Focus List Update: Numbers No Longer Support Shorting Consumer Discretionary

by: Stephen Castellano

We are taking our proven methodology used to rebalance the Ascendere Long/Short Model Portfolio of 80-100 stocks on a monthly basis, and applying the format on a weekly basis. While introducing some noise, it is also uncovering some good ideas. For paying subscribers we may consider following up with this on a daily basis, as well as providing limited distribution and more timely access of our existing products.

Our approach has been extremely successful at pre-empting a number of ratings actions by major sell side firms. In case this escaped anyone's attention, last week we laid this out in excruciatingly manic detail in "Goldman Sachs and Nostradamus versus Simple Quantitative Models and Common Sense." We are looking forward to continuing the tradition.

Focus List -- Weekly Long Ideas Disappoint
The long focus list as of March 12 started out well enough, but ended the week with a dismal decline on average of 0.84%. This compares to a an increase of 0.86% in the S&P 500. The one positive stock, Bank of Montreal (NYSE:BMO) was unable to offset declines in Macy's, Inc. (NYSE:M), Ultrapar Holdings Inc. (NYSE:UGP) and flat performance from Dick's Sporting Goods Inc. (NYSE:DKS). As we had suspected, DKS fulfilled its destiny by outperforming M.

Focus List -- Weekly Short Ideas Disappoint
The short focus list as of March 12 started out well too, but a huge 6.52% move up by Martin Marietta Materials Inc. (NYSE:MLM) offset a flat return from Carnival plc (NYSE:CUK) and a 4.20% decline from Central European Distribution (NASDAQ:CEDC). Following the passage of a jobs build that included $28b of highway spending, Construction Materials companies rebounded and at least one analyst believes that "revision bias for the Street is probably going to be to the upside." As we explained last week, ATVI does not belong on the list but for consistency's sake we kept it on.

New Long Ideas for the Week

Of these new long ideas available as of the close of March 19, 2010, we would focus our attention on Jefferies Group Inc. (JEF), Berkshire Hathaway Inc. (NYSE:BRK.B) and Towers Watson & Co. Jefferies Group and Berkshire Hathaway makes sense to us as we have been hearing good things about these companies. Credicorp (NYSE:BAP) is not a focus list stock but banks have been doing well of late, so may deserve a look as well.

While Ross Stores Inc (NASDAQ:ROST) is not a focus list stock, we note that it fell off the list last week, but is now back on as relative rankings get updated and reshuffled back to its favor. This would support the notion that higher frequency equates with higher noise on a weekly basis -- perhaps exploitable by traders having the right information.

New Short and Contrarian Long Ideas for the Week

Once again we are somewhat hesitant to print this list. Materials stocks have been on a run and if the economy is improving so will a number of Utilities. The "low-quality" stocks we would focus on this week include Companhia Siderurgica Nacional (NYSE:SID), Fibria Celulose SA (VCP), NII Holdings Inc. (NASDAQ:NIHD), FPL Group Inc. (FPL-OLD) and Southern Company (NYSE:SO).

However, these stocks will probably outperform on the upside and the downside, depending on the direction of the market. If the decline in market momentum that we saw on Friday March 19, 2010 continues, this focus list of short ideas could work very well.

Recent evidence seems to support the idea that buying "low-quality" stocks would have been the right strategy because these stocks are anticipating an economic recovery. At key inflection points in the economy, focusing on analyst revisions loses its efficacy. This is because for all the marketing power and intelligence on Wall Street, sell side estimate revisions tend to lag the market -- they do not lead it.

To avoid getting hurt by individual stocks during economic inflection points, we are exploring ways to adjust our models to take this into account. Meanwhile, the overall long/short model portfolio continues to benefit from a weighting strategy that has significantly offset the negative impact of "wrong" short ideas.

We Really Wanted to Focus on Consumer Discretionary Short Ideas, But the Numbers No Longer Support This

A proprietary indicator that we have developed which has had a good track record of helping us determine the long/short weightings in our model portfolio has turned down for the last four days. This indicator is nowhere close to suggesting that we change from our net long position, but it is heading in that direction.

We are a little disappointed that none of these Discretionary names showed up on our short focus list. For example, we were really hoping we could lay into Abercrombie & Fitch (NYSE:ANF) as perhaps one of the best short ideas available right now. But an updated look at the key metrics do not support this. What was an extremely ugly stock on February 26 is now an ugly but improving stock.

We do think that ANF and a number of other Discretionary names that have run up double digits in the last few weeks have the potential to decline in the next few days. But if ANF is any indicator, such declines could be only short-term and technical in nature and may be dangerous to hold on to for an extended period on time.

Off the "Buy List"

Some stocks that were focus list ideas last week are now completely off the "buy" list. These include, Dick's Sporting Goods Inc. (DKS) and Ultrapar Holdings (UGP). We also note that Annaly Capital Management, Inc. (NYSE:NLY) which was a new idea last week but not a "focus list" idea is off the list this week. UGP rankings have drastically changed for the worse while modest changes to DKS and NLY are enough to take them off the list for the week.

Off the "Sell List"

These stocks just do not look as ugly as they did last week. Material stocks that were not looking so good on our rankings are now off our list; another indicator that at times of economic inflection points, factors like analyst revisions are in fact lagging indicators and may be completely irrelevant in determining future price direction.

Ascendere Long/Short Model Portfolio is Holding its Own
For the month to date, the Ascendere Long/Short Model Portfolio has shown a positive performance but has lagged the market. The portfolio is net long, which has offset positive double-digit percentage changes of some "low-quality" stocks in the short portfolio.

As we mentioned earlier, an indicator we developed that helps us set the proper long/short weightings has been turning down in recent days. While it will take many more days for this indicator to provide a net-short signal, we would expect a continued down market should continue to help the model portfolio as "low-quality" stocks pull back significantly more than "high-quality" stocks.

For a list of the "low-quality" stocks that may drastically underperform over the next few weeks if the market corrects, readers can download a pdf of the latest Ascendere Long/Short Model Portfolio list, as well as a look at back-of-the-envelope model portfolio performance attribution. A pdf of this report is also available.

Disclosure: No positions