Monitoring John Paulson’s Top Holdings

I have written an exclusive article for Seeking Alpha regarding Hedge Fund Manager John Paulson and his top positions.  His largest position by far is gold via the GLD ETF. The full article can be viewed here.

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Disclaimer: No current positions in stocks mentioned. Please note that Scott’s Investments is not a financial adviser. Please consult your own investment adviser and do your own due diligence before making any investment decisions. Please read the full disclaimer at the bottom of Scott’s Investments.

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Read more on John Paulson at Wikinvest

Wednesday Investment Readings

How and When to Buy More Gold and Silver – Chris Vermeulen

The King Report: Parsing the Fed – Bill King, courtesy of The Big Picture

Macro Tides: How Much Longer?

The Road Ahead: Is it Inflation or Deflation? (pdf) Pring Turner Capital Group

Textbook Bear Flag: S&P 500 Target Under 1,000 Explained – The Disciplined Investor

Roque on Gold’s Pullback (courtesy The Big Picture)

Catastrophic Success (pdf) – John Mauldin

Absolute Zero (pdf) John Mauldin

Not Over by a Longshot – John Hussman

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Disclaimer: No current positions in stocks mentioned. Please note that Scott’s Investments is not a financial adviser. Please consult your own investment adviser and do your own due diligence before making any investment decisions. Please read the full disclaimer at the bottom of Scott’s Investments.

More on this topic (What's this?)
Has Gold & Silver Finally Bottomed?
Read more on King, Gold at Wikinvest

7 Low PEG, High Momentum Stocks

Each month I update a fundamental/technical screen at Scott’s Investments and track the results real-time. August’s list of 5 stocks is here and the performance of the list as a whole is a perfect example of the pitfalls in blindly investing in a screen or investing with no risk management strategy.  

Giant Interactive (GA) was on last month’s list and declared a special dividend of $2.99 that went ex dividend September 12th. Despite this dividend, the stock was down over 36% (including the dividend) during the last month’s screen until today.  One method for avoiding a significant drawdown  is to use a stop loss, typically set 5 – 20% below your purchase price.  The size of the stop loss depends on your risk appetite, the volatility of the underlying stock, and timeframe.  A stop loss does not guarantee your losses will be limited at your stop price level, as stocks can gap down (typically on the open) and open below your stop price level. Nevertheless, it is one of the most common methods for risk mitigation.

The screen looks for the following:

  • earnings growers still reasonably priced as judged by the PEG ratio 
  • low debt 
  • a history of high return on equity and investment, and 
  • price momentum as gauged by the percentage the stock is trading to its 250 day high. 
  • The stocks are then ranked based on fundamental factors as compiled by stockscreen123.

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Seven stocks qualify for this month’s list.   Apple (AAPL) remains number one on this month’s list because of its technical momentum, absence of debt, a PEG ratio of .70, a 5 year average ROE of 31.92%, and 5 year average ROI of 28.48%.  The Jobs resignation could take time to affect the material operations of Apple. It is too early to say if it will have any significant material impact, so until the numbers and momentum say otherwise, Apple remains on the top of this month’s list.

Wet Seal Inc. (WTSLA), an apparel store for women, is a repeat stock on this list and one I highlighted in depth last month.  It is a stock worth watching as it continue to make higher lows and has a long-term channel that is beginning to hit resistance around $5.25.  I expect to find resolution soon, and the two levels to watch here are $5.25 and the bottom of the channel, as we can see in the weekly chart below:

Below is the entire list for this month. It is worth noting that all of the names for this month have made prior appearances on the list:

Ticker Name Overall Ranking MktCap PEGLT DbtTot2EqQ
AAPL Apple Inc. 92.22 373775.19 0.7 0
WTSLA The Wet Seal, Inc. 82.06 419.85 0.87 0
NSR Neustar, Inc 79.6 1855.1 0.76 0.01
INTC Intel Corporation 77.33 116782.2 0.88 0.04
AZO AutoZone, Inc. 73.13 13595.27 0.91 0
NVEC NVE Corporation 65.14 296.08 0.77 0
DECK Deckers Outdoor Corporation 49.97 3852.41 0.89 0

Disclaimer: No current positions in stocks mentioned. Please note that Scott’s Investments is not a financial adviser. Please consult your own investment adviser and do your own due diligence before making any investment decisions. Please read the full disclaimer at the bottom of Scott’s Investments.

Explaining Gold’s Move & Some Perspective on Gold Miners

Ben Bernanke’s announcement last week of Operation Twist, the strategy of selling short term treasury holdings and purchasing longer term treasuries in an effort to lower long rates, coincided with a sharp selloff in Gold.  The US Dollar also strengthened last week, with UUP, the Powershares DB US Dollar Index Bullish ETF, finishing the week up 2.12% and up 5.61% the past month.

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Given the nature of Operation Twist, I began by asking what correlation, if any, does the dollar or US Treasury interest rate spreads have on Gold?  One way to analyze the relationship between Gold and interest rate spreads is to look at the correlation between GLD and FLAT, the iPath US Treasury Flattener ETN, which I first featured earlier this month.  FLAT seeks to replicate the inverse performance of the Barclays Capital US Treasury 2Y / 10Y Yield Curve Index.  In other words, a flattening of the 2 year/ 10 year yield curve results in FLAT moving higher.  This flattening occurs when either 2 year yields move higher or 10 year yields move lower, or a combination of both.

Since FLAT began trading in August 2010, we see that FLAT and Gold (via the ETF GLD) have had a wide correlation range and is currently near the high of its range:

Given that there has been no consistent correlation between the two assets, it is difficult to base a future investment decision in gold solely on a flat 2y/10y yield curve.  However, long term interest rates still hold valuable information on the direction of gold.

As John Hussman detailed here, huge and sustained upward moves in gold are driven by worldwide inflation or a plunging US Dollar:

The price of an ounce of gold in U.S. dollars is measured as $/ounce of gold. In foreign countries, the price of an ounce of gold is measured as FC/ounce of gold (where FC denotes “foreign currency”). The exchange rate between the U.S. and foreign countries can be written as $/FC. That’s the price (in dollars) for 1 unit of foreign currency. Now, since gold is easily transportable, it obeys the “law of one price”. That is, the price in dollars is the same as the price in foreign currency, after currency translation:

$/ounce of gold = $/FC x FC/ounce of gold.

Stare at that equation for a minute. Any time you see the price of gold rise, one of two things must be true. Either the foreign price of gold (FC/ounce of gold) has increased, or the value of the dollar must have declined (i.e. foreign currencies have become more expensive, and $/FC has increased).

What have we seen since Quantitative Easing began? Global inflation, driven by accommodating monetary policy and rising agricultural prices, and a falling US Dollar, which has the circular effect of causing global inflation since most commodities are priced in Dollars.

Gold, via the ETF GLD, and a bullish US Dollar (via UUP) have, for the most part, had a negative correlation the past four years, although it has not been a perfect relationship:

When the dollar rallies, it can adversely impact the price of gold.  A rally in the dollar can be caused by many things, but the primary driver (see Hussman article) is long-term real interest rates. He defines real rates as long-term interest rates minus long-term inflation expectations.  When long-term real rates decline, the dollar typically declines.  An increase in long-term real rates typically leads to an increase in the dollar. Thus, a decline in long-term real rates makes the dollar less attractive, increasing the likelihood of rising gold prices.

As we see below, TLT (iShares Barclay 20+ Year Treasury Bond ETF) has been in rally mode since August, meaning long term nominal rates have been falling (chart courtesy of Finviz):

As we saw this past week a rally in the dollar can also coincide with falling interest rates. Using Hussman’s definition of real long-term rates, if nominal long-term rates are falling and the dollar is rising, this implies long-term inflation expectations have decreased.

If investors expect a soft economy for sustained periods of time, and Operation Twist helps to reinforce this thesis, then inflation expectations are muted. Inflation expectations and the dollar may have also been impacted by Europe’s financial woes, which have accelerated in recent weeks as has the potential for a global economic shock.  As Euro holders sell their Euros, they are exchanged for US dollars and other currencies.   On Thursday we saw a large spike up in the dollar and long-term US Treasuries, which coincided with a huge decline in gold and GLD and preceded an even larger drop on Friday (chart courtesy of Finviz):

Where does this leave Gold investors or prospective investors?  Investors need to decide if they are bullish or bearish on long-term treasuries & inflation expectations (real interest rates), the US economy, and the US Dollar, as these will be key drivers of gold prices.  There will be many global fiscal and monetary announcements/initiatives/plans announced in the coming days, weeks, and months.  This makes projecting long-term interest rates, inflation, and currency movements a Herculean task.

For investors wanting exposure to gold, GDX (Market Vectors Gold Miners ETF) or specific mining stocks may be a better option today.  I have detailed numerous times on Scott’s Investments the relationship between gold prices and miners.  In July I wrote that conditions were favorable for the miners, although not yet “optimal”.  I have no personal desire to see a contracting economy, but the optimal setup for gold mining stocks would be for the Purchasing Managers Index (PMI) to have a reading below 50, indicating a contracting economy.  The latest reading was 50.6.

The ratio of gold to the Gold &Silver Index (XAU) is at levels not seen since the crisis of 2008, a bullish sign for the miners in relation to the price of gold.  In other words, when this ratio is overextended, I expect miners to outperform gold. Falling Treasury bond yields and rising inflation have also historically been bullish indicators for gold mining stocks.

The miners still have a high correlation to the price of gold, so it is useful to determine your stance on the underlying commodity and some technical entry points.  As I already mentioned, predictions in a market littered with fiscal and monetary initiatives and interventions can be a frustrating task.  Nevertheless, Dave Banister stated last week The first area to watch is the re-test of $1702 spot pricing for a C wave low, but the evidence is for a further drop to $1643 before I would get too interested in trying to game Gold to the upside. He has been hitting his gold predictions fairly well this year and given that gold touched $1643 on Friday it is possible that we may be due for a bounce.

If spot gold cannot hold its low last week of $1632 then I think a retest of the $1555-$1575 level is likely (which corresponds to roughly $151-$153 on GLD):

The magnitude of the sell-off in gold and silver this past week was enormous.  In the short-term anything is possible, but I think a long-term continuation of gold’s upward trend is still possible. If this upward trend resumes, the most profitable angle is gold mining stocks. I am happy to wait for confirmation of a reversal in gold and mining stocks rather than trying to “catch” the bottom.  Given the nature of today’s world and the possibility of dramatic volatility in any asset class, investors and traders should always have risk management and capital preservation as their first priority.

Disclaimer: No current positions in stocks mentioned. Please note that Scott’s Investments is not a financial adviser. Please consult your own investment adviser and do your own due diligence before making any investment decisions. Please read the full disclaimer at the bottom of Scott’s Investments.

Stocks to Watch This Week

Equity markets had a rough week this past week with SPY (SPDR S&P 500 ETF) closing the week down 6.77%.  Last week we had 15 stocks to watch, which was on the heels of an outstanding week for equity markets.

This week we only have 2 stocks 2 ETFs, and 1 closed-end ETF on the watch list.  The list is comprised of stocks which traded at a 52 week high on Friday on strong volume and is generated using Finviz.  It is a useful tool for finding future potential investment or trading opportunities.

The list of five is below. It is worth noting that Goodrich (GR) has agreed to be bought out by United Technologies (UTX), so at this point it should considered more of a “special situation” than a momentum candidate:

Ticker Company 9/23 Update Industry
AFB AllianceBernstein National Municipal Income Fund, Inc Here Closed-End Fund – Debt
BOM PowerShares DB Base Metals Dble Shrt ETN Here Exchange Traded Fund
GR Goodrich Corp. Here Aerospace/Defense Products & Services
ITM Market Vectors Intermediate Muni ETF Here Exchange Traded Fund
MXWL Maxwell Technologies Inc. Here Diversified Electronics

Maxwell Technologies (MXWLdevelops, manufactures, and markets energy storage and power delivery products, and microelectronic products. It currently has no earnings but is projected to have a forward P/E of 33.24.  It has little debt and has shown earnings and sales growth the past year.  Its EPS growth this year is 75.36% and 33.71% the past 5 years.  Sales have grown 21.82% annually the past 5 years.  The company is projected to grow EPS at 27% the next 5 years.

The company has a high short ratio of 15.88 and short float of 12.92%, so the move to a 52 week high could be based in part on a short squeeze, where shorts are forced to buy the stock to cover their short position.  From the first to second quarter of this year AlphaClone states that funds increased their holdings from 5.8 million to 6.4 million shares and funds in their database currently hold 31.1% of the company.

The stock does not look overly extended on a daily chart; however, as you will see on the second (monthly) chart there is still some overhead resistance to the stock moving dramatically higher:

The bottom line is that using a 52 week high screen when the market is struggling can be a frustrating endeavor, but could lead to a few select ideas.  This is a difficult market for investors to find stability as the market has been anything but stable since July.  Stocks bucking the technical trend, especially those stocks with strong balance sheets, could be worth a long-term look on a short-term pullback but risk management and preservation of capital should always remain priority number one.

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Disclaimer: No current positions in stocks mentioned. Please note that Scott’s Investments is not a financial adviser. Please consult your own investment adviser and do your own due diligence before making any investment decisions. Please read the full disclaimer at the bottom of Scott’s Investments.

Investment Readings

Below are a few investment articles for Friday and through the weekend:

Gold and Silver Stocks – Frederick Sheehan courtesy of The Big Picture

Grantham: ‘No market for young men’ – MarketWatch

Preparing for a Greek Default – John Hussman

Recent Market Trends Remain in Place – Get Positioned! Chris Vermeulen

Implied Volatility: A Better Way to Gauge Risk – Geoff Considine

Twist and Shout? (pdf) John Mauldin

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The S&P 500, Dow & The Dollar Ahead of the Fed Statement

I will be taking some time away from the computer this week so posting may be light.  However, JW Jones of Options Trading Signals has a great article below detailing his projections and technical analysis of the S&P 500, Dow and US Dollar (UUP):

“The Federal Reserve is holding a two-day meeting Tuesday and Wednesday of this week. Market participants are expecting the Federal Reserve to prop up financial markets yet again with some grand new plan. The fact is the Federal Reserve is running out of bullets.

Interest rates cannot move much lower in terms of the Federal Funds rate, additional quantitative easing seems redundant since Treasury yields are close to all-time lows, and finally a twisting of maturities will do little to alter the current economic conditions. The Federal Reserve is just repeating practices which have proven over a long term do little to create jobs or get the economy moving in the right direction. A stock market rally does not help a person looking for a job!

It is possible that even if the Federal Reserve proposes additional stimulus the market could sell off. I have been trading less in this environment and have been focusing on looking for trade setups that could work regardless of price action. For now I am sitting predominantly in cash waiting to see how price action reacts to the news flow tomorrow.

S&P 500
If I had to guess, I continue to believe that the S&P 500 will get back to test the key 1,250 – 1,280 price level. While this resistance level is apparent, Mr. Market will be able to tear up traders if price jams into that resistance zone. Mr. Market loves nothing more than to shake people out of positions. If price works higher I would expect the 1,250 – 1,280 price range to offer just enough risk / reward to get investors and traders involved in a choppy trading environment. The key upside levels on the S&P 500 are shown below on the daily chart of the S&P 500 Index ($SPX):

The flip side of that argument would see the S&P 500 jamming into recent resistance around the 1,230 price level. If prices rolled over and momentum picked up, a test of the recent August lows would likely transpire and could produce a breakdown and a lower low.

When looking at recent price action, the S&P 500 Index has put in a series of higher lows which is a bullish signal, however the S&P 500 has a long road ahead to break out above the 2011 highs. If the S&P 500 carves out a lower high on the S&P 500 Index at 1,230, 1,250, or even 1,280 and subsequently takes out the August lows then the secular bear will be back. The weekly chart of the S&P 500 Index ($SPX) shown below illustrates key support levels:

For now I am just going to sit in cash and wait for Mr. Market to provide me with some better clues. The trading range is pretty wide going from around 1,100 to 1,280. What I will be watching for is a strong move supported with volume that pushes price out of this range. As of the close today, price action was trading around the middle of this range but depending on how price action reacts to the news that comes out Wednesday it is possible that in coming days we could see a breakout in either direction.

Dow Jones Industrial Average
It will likely surprise long time readers that I am actually going to comment on the Dow. I will keep this brief, but I wanted to point it out to readers as I have not heard much mention of this pattern in the main stream financial media.

Over the weekend I was looking at some longer term charts and I accidentally stumbled across this head and shoulders pattern on a weekly chart of the Dow Jones Industrial Average. I rarely pay much attention to the Dow as I monitor the S&P 500 closely. However, I could not ignore what I was seeing. I also noted that a similar pattern also exists on the S&P 500.

I am generally not the kind of trader who tries to predict where price action will arrive in the distant future. However, I am not going to ignore clear chart patterns that I recognize regardless of the time frame I am looking at.

For those not familiar with a head and shoulders pattern, it is a very ominous signal. Head and shoulders patterns are generally topping formations that if triggered result in violent selloffs. On this chart the pattern is obvious and if the pattern were triggered the forthcoming price action would be decisively negative for domestic equities. The long term monthly chart of the Dow is shown below:

If the pattern is triggered on an undercut of the March 2009 lows, the head and shoulders formation would produce selling pressure that would target the 3,800 – 4,000 level on the Dow. Yes, you read that right! I want readers to recognize that this pattern is not a given and it could play out over a long period of time. The pattern would suggest that a test of the 2009 lows is possible, but I will leave the likelihood of that test up to Mr. Market.

I view this pattern as a potential warning signal for long term equity positions. Consequently, it is far too early to jump into a plethora of short positions or sell every equity position owned simply because of this pattern. While I do not know where price goes from here or if this pattern will ever trigger, I think market participants should be aware of its existence.

It would take the perfect concatenation of events to push prices down to the March 2009 lows, but unfortunately the condition of social mood paired with all of the risks facing financial markets is notable. The recent selloff in August came on the heels of a head and shoulders pattern that was triggered. We all know how August played out, but this pattern on the Dow Jones Industrial Average has a long way to go before it can even trigger. Time will tell, but readers should at the very least put this chart pattern on your radar!

U.S. Dollar Index
The U.S. Dollar Index has ripped higher by more than 5% since August 29th. The strength in the Dollar has likely been precipitated by fear based on the European sovereign debt and banking crisis. While the Dollar certainly has long term flaws, it may simply be the best of the worst.

If the situation in Europe begins to break down further based on any number of events it could likely push the U.S. Dollar Index considerably higher. My trading partner Chris Vermeulen has been riding this strong impulse wave with his subscribers Swing trading the UUP etf and thinks there is big potential still if Euro-Land fears continue to rise.

The daily chart of the Dollar Index futures is shown below:

Mid-Week Market Trend Conclusion
Wednesday will be filled with a variety of news and headlines. The Greek government is meeting and a news release regarding the conference will likely come out around the time domestic markets in the United States open. The news has the potential to move markets considerably.

In addition, the Federal Reserve is set to end its September meeting and market participants will be sitting on the edge of their seats waiting to hear from the Federal Reserve about any stimulus the central bank may provide.

Overall, the news and headlines on Wednesday will certainly impact the current conditions of financial markets. Right now I am pleased to be sitting primarily in cash. I have a few positions open, but for the most part the trades are not directional and are profitable based on time decay.

The one directional trade I have on presently is a remaining sliver of a position I have already taken profits from and stops are in place. While I have been risk averse the past few trading sessions, I am flush with cash and ready to accept new risk if high probability setups emerge.

However, the best trade can sometimes be no trade at all and I intend to remain patient. Risk is extremely high!

Subscribers had over 100% return in August and already up over 50+% for September!

Review my track record and join now at Options Trading Signals and receive a 24 hour 66% off coupon.
-JW Jones”

Disclaimer: No current positions in stocks mentioned. Please note that Scott’s Investments is not a financial adviser. Please consult your own investment adviser and do your own due diligence before making any investment decisions. Please read the full disclaimer at the bottom of Scott’s Investments.

Stocks to Watch This Week

Each weekend I publish a weekly “Stocks to Watch” list on Scott’s Investments.  The list is not a blanket buy recommendation, but is a way to generate potential future investment or trading ideas.  The list is generated using Finviz and looks for stocks hitting 52 week highs on Friday on high relative volume.  Since the US equity market has struggled in recent weeks, recent lists have been sparse.   

US equity markets had an outstanding week this past week, so the “Stocks to Watch List” is larger than previous weeks.   There are several noteworthy names on this list, the largest being (AMZN).  AutoZone (AZO), Hansen Natural Corporation (HANS), and Whole Foods Market (WFM) are three other noteworthy names on the list.  PriceSMart (PSMT) is a stock which has made several of my “Stocks to Watch” lists, most recently discussed on the 5th, and appears on this weeks list.  It has institutional support and The Benchmark Company upped its price target to $87 on September 14th.

I typically use this list to find stocks that have attractive valuations or growth stories (in addition to the strong trend).  Akorn (AKRX) manufactures and markets diagnostic and therapeutic pharmaceutical products, hospital drugs, and injectable pharmaceuticals.   The company looks attractive using technicals and fundamentals.  It currently trades at a PEG ratio of .71 and has a strong balance sheet with a quick ratio of 8.49 and current ratio of 9.96.   It has shown EPS growth this year 178.42% and is projected to growth EPS the next 5 years at 25.5% annually.  The company has a return on assets of 31.26%, return on equity of 53.39%, and return on investment of 34.05%.

According to AlphaClone, 7 funds bought into the stock for the quarter ending 6/30/11 (0 sold out).  Twenty-three increased their position in the company while three decreased their position, so the company has institutional support.  From a technical perspective, the stock has been in an upward channel since March:

Below are the 15 stocks qualifying for this week’s list:

Ticker Company Industry Daily Market Updates Market Cap Price
ACFN Acorn Energy, Inc. Computer Peripherals Here 98.11 5.6
AKRX Akorn, Inc. Drugs – Generic Here 857.44 9.06
AMZN Inc. Catalog & Mail Order Houses Here 108627.84 239.3
AZO AutoZone Inc. Auto Parts Stores Here 13766.75 331.25
CASY Casey’s General Stores Inc. Grocery Stores Here 1810.32 47.59
DMND Diamond Foods, Inc. Processed & Packaged Goods Here 1922.35 87.3
EBIX Ebix Inc. Business Software & Services Here 663.63 17.73
HANS Hansen Natural Corporation Beverages – Soft Drinks Here 8160.95 92.11
INSP InfoSpace Inc. Internet Information Providers Here 374.25 9.81
LQDT Liquidity Services, Inc. Internet Software & Services Here 942.96 33.32
NDN 99 Discount, Variety Stores Here 1443.25 20.46
PSMT PriceSmart Inc. Discount, Variety Stores Here 2191.07 73.28
SIMO Silicon Motion Technology Corp. Diversified Electronics Here 417.56 13.5
SUI Sun Communities Inc. REIT – Residential Here 858.28 39.92
WFM Whole Foods Market, Inc. Grocery Stores Here 12234.97 69.05

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Disclaimer: No current positions in stocks mentioned. Please note that Scott’s Investments is not a financial adviser. Please consult your own investment adviser and do your own due diligence before making any investment decisions. Please read the full disclaimer at the bottom of Scott’s Investments.

Mid-Month ETF Review, Gold Still Strong

Every month I publish an portfolio comprised of 4 ETFs.  This month’s current holdings are GLD (Gold), IEF (iShares Barclays 7-10 Yr Treasury), PCY (Emerging Markets Bond), and DBA (PowerShares DB Agricultural Commodities).  The portfolio is up 12.13% year to date, bolstered by its position in GLD, which has been partially offset by DBA’s recent poor performance.

I update the portfolio after the close of the month; however, I frequently provide mid-month reviews for informational purposes or for those interested in re-balancing more frequently.  The holdings in the portfolio are based on the relative strength of a basket of 25 ETFs.  It holds the top 2 ranked ETFs based on the average of their 3 month returns, 20 day returns, and 20 day volatility (what I call “3/20/20”) and holds the top 2 ranked ETFs based on the average of their 6 month returns, 3 month returns, and 3 month volatility (“6/3/3”).  

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As of September 16th, the top 2 ETFs based on 3/20/20 rankings are IEF and XLU (U.S. Utilities).  the top 2 ETFs based on 6/3/3 rankings are IEF and PCY.  Since the portfolio I created always holds 4 ETFs, when they are duplicates in both rankings I look to the third ranked 3/20/20 ETF, which is PCY.  Thus, since PCY is a duplicate, I look to the third ranked 6/3/3 ETF which is GLD.  Therefore, if an investor were to re-balance at the end of this past week, the portfolio would consist of IEF, XLU, PCY, and GLD.  In other words, DBA would be sold and XLU purchased.

Utilities have performed well of late, as followers of my High Yield High Momentum Portfolio may have noticed.  This months’ high yield momentum stocks is largely comprised of Utility stocks.  

How has this strategy performed historically? Below are backtest results, which include dividends but exclude commissions, taxes, and slippage.

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The backtest is not identical to the strategy I employ. The difference is that the backtest does not always hold 4 ETFs – if the top 2 ETFs in the 6/3/3 and 3/20/20 rankings are the same, then the backtest holds only 2 ETFs.   However, the two strategies are similar and there are months when both the backtested strategy and the one I track will hold identical positions.

The first backtest are based on a monthly rebalance beginning in 2005:

The second test is are based on a semi-monthly rebalance:

Both backtests show strong results with low volatility across a variety of multiple market conditions.  A more frequent rebalance period will increase commissions costs, thereby decreasing returns (taxes should also be considered).  Bear in mind that historical success does not guarantee future gains…

Disclaimer: No current positions in stocks mentioned. Please note that Scott’s Investments is not a financial adviser. Please consult your own investment adviser and do your own due diligence before making any investment decisions. Please read the full disclaimer at the bottom of Scott’s Investments.

Nine Small Cap Stocks With Positive Earnings Trends

Each month I search for small cap stocks priced reasonably based on price to earnings growth (PEG) and that have a recent history of positive earnings surprises. I use  stockscreen123 as the tool for this particular screen.  The basic premise of the list is that stocks with a history of earnings surprises have the strong probability of positive earnings surprises in the future.  If the stocks are already trading at favorable valuations, then continued earnings surprises could mean that the stocks below are undervalued.

Last month‘s list performed very well, up 5.21% for one month versus 1.64% for SPY over the same period.  The list tends to be high beta and could be more volatile than the overall market.  However, it is not a comprehensive portfolio but rather a starting point for further research and an attempt to uncover some “hidden” gems.  

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Using the identical parameters I screen each month, the strategy has performed well historically.  The 5 year and 10 year performance are charted below. The screen results exclude commissions and taxes. It also limits positions sizes to 10%, in months when less than 10 stocks qualify:

Datalink (DTLK) remains attractively priced as I highlighted last month.  Resistance remains around $11, with the stock closing at $10.21 today.

GSI Group Inc. (GSIG) designs, develops, manufactures, and sells precision motion control devices and associated precision technologies, photonics-based solutions, and semiconductor systems.  It has broken the trading channel between $10-$14 it had been trading in since late 2010 and is down over 10% in a month.  However, the company trades at a forward P/E of 8.38 and price to sales of .82. The company announced second quarter earnings in August, with revenue of $101.4 million, an increase of 18% over the same period a year ago.  Earnings per share for the quarter were $.30 versus a loss of $(.32) a year ago and Adjusted EBITDA was $19.4 million. The company has cash and cash equivalents of $74 million and $34.1 million in net debt.  The company maintained annual guidance of $375-$385 million in revenue and Adjusted EBITDA of $68 million to $73 million.

According to AlphaClone, institutional holdings have increased for GSIG for the quarter ended 6/30/11.  Royce & Associates is currently the largest institutional holder with over 1.5 million shares. Ten funds bought into the stock for the quarter, zero sold out, and 17 increased their position while 2 decreased their position during the quarter.

Chart courtesy of Finviz:

Ticker Name Rank MktCap ProjPECurFY PEGLT
LABL Multi-Color Corporation 97.49 351.49 11.54 0.77
LAD Lithia Motors, Inc. 96.83 445.46 9.17 0.35
SUSS Susser Holdings Corporation 96.29 399.22 10.98 0.95
CRD.B Crawford & Company 96.11 286.29 8.47 0.56
DTLK Datalink Corporation 95.08 178.82 13.97 0.7
GSIG GSI Group Inc. (USA) 92.35 282.89 8.95 0.72
EXLS ExlService Holdings, Inc. 81.42 684.74 17.61 0.95
CBM Cambrex Corporation 80.05 153.05 10.83 0.89
SIMO Silicon Motion Technology Corp. (AD 74 387.35 12.41 0.62

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