It was a relatively good week but we are beginning to see under-performance by the average stock again while just a few flyers on the NASDAQ are moving the major averages higher. Because of the high valuation, it is critical that we see a path to corporate tax rate reduction this year and, with the "resistance" movement thriving, it looks harder and harder to achieve those tax cuts. Earnings estimates were down last week but the trend is still higher and first quarter results were outstanding. Unemployment looks good and sentiment is a bearish factor but not extremely so. I am still waiting and hoping that things will work out in Washington and I am maintaining a fully invested position.
We got a taste of what happens if cuts in the corporate tax rate get derailed by the foolishness in Washington on Wednesday and it wasn't pretty. Hopefully the politicians can get back on track but I'm not terribly optimistic. I am still adjusting my valuation numbers by 5% or so and that is the only reason I am not hedged at this time. Valuation did improve modestly last week while earnings estimates continue positive and unemployment is low and stable. Sentiment is poor but not extreme. EML was just about my only winner last week while SHLO continues to fall apart for unknown reasons. My model is continuing in a fully invested position.
The most important factor in my model is valuation and, this week, because I was concerned that free cash flow was too volatile, I switched over from that metric to regular operating cash flow. There was not much change in backtested results or drawdown so this is mainly a desire to cut down on trading because of volatile factors. My stock screen has had excellent results this year and is performing well above the Russell 2000. INCR was a big winner last week after announcing a merger. Earnings expectations remain good, unemployment is low and stable and valuation remains unattractive. Sentiment looks like it is turning the corner as small investors and speculators get more and more bullish. They are not at extreme levels just yet, though, so the upside momentum can continue for awhile longer.
They say you should not fix it if it's not broken so everything continues pretty much on track and working as it should. Earnings estimates are increasing and actual first quarter earnings have been quite good. Unemployment was reported last week and was down. Valuation continues to be poor but that is not anything new. Sentiment remains mostly neutral. My model remains fully invested in the twenty stocks picked by my screening system. The French Elections could cause short-term problems but the polls indicate the status quo is likely to prevail there. We will know very soon.
Richard Moore, CFA
With my wife in Hawaii