causing many to head for the exits. We have the usual round of suspects with geo politics at the top of the list. Escalating tensions in the Ukraine and increased sanctions on Russia announced both here and in Europe added to the turmoil. If that wasn’t enough, Argentina went into default something they seem to do every 10 years or so.

Geo political concerns are always with us and almost impossible to quantify. While the sell-off may have started on the backs of these concerns I don’t think this is what drove the continued push lower. If it had been, I would have expected treasuries and gold to rise.

A day earlier we heard the last FOMC statement for the summer and also got our first look at 2nd Quarter GDP. Thank God GDP data came in at 4%. What if it had been 3? We might have had back to back 2% declines. While I didn’t read anything startling in the FOMC statement it came across as a bit more hawkish. The committee acknowledged inflation “moved somewhat closer to the committee’s longer run objective.”

It’s clear there is a huge debate raging inside the Fed. Earlier this week Dallas Federal Reserve Bank President wrote a scathing op ed in the Journal saying the Fed has stayed too loose for too long and is in danger of damaging some of the progress already made. I thought Mr. Fisher might dissent but it was Plosser that dissented. Earlier this week I was on Fox Business’ Making Money with Charles Payne to discuss my article from Monday, FOMC Statement – The One Word That Matters Most. The phrase considerable period of time when referring to accommodation is critical in Fed Speak and yesterday’s action convinced me that its removal is closer than we think.

Whenever I’m looking for news on market action or what the prevailing sentiment across trading desks is, I turn to my good friend Robert Funk. Rob and I go back to my early days at Merrill. He’s a great trader and always seems to have his finger on the pulse of the day’s action. Yesterday he sent out a note with comments from a few traders and analysts all pointing to the single data point that probably caused the most damage. The employment cost index was up 0.7% up from a 0.3% hike in the first quarter. This is one of the biggest moves since 2008. While I’m certain the Fed wants to see this number move higher, if it moves too fast it could act as a trigger forcing the Fed to move rates higher quicker than planned.

Employment Cost Index


While all of the above may have contributed to yesterday’s action it seems that the Fed moving up their time table on an interest rate hike was the culprit handing stock investors their first monthly loss since January. While it’s important not to rely on a single data point, evidence seem to be mounting that the Fed is closer to a change than earlier believed. I now expect the Fed to hike rates early in the first quarter of 2015 possibly as early as January.

A Fed exit while scary isn’t the end of the world if they are doing it for the right reasons. Removing accommodation because the economy and job market are improving will eventually be what the doctor ordered even if we don’t like taking the medicine. However, if it’s because they are losing their grip on inflationary pressures than “Houston, we have a problem.”

Alpha Select Update

No matter how you slice it July wasn’t a great month for Alpha Select. We underperformed our benchmark largely on the back of missed earnings expectations on a number of our names. While there were many that had superb results like Service Corp (SCI), Lyondell (LYB) and Dow (DOW) too many failed to step over the bar or guided lower. This was particularly evident for industrials. Caterpillar (CAT) and Cummins (CMI) both disappointed guiding to lower orders overseas. For CMI orders for some strategic products were down mid-teens.

Boeing (BA) actually delivered a positive surprise and numbers across the street are going up. Nevertheless the stock is down since the report. If you’ll remember Boeing was our biggest winner last year and shares were sold in early January for a capital gain of close to 100%. The re-entry a few weeks ago has been problematic.

While we’re still up 6.8% YTD and ahead of the S&P no manager likes to give up that much alpha in a single month.

Sector Update

The only sector that managed to hang on to a positive return for July was Technology. Utilities were hardest hit. While utilities are still up strongly year to date this sector could see continued selling as interest rate fears rise.


The Good the Bad & the Ugly 

Realized Winners & Losers 

The three best realized winners for July were Avago (AVGO), Delta (DAL) and Micron (MU) coming in at +48%, +31% and +12% respectively.

The worst losses came from Corning (GLW), Cummins (CMI) and CBRE Group (CBG) at (-7.9%), (-7.4%) and (-5.1%) respectively


Of stocks still in the Alpha Select Portfolio the best performers were Lyondell (LYB), Gilead (GILD) and Microsoft up +6.6%, +4.2% and +3.3% respectively.

The three worst losers included Helmerich & Payne (HP), Boeing (BA) and Johnson & Johnson (JNJ) at (-10%), (-6.3%) and (-5.1%) respectively.

The markets don’t care that most of Wall Street is on vacation. As always there is a lot of work and analysis to do. I’ll be back several times over the course of the month. Please feel free to reach out with any questions.


Regarding Alpha Select Performance: Performance data quoted represents past performance and does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investment, when withdrawn from the strategy, may be worth more or less than a client’s original investment. Referenced performance is from a client’s account (model account. Performance is inclusive of all dividends, costs, commissions and the deduction of a 1.00% annual management fee (deducted quarterly in advance).

No current or prospective client should assume future performance of any specific investment strategy will be profitable or equal to past performance levels. All investment strategies have the potential for profit or loss. Differences in commissions charged or management fee charged can cause performance to vary from one account to another in identical strategies. Changes in investment strategies, contribution or withdrawals may cause the performance results of an investor’s portfolio to differ materially from the reported composite performance. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will either be suitable or profitable for a client’s investment portfolio. Historical performance results for market indices generally (such as a benchmark) do not reflect the deduction of transaction and/or custodial charges or the deduction of an investment management fee, the incurrence of which would have the effect of decreasing historical performance results. Economic factors, market condition and investment strategies will affect the performance of any portfolio and there are no assurances that it will
match or outperform any particular benchmark.

Performance reported is not GIPS compliant and has not been audited by a third party. Policies for valuing portfolios, calculating performance, and preparing compliant presentations are available upon request. Data as of 08/01/2014.