361 Capital Weekly Research Briefing

361 Capital portfolio manager, Blaine Rollins, CFA, previously manager of the Janus Fund, writes a weekly update looking back on major moves, macro-trends and economic data points. The 361 Capital Weekly Research Briefing summarizes the latest market news along with some interesting facts and a touch of humor. 361 Capital is a provider of alternative investment mutual funds, separate accounts, and limited partnerships to institutions, financial intermediaries, and high-net-worth investors.

361 Capital Weekly Research Briefing
November 12, 2013
Timely perspectives from the 361 Capital research & portfolio management team
Written by Blaine Rollins, CFA

(EricKogan)

The drive through the financial markets remained blurry last week…

The market continued to show RISKOFF tendencies as Small Caps, Nasdaq100, Cyclicals, Low Quality and Higher P/E stocks underperformed. It looked as if the bears would get their Thanksgiving pumpkin pie with a big dollop of whipped cream. But then, the much better than expected Jobs data hit on Friday sending interest rates soaring and pushing Bank stocks to All Time Highs. The rest of the market grabbed onto the coat tails of the Financials and put up its best day in 3 weeks. Bank Stock investors want 3 things right now: 1) an improving economy for their loan growth, 2) a steeper yield curve so that they can lend at a higher rate than they are paying for deposits and 3) to keep off the front page for more than 3 days in a row.

Just when investors had given up on Financials, they came roaring back Friday…

Sticking with Financials, Brian Gilmartin reminds you that banks still have some of the best bottom line earnings growth in the S&P 500…

Financials have lagged since the start of the 4th quarter, which is contrary to our belief they would outperform in q4 ’13, and isn’t helping our performance, given the Financials overweight. That being said, we bought a little more JPM and BAC this last week, as (according to Bespoke), in a very overbought stock market, the Financials are the least overbought of the 10 SP 500 sectors. JP Morgan (JPM)’s legal charge in q3 ’13 continues to weigh heavily on Financials and the SP 500 as a whole: Per Thomson, the current earnings growth estimate for Financials as of q3 ’13 is +1.4%. Per Factset, and excluding JPM, the growth rate for Financials for q3 ’13 would be +15.1%. Typically Factset’s sector growth estimates are lower than Thomson’s (as a rule of thumb.)

Q4 ’13 earnings growth estimates for Financials are +23.8% as of Friday, the best growth of any sector within the SP 500. A lot of this is loan-loss reserve (LLR) releases, as Financial revenue growth continues to be punk at 0.2%. I would expect q4 ’13 Financial sector revenue growth would be higher given capital market activity and the rather tempered Treasury market. We are staying with Financials through q4 ’13. The sector needs to get out of the headlines, but with every regulator suing the big banks for past transgressions, the headlines are “p.e compressing”. (Unlike Thomson, Factset data gives revenue growth expectation for the 4th quarter in their weekly release, and Financial sector revenue growth for q4 ’13 (per Factset) is currently calling for a 10% decline. That could also be weighing on the sector.)

(Fundamentalis)

The Employment and Q3 GDP data gave everyone something to chew on…

This week’s big economic reports—October jobs and third-quarter GDP—reveal an economy that continues to plod along. At least it’s growing and creating some new jobs, but growth remains too slow to lift incomes for most Americans. The reports highlight two points that deserve more attention. The first is how little the private economy was damaged by the government shutdown. The Bureau of Labor Statistics reported no major impact from the shutdown on hiring by private employers, who added 212,000 jobs. Washington views itself as the main driver of growth, but the opposite is closer to the truth. The shutdown underscored how much of the government could go away with little impact on growth… A more troubling theme in the latest economic data is the decline in business investment. More than a third of the 2.8% growth rate came from businesses building up inventories. Unless companies can find more demand for their products in the coming months, these inventories will have to be worked down and growth in future quarters will be slower.

(WSJ)

But definitely no arguing that the weekly railroad data is seeing a surprising surge in carloadings…

Excluding coal and grain, U.S. carloads in October 2013 were up 5.6 percent, or 42,037 carloads. “There’s been some concern lately that the recovery may be running out of steam. Rail traffic data for October doesn’t seem to support that,” said AAR Senior Vice President John T. Gray. “A number of economically sensitive commodities, like lumber, autos, and chemicals, saw higher traffic volumes in October. The sharp increase in grain carloadings is a welcome change and points to the cooperative relationship railroads have established with their partners in the agricultural community.”

(AAR)

And London is also seeing a surge in business levels…

The UK services sector – representing nearly 80 percent of the economy – is roaring ahead, with the Purchasing Managers’ Index giving a forecast-busting October reading of 62.5 and rising at its fastest pace since 1997… Markit’s key points from the data: 1) Strong rise in new work supports sharpest rise in activity for over 16 years, 2) Backlogs of work and employment both increase markedly.

(FinancialTimes)

So if most European countries are seeing improvement, why did the ECB cut interest rates?

Check out the inflation data. They have plenty of room to cut and the last thing they want to see is deflation.

(WellsFargoSecurities)

We would still like to see a more stable & healthy U.S. Treasury Bond market…

Because many large institutions were positioning themselves for lower yields into year end, the Friday data caught most by surprise. I still think that 10 year rates need to stay below 3% into year-end to provide equities with their upward bias. But with the break on Friday, all bets are off. Expect Housing, REITs, Utilities, and other fixed income proxies to feel the heat.

Back to Equities, the bears continue to search for reasons for a pullback…

@HistoryInPics: Soviet Plane-spotters around 1917.

Elevated equity sentiment remains a poor indicator of future market weakness…

I have always liked market sentiment indicators on the low side as they give much better reads on when to buy a market. But as this chart illustrates, market strength typically leads to further strength. (data from 1963 to today)

(RenaissanceMacro)

Ed Yardeni also has some market sentiment thoughts in Barron’s…

I have met a lot of institutional investors I call “fully invested bears” who all agree this is going to end badly. Now, they are a bit more relaxed, thinking it won’t end badly anytime soon. Investors have anxiety fatigue. I think it’s because we didn’t go over the fiscal cliff. We haven’t had a significant correction since June of last year. We had the fiscal cliff; they raised taxes; then there was the sequester, and then the latest fiscal impasse. And yet the market is at a record high. Investors have learned that any time you get a selloff, you want to be a buyer. The trick to this bull market has been to avoid getting thrown off.

(Barron’s)

For the week, Financials saved the markets on Friday…

Across the broader markets, falling Bonds and a rising U.S. Dollar had a material impact…

Byron Wien unveiled his model portfolio for 2014. Biggest change was the increase in Long Only exposures to Equities…

• 10% position in high-quality global multinationals.
• 10% position in small and medium capitalization American companies.
• 10% position in European stocks.
• 5% position in Japan.
• 10% position in emerging markets.
• 10% position in hedge funds.
• 10% position in private equity.
• 10% position in real estate.
• 5% position in gold.
• 5% position in natural resources and agricultural commodities.
• 15% position in high yield securities.
• ZERO% position in U.S. Treasuries.

(Blackstone)

One great employment data series from the BLS on Friday shows what High School & College students should be studying…

@MichaelMandel: Computer/math jobs jump to all-time high of 4.3 million in Oct. 12-month average rises sharply after pause

And if you don’t have your younger kids signed up for a summer programming class, what are you waiting for?

@jyarow: Teach your kids to code. Short of that, teach them how to write about the kids that do learn to code.

NBA Superstar Chris Bosh: Here’s Why You Should Learn to Code…

Being a kid of the 1990s and living in a house run by tech-savvy parents, I began to notice that the world around me was spinning on an axis powered by varying patterns of 1s and 0s. We’d be fools to ignore the power of mastering the designing and coding of those patterns. If brute physical strength ran one era, and automation the next, this is the only way we can keep up. Most jobs of the future will be awarded to the ones who know how to code. We use code every time we’re on the phone, on the web, out shopping — it’s become how our world is run. So I take comfort in having a basic understanding of how something as big as this works… I’ve seen lots of videos with me in them throughout the years – games, music videos, commercials — but watching myself in the Code.org video was one of the coolest moments of my life. When fans started tweeting at me that their teachers showed them a video of me along with some of the most famous tech icons in the world, it all came together for me and made one thing clear: the nerds have finally achieved their revenge.

(Wired)

Speaking of guys that know how to code, my colleague, Nick Libertini, just had a paper published that will be of interest to the many Traders and Quants who follow 361 Capital…

“The Impact of Stop Losses on Short-Term Countertrend Trading Strategies” can be found in the latest issue of The Journal of Investment Strategies: Volume 2/Number 4, Fall 2013 (JoIS). You can also contact 361 Capital for a licensed PDF copy.

In the event that you missed a past Research Briefing, here is the archive…

361 Capital Research Briefing Archive

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Blaine Rollins, CFA, is managing director, senior portfolio manager and a member of the Investment Committee at 361 Capital. He is responsible for manager due-diligence, investment research, portfolio construction, hedging and trading strategies. Previously Mr. Rollins served as Executive Vice President at Janus Capital Corporation and portfolio manager of the Janus Fund, Janus Balanced Fund, Janus Equity Income Fund, Janus Aspen Growth Portfolio, Janus Advisor Large Cap Growth Fund, and the Janus Triton Fund. A frequent industry speaker, Mr. Rollins earned a Bachelor’s degree in Finance from the University of Colorado, and he is a Chartered Financial Analyst.