New highs for the major averages last week didn't help my portfolio much. I'm still down 1/4% for the year to date. My model continues to find fewer and fewer stocks to buy because valuation is so poor. Earnings continue to plug along and unemployment is OK, but sentiment is somewhat negative and valuation is way out of line. Layered on the normal market uncertainties is a political background that is like a roller coaster ride. For more on the current administration, I would highly recommend the current week market letter at husmanfunds.com. I haven't given up but I think caution is warranted.
Since soon after the election, I have been giving the poor valuation statistics the benefit of the doubt, thinking that a substantial reduction in the corporate tax rate would improve the situation going forward. However, given the uncertainty of what President Trump will do - especially with regard to trade policy, I have gone back to more traditional valuation measures. That doesn't mean a big difference but I am still holding a good sized cash position. My screen this week holds 14 names out of a potential 20. So everything remains pretty much the same: Earnings estimates are showing increases as we go through time and the unemployment rate is low. Valuation remains poor and sentiment is also poor so the current correction could have farther to go.
I have a small problem with my data provider so I cannot reproduce last week's chart extension into this week. Hopefully, there will be corrections coming up. Fortunately, nothing much has changed. Earnings estimates and unemployment are favorable, while sentiment has improved a bit. Valuation still remains a significant problem and accounts for the number of holdings in my portfolio being less than 20. My model suggests holding some cash and waiting for better prices.
I'm going to change things up just a bit for 2017. I will be hedging only when there are specific reasons to expect weakness - either an increasing unemployment rate or decreasing earnings expectations for the coming year. In the two year chart above, there were two instances when I would have been hedged, represented by the decline in cash invested to zero. I am unable to show the exact performance during hedged periods but zero would be a good approximation. I am also going to change my requirements to buy so that, during periods of unfavorable valuation, I want a higher rated company than at other times. Currently, that is the case so I am holding 13 stocks in my model instead of 20, resulting in a current cash position of about 35%. Valuation could get even worse, thus resulting in even more cash being held. There are several factors at work now including both valuation and sentiment that would lead me to believe we will have a period of decline or consolidation. I am holding stocks that should do better than average if my fears are realized.
2017 promises to be an interesting year politically as well as economically. Investors have priced in a good year with some sizable corporate tax cuts thrown into the mix. So far, I don't see any reason why that optimistic vision can not occur. However, the situation is going to be volatile. I continue to watch earnings estimates and the unemployment rate, both of which look positive. Valuation is poor but not prohibitive if the tax cuts get passed. I am working on a more restrictive model that requires stronger stocks when valuation is poor and hope to have that next week. Sentiment is still mixed but tilting negative as small investors and speculators are mainly optimistic. My model remains at a 60% net long exposure to equities at this time. Best wishes for a healthy and happy New Year!
Richard Moore, CFA
With my wife in Hawaii