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Medium-term horizon, long/short equity, research analyst, portfolio strategy
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The past month has been tough for active management. Economic indicators have been improving in the U.S. and China, but the U.S. market had been subject to significant downside risk from the "fiscal cliff" and looming "debt ceiling". Meanwhile, China has once again produced improved manufacturing statistics which drew all manner of caveats from interested observers. So, the investment and trading climate is confusing.

At the quantitative level, my non-propriety "Indicator" is stuck in neutral, and my risk/reward ratio for SPY is also static. However, the market is going up, and this produces performance anxiety, as I pointed out in a recent Instablog.

So, in these circumstances, the conservative in me says "stay in cash", but I feel uncomfortable doing that because of performance anxiety. The alternative is to look for specific short-term opportunities promising limited risk with a prospect of profit. While the talk is of the "stock market" in aggregate, it isn't homogeneous and my thought is to search for outliers, that is stocks which are not behaving as expected.

To recap, in the past I have advocated "High Beta" investing as a viable strategy. Stocks are selected by comparing the risk/reward ratios for stocks versus the risk/reward ratio for the S&P 500 Index (NYSEARCA:SPY). An example is shown in the following graph with Caterpillar (NYSE:CAT) in red and Terex Corp. (NYSE:TEX) in blue. In the past few years, both have tended to increase at a higher rate than the S&P 500 Index during up-trending markets, Therefore I classify them as "High Beta" stocks and would buy in as the risk/reward for SPY increased. However, in the past month or so, SPY was not performing and CAT wasn't performing either. But it was evident that TEX in particular was nevertheless plotting along a different but superior path to the historical (the yellow markers), and was therefore considered an outlier.

(click to enlarge)

The price graph for CAT and TEX is easier to follow and is shown below illustrating this trend.

(click to enlarge)

So, on the basis that Terex has displayed "High Beta" characteristics in the past, and is producing positive outlier results currently, unlike Caterpillar, I classified my stock universe to align with Terex, and then put together a stock portfolio with similar characteristics. The portfolio I ultimately selected comprised:

BC

Brunswick Corp

Recreational Products

CVI

CVR Energy

O&G Exploration & Production

DFS

Discover Financial

Consumer Finance

EMN

Eastman Chemical

Commodity Chemicals

ES

Energy Solutions

Waste & Disposal Services

HMN

Horace Mann

Property & Casualty Insurance

IBA

Industria Bachoko

Food Products

LII

Lenox Int

Building Materials & Fixtures

RBC

Regal-Beloit Corp

Electrical Components & Equipment

TEX

Terex Corp

Commerical Vehicles & Trucks

TTM

Tata Motors

Commerical Vehicles & Trucks

I recorded this portfolio as at December 12th on the Seeking Alpha portfolio service with a nominal equal weighted allocation. The performance to date is around 7%, with the volatility as shown in the following graph. My view is that this approach indicates an interesting trading strategy. It is proving attractive both as a long only portfolio, or as a market neutral portfolio, which is the strategy I advocated at the time.

(click to enlarge)

Source: Terex: Profiting From Outliers