For the first time this year my model portfolio has taken a lead over the Russell 2000 as of last week. No, it is not a tremendous lead but it's a start and I might as well enjoy it while it lasts. Smaller stocks like KMG have really helped. Valuation, of course, got even worse last week but it is still not bad enough to take a hedged position because I am adjusting for an expected substantial cut in corporate tax rates. Currently, it would take a move in the Russell 2000 to 1450 or more to make me adopt a hedged position. Earnings estimates continue to increase, especially now as the first quarter is reported and analysts look out to the first quarter of 2018. Sentiment has gotten a bit worse also but it is still considered neutral. Absent a foreign shock to the system, the market should be able to work its way higher.
This has been a schizophrenic market this year and last week was no exception. It was a good week for smaller stocks and for my model but I'm not able to add any alpha so far in 2017. I'm moving right along with the Russell 2000 which, for the moment is up a couple percent year to date. It really wouldn't matter much if I was hedged and I would be if I were not adjusting the poor valuation for what I hope will be a substantial cut in corporate tax rates. Hopefully, we will find out more about tax plans this week. Everything else that I look at is still basically the same. Earnings estimates are slowly increasing as we go through the year. The unemployment rate is low and stable. Sentiment factors are mixed and neutral.
The broad market as measured by the Russell 2000 is gyrating but going nowhere. My portfolio got hit last week and brought it down to below breakeven year to date along with the Russell. A major bear market is not likely unless we see some deterioration in the earnings outlook but that doesn't mean we could not have a sharp correction based on the continuing high valuation. I am giving the market the benefit of the doubt based on expectations of a significant corporate tax cut and, hopefully, it will happen. Sentiment is still a modestly negative factor although some indicators improved last week. My model is still fully invested in stocks.
I think going nowhere is about all that can be expected given the high levels of valuation currently but, as long as earnings expectations hold up and unemployment looks good, I don't look for a new bear market. All bets are off, of course, if WW3 begins. Sentiment remains neutral now and there is always the prospect of a large corporate tax cut to keep the bulls happy. My model remains fully invested.
Changing leadership, almost on a weekly basis, favored small stocks last week and my portfolio benefited accordingly. The botched health care repeal has faded from view and the optimism surrounding tax cuts still remains. Valuation is very poor, as has been the case for some time, but earnings expectations are still increasing. Unemployment is low but there could be some changes when the report for March is presented next Friday. Sentiment improved a couple of weeks ago and is still neutral at this time. My model continues to find 20 stocks to own so I remain fully invested.
Richard Moore, CFA
With my wife in Hawaii