Going Net Short in Model Portfolios

by: Stephen Castellano

A net long/short indicator for our fundamental-factor model portfolio strategies moved sharply lower again Wednesday. Even a miraculous market bounce over the next few days will not be enough to offset our technical net short signal, which should be firmly in place by Monday, May 10, 2010. Anticipating that signal, we are switching our models to a net short position at the market open, May 6, 2010.

Our Moderate Model Portfolio strategy is moving from 120/80 long/short to 80/120, and our Aggressive Model Portfolio strategy is moving from 200/0 long/short to 50/150.

Our technical long/short indicator has not always worked perfectly, but it has worked well enough to compel us to reallocate our model portfolios prior to the market open Wednesday evening in anticipation of a net short signal, which now appears inevitable. We are being proactive in our net long/short weighting as it applies to our model portfolios because even a few extra days of being correct in our general market calls can have a huge impact on cumulative performance when compounded over time.

The model portfolio has been net long since the close of February 26, which has worked out well. But as a caveat, prior to that it was net short -- from January 28 to February 26. For much of that period it was weighted completely the wrong way, but it did eventually capture the general uptrend since February 26 that so many other investors were skeptical about. Other recent head fakes in which the model incorrectly went net short included the period from October 30 to November 10, 2009 and September 8-9, 2009.

"Low-quality" stocks that have run up recently now seem especially prone to near-term declines. MGM Mirage (MGM) and EOG Resources, Inc. (EOG) are the first ones that come to mind. They were the top two worst short ideas in our "low-quality" portfolio last month having run up 32.4% and 20.6% in April. Yet they still remain in our "low-quality" portfolio this month. Our "focus-list" short ideas for May include ProLogis (PLD), Randgold Resources (GOLD) and TransAlta Corp. (TAC). Readers can peruse our "low-quality" model portfolio for other potential short ideas as well.

Where is a good place to hide? Probably nowhere, but perhaps stocks that recently moved of our "low-quality" list due to sharply higher analyst revisions could be worth some consideration

A group of stocks worth reviewing could be stocks that recently moved out of our model portfolios as the result of sharply higher analyst revisions. The basis for reviewing such a list of stocks assumes that if analyst estimates are moving sharply higher, then positive changes to their fundamentals cannot be far behind. The next step to the logic is that if these stocks still need to revert to some normalized and higher mean, then perhaps the stock prices will stand up to an overall market beating on a relative basis. If the seemingly preordained market sell-off is short lived, then these stocks could very well rebound sharply. In any case, all will be clear in retrospect.

The stocks in this group include Valero Energy Corp. (VLO), Hertz Global Holdings, Inc. (HTZ), Hanesbrands Inc. (HBI), Harley-Davidson, Inc. (HOG), BRF - Brasil Foods S.A. (BRFS), Arch Coal Inc. (ACI) and Arcelor Mittal (MT).

Ascendere Long/Short Strategy Daily Update
'High-quality' stocks in the unleveraged long portfolio declined -0.95% and 'low-quality' stocks in the unleveraged short portfolio declined -1.28% for Wednesday, May 5, 2010. This compares to a decline of -0.66% in the S&P 500.

For the MTD, 'high-quality' stocks in the unleveraged long portfolio are down -2.01%, behind of the S&P 500 (ex dividends) at -1.75%.

'Low-quality' stocks in the unlevered short portfolio are down even more for the MTD at -3.06%.

Market Neutral Portfolio
As a result, the Market Neutral Model Portfolio increased 0.33% Wednesday and is now up 1.08% MTD.

Moderate Long/Short Portfolio
Given the 120/80 long/short weighting in the Moderate Long/Short Model Portfolio, it declined -0.12% overall for the day. The Moderate portfolio performance is now up 0.06% MTD versus -1.75% for the S&P 500, excluding dividends.

The Moderate Long portfolio is down -2.42% for the month and the Moderate Short portfolio is up 2.43%.

Aggressive Long/Short Portfolio
Given the 200/0 long/short weighting in the Aggressive Long/Short Model Portfolio, it declined -1.90% overall for the day. The Aggressive portfolio performance is now down -4.10% MTD versus -1.75% for the S&P 500, excluding dividends.

'High-Quality' Long Stocks Performance
The best daily performers in the long portfolio included ITT Educational Services Inc. (ESI) up 2.75%, Macy's, Inc. (M) up 1.98%, and Humana Inc. (HUM) up 1.57%.

The worst daily performers in the long portfolio included Kinross Gold Corporation (KGC) down -4.79%, Tupperware Brands Corporation (TUP) down -4.74%, and Best Buy Co. Inc. (BBY) down -3.70%.

'Low-Quality' Short Stocks Performance
The best daily performers in the short portfolio included Reliance Steel & Aluminum Co. (RS) down -4.84%, EOG Resources, Inc. down -4.60%, and Weatherford International Ltd. (WFT) down -4.21%.

The worst daily performers in the short portfolio included The St. Joe Company (JOE) up 4.34%, Thomson Reuters Corporation (TRI) up 2.44%, and Nasdaq OMX Group Inc (NDAQ) up 2.25%.

About the Model Portfolio
The Ascendere Long/Short Model Portfolio Strategies are "tactical tilt" portfolios that buy the highest quality stocks and sell the lowest quality stocks while maintaining a net long or net short position at all times. They are composed about 80-100 stocks and rebalanced monthly.

Investors focusing on daily performance could find monitoring our model portfolio useful as a proxy for what is working in the market in general as viewed through the lens of "high-quality" versus "low-quality" stocks.

In addition, daily readers can be apprised of changes in our proprietary long/short indicator, which has been successful at capturing general trends in the market.

We do our best to provide relevant and accurate analysis, but make no guarantee. Investing in securities entail a high degree of risk, including risk of total loss.


Disclosure: None