The sideways action of the past several weeks has managed to cause concern among small investors and speculators so my model has moved to a neutral position with respect to sentiment indicators. Earnings estimates modified to exclude commodity companies are increasing and still positive. Valuation is still horrible. I am removing one half of my hedges and will target a net long 30% position for the time being.
The market continues to churn day to day with no real discernable trend. We are starting to see divergences again between the smaller cap stocks and the major averages. For the last three weeks, the Value Line Geometric Average underperformed the S & P 500 and last week there were substantially more stocks down than up. Sentiment measures are improving marginally but are still negative. Valuation remains very negative. Earnings expectations are doing fine so far but current earnings are declining. I am still 100% hedged.
I started out tinkering with my model to make it easier to update and to stress the earnings factor more than I had been previously. As I researched alternative approaches, though, I arrived at the conclusion that when sentiment and valuation are extremely negative (as they are now) it is best to move away from the market until conditions improve. As everyone knows, there are no good alternatives that produce a reasonable return so I have determined that my best bet is to concentrate more on owning stocks that are going to do better than the market whether the market is advancing or declining. This means using smaller companies that are not well followed and hedging against them when the market looks risky. My model now can be either 100%, 60%, 30% or 0% net invested in stocks. For much of the last year, valuation and sentiment have been poor enough that a totally hedged portfolio is called for. That is the situation now. I would rather be safe than sorry in this environment. I'll try to point out attractive individual equities as time goes on.
Too much golf this weekend for a full update but I am attempting to reduce the volatility in the signals of my model. Earnings remain positive but sentiment and valuation are both marginally negative. My model would call for a minimal exposure to equities at best. I will post a full update later this week.
Richard Moore, CFA
With my wife in Hawaii