It really bothers me that I have to give so much weight to what happens in Washington but that has been the way our society has moved for my whole life. Now we have the prospect of another failed health care vote that will, in turn, call into question the ability of our elected representatives to do anything in general and tax reduction specifically. My valuation statistics assume a substantial reduction in corporate tax rates and my model would call for a fully hedged position if tax rate reduction does not happen. All other items of importance are unchanged again this week with the exception of sentiment which has become fully negative. Sentiment does not do a good job of pinpointing tops in the market but it certainly adds more risk to the equation. Some hedging makes sense until the Washington circus looks clearer but my model is not capable of factoring politics into its quantitative base.
I am trying to get a handle on how many people are interested in my model and its stock picks. I want to ask a favor - if you are interested in continuing to follow this site whether you are actually using it in your portfolio or not, please click on the "like" button below this post on the left. Thanks very much!
As I have mentioned many times, the lofty valuation of stock prices currently is dependent on a cut in corporate tax rates - hopefully this year. But when Republicans get shot at by left wing nut-jobs the agenda is slowed and possibly derailed. Absent the prospect of such a cut in rates, my model would be 100% hedged at this time. I'm not going to change anything currently but I continue to watch the situation closely. Earnings estimates remain in an upward trend and the unemployment rate remains low. Sentiment is somewhat bearish but not very different than it has been. My model remains fully invested at this time.
NASDAQ took a hit on Friday for no particular reason other than valuations seemed a bit high (actually exorbitant). We will probably see lots of days like that in the future but it still seems premature to move to the sidelines. Earnings estimates remain in an uptrend and unemployment is very low and stable. Sentiment is really getting close to being a big problem but we are not quite there yet. Valuation is too high but it is OK if we factor in a significant corporate tax cut. However, if the Republicans cannot get their act together, market weakness will ensue. I have changed my chart above somewhat and am now showing a three year chart of my simulated portfolio compared to the Russell 2000. I have also expanded the number of stocks in the portfolio from 20 to 30. I can't find any better way to invest in the equity market for myself.
It was a great week for my model as I have now reached a 17+% gain year to date compared to +3.4% for the Russell 2000. The interesting thing is that small investors and speculators remain unconvinced by the rally. If anything, they got a bit less bullish last week. This argues for continuing strength as long as other factors don't go off the rails. Specifically, valuation is way too high but I continue to adjust for potential tax rate reductions that would make stocks look cheaper. If the politicians cannot get their act together, the market will suffer. Earnings were great in the first quarter and the trend of estimates 52 weeks out remains higher. Unemployment was reported at 4.3%, a strong number in spite of the disappointing number of jobs added last month. These factors are keeping my model in an unhedged, fully invested position.
Richard Moore, CFA
With my wife in Hawaii