Investment Models

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by: Jeffrey Saut

Having missed most of the bull market over the past nine years, a great many investors have pronounced that we are now, at last, in a bear market. I do not know. What I do know is that our companies are doing better than I could have ever hoped, their current prices seem reasonable, and their futures look very bright.

. . . Frederick "Shad" Rowe, Greenbrier Partners, June letter

Our friend Shad goes on to write in his June letter:

As bulls and bears battle it out, stock market volatility increases, rattling our teeth and shaking our brains, we go over again and again what we are trying to do. As we have repeated ad nauseam, we attempt to invest at reasonable prices in publicly traded companies that conduct their businesses better, faster, and cheaper than their competition and whose primary motivation is to do things for rather than to their customers. We also look for that something extra that sets our companies apart. That something extra is company culture.

Of interest is that in Shad's "investment model" 95% of his portfolio is in just 12 stocks. We call that "concentration," and I actually like concentration. Concentration is how you get rich! Diversification is how you stay rich. You can look at just about any billionaire and see that's how they got rich, by being "concentrated" with their investments. My own approach to investing is actually quite simple.

Personally, I start with a base position of actively managed mutual funds, but not just any fund. The funds I want to own are the ones where I know the portfolio manager. Importantly, I don't monitor the price of funds I own, except at tax time, because I'm confident over the long run my pal Tom O'Halloran at Lord Abbett, who manages the Lord Abbett Growth Leaders Fund, is going to make me money. A couple of other such names would be my friend Mary Lisanti, who manages the Lisanti Small Cap Growth Fund, and Amy Zhang, who manages the Alger Small Cap Focus and the Alger Small Cap Growth Strategies funds. If you want to be impressed, check out Mary and Amy's performance year to date.

So, for my own investments, I start with a base of mutual funds, but because I talk to these boys and girls that have to put money to work, I hear a bunch of good ideas. Now in a past life I have been on a trade desk, a stockbroker, analyst, portfolio manager, director of research at five different firms, and the head of capital markets at three firms. Accordingly, when Ron Baron (Baron Capital and one of the best stock pickers I know) gives me an idea, I can spend some time on Factset looking at the technicals, fundamentals, ownership, etc. and decide if I want to start buying the stock. And that, ladies and gents, is how I attempt to add alpha (read: outperformance). As stated, my personal approach to investing is really simple, but it works.

Moving on to the equity markets, as we wrote in last Friday's Morning Tack:

The intermediate-term model remains on a "buy signal," while the short-term model is basically trendless, implying what we have been through is just a normal/standard retracement move despite the recent downside "heart attack." As often written, following a stock market heart-attack the equity markets typically need to convalesce for a few sessions before regaining their poise; and, it manifestly has been a few sessions. Looking at the "internal energy" model shows there is plenty of energy to make a rally attempt have a sustained "leg" to the upside. Accordingly, it would be surprising to Andrew and me to see the SPX comeback down to yesterday's intraday low of 2691.99.

Our work suggests the equity markets are gathering enough energy, and momentum, to permit a dash to new all-time highs and then keep right on pushing higher. Interestingly, almost NOBODY is expecting this to occur. Most continue to look for a decline, or at best a range-bound stock market. We do not believe it, but must admit we were surprised by the additional tariff news and the concurrent stock market one-session "heart attack," which interrupted the upside rhythm of the market we had expected. However, that heart attack is now in the rearview mirror.

Plainly energy stocks, and crude oil prices, were in the forefront of last week's trading as WTI crude leaped 8.08% (spot month). Readers of these missives know that for many months we have been favorable on the energy complex and have recommended tilting portfolios accordingly (Chart 1). Over the weekend President Trump tweeted that he has asked Saudi's King Salman to increase oil production by some two million barrels a day. Therefore, it will be interesting to see how crude oil prices act. If oil prices decline, with a concurrent decline in share prices, there are two stocks that are favorably rated by our energy analysts and screen well on our algorithms: Occidental Petroleum (OXY/$83.68/Outperform) and Marathon Petroleum (MPC/$70.16/Strong Buy) are offered for your consideration.

Turning to earnings, as we approach yet another earnings season, we believe the same folks that told us 1Q18 represented "peak earnings" are going to be proven wrong once again. Just look at the attendant chart of the spread of the percentage of companies raising, versus lowering, forward earnings guidance (Chart 2). As our friend Bob Pisani notes, "S&P 500 earnings are not peaking yet. Quarter 2 estimates earning to be up 20.3%, Q3 up 23.1%, and Q4 better by some 20.1%." Another thing we will be watching closely will be the U.S. Dollar Index (DXY/94.47), which looks to us as if it attempting to stage another leg to the upside (Chart 3).

The call for this week: While it didn't happen last week the recent new all-time highs in the small/mid-cap indices, as well as the Advance/Decline Line, indicate the bull market is alive and well. Moreover, as the indispensable Lowry Research Corporation writes:

At the time of the June 12th high, Buying Power was at a new recovery high while Selling Pressure was at its lowest level in over 70 years, indicating a healthy expansion in Demand and contraction in Supply. Short-term Demand was also strong, as our Short Term Index reached its highest level since early 2011. And, as of the June 12th high, measures of market breadth all indicated a healthy primary uptrend. Not only was our Operating Companies Only (OCO) Adv-Dec Line at a new all-time high, but the OCO and S&P Large, Mid and Small Cap Adv-Dec Lines was each at a new all-time high. In fact, the OCO and S&P Mid and Small Cap Adv-Dec Lines recorded new all-time highs again on June 20th.

Monday morning, however, the preopening S&P 500 futures were off some 13 points at 5:31 a.m. due to: DJT's EU sanctions over Iran tweet, Canada's retaliatory tariffs, Germany's Merkel possible fall; and Obrador, an anti- DJT Marxist is set to win the Mexican presidency.

Chart 1

Source: The Chart Store

Chart 2

Source: Bespoke Investment Group

Chart 3

Source: Bespoke Investment Group