Here’s the final list that I worked with in making my trades. Working up from the bottom of my list, I decide on what to sell. If I’m not selling something that rates low on my quantitative screen, I have to have an explanation as to why I am keeping it.

What I Am Not Selling


St. Joe – This doesn’t score well. The idea here is the land is considerably more valuable than the share price would indicate.

SPX Corp, Sara Lee – These are still in turnaround mode. Metrics don’t look good now, but should improve.

Sappi – Value of underlying assets not reflected in the metrics. South Africa is also out of favor.

Dow Chemical – it’s still cheap, and there are probably transactions that can unlock value.

DTE Energy – My one US utility. Would benefit from a sell-off of their energy production arm. I might be close to selling, but am not there yet.

Premium Standard – The merger with Smithfield will go through, and Smithfield will be able to take out costs. They might also gain a wee bit of pricing power. I think cost pressures have reached their maximum here, and profits will improve more than street estimates.

What I Am Selling

ABN AMRO – Barclays may do the deal or not. ABN Amro is fully valued here, and then some.

Devon Energy and Apache – I like them both, but their valuations have risen, and I have other places to deploy money.

What I am not Buying

After this, I look from the top down, and look for replacement candidates from the list. If I reject a highly rated name, I have to have a reason:

Group 1 Automotive – I already have Lithia Motors and Sonic Automotive. It’s in less desirable areas of the country, so I will pass on it for now, but will revisit it at a later date.

Georgia Gulf – It’s cheap, but I worry about the balance sheet, and I already own Dow and Lyondell.

Thornburg Mortgage – Would give me conflicts of interest with my employer.

Optimal Group – This is the most interesting of the ones that I did not buy. They have some interesting payments technologies, but the earnings estimate momentum was negative, and I could not really discern what competitive advantages they had.

Encore Wire – A bit of a cult stock. I just don’t like the business that they are in.

Arkansas Best, P.A.M. Transportation – I own YRC Worldwide, and these are not appreciably cheaper.

Foot Locker – Too many earnings disappointments.

Spectrum Brands – Lousy set of brands, and a poor earnings history.

Stolt Neilsen – I own Tsakos, and I think it has better growth prospects.

National Coal – Too small.

Home Solutions of America – I don’t like their business, given my view of the housing market.

What I am Buying

Bronco Drilling – Seems to be a cheap land driller, and replaces some of the exposure I lost selling Apache and Devon.

Komag, Nam Tai Electronics, Vishay Intertechnology – Cheap technology stocks that are near the beginning of the technology food chain. The businesses are more stable than those who buy their products.


I always get a little amused when the permabears emerge from their dens and parade around for the media to observe.  I myself am often bearish, but I have an investment policy that keeps me from expressing too much confidence in it.  I have no doubt that the permabears will eventually be right on much of what they are claiming will happen… but permabears by their nature are too early, and miss more gains from the “boom” than they typically make in the “bust.”

In general, and over the long run, prudent risk taking is the best strategy.  The only exceptions are when there is war on your home soil, and aggressive socialism.  That said, in this post, I want to detail reasons to be concerned, and reasons to not be concerned.  Here we go:


  1. Earnings growth is slowing year-over-year to about a 4% rate, and actually fell from the third to fourth quarters of 2006.
  2. Loan covenants for loans to private equity have almost disappeared.  Bullish in the very short run, but what are the banks thinking?!
  3. Anytime the bond market maxes out in a given sector, tht is usually a bad sign for that sector.  42% or so of the whole Investment Grade corporate bond market is financials.  (Contrast that with its weight of 21% in the S&P 500.)  I would be very careful with financial companies as a result.  Were I running a corporate bond portfolio, I would deliberately tilt against financials, and give up income in the process.
  4. Have you noticed the small stocks have begun to underperform?  Not bullish.
  5. The balance sheets of US consumers are in poor shape.  The further down the income spectrum you go, the worse things are.
  6. Abandoned housing is becoming a problem in many parts of the urban US.  (Hey, I’m in the suburbs, and I have two abandoned homes on my block!)
  7. According to ISI Group, corporate capital expenditures exceeds free cash flow by $70 billion.  (That’s what’s driving corporate bonds!)
  8. In 1998, one of the causes of the volatility was a rise in the Japanese yen, which blew out the “carry trade” at that time.  That may be happening now.
  9. Chinese and Indian inflation is accelerating.
  10. In general, central banks of the world are tightening monetary policy.  The US is an exception, which helps to explain the weak dollar.  Even China is tightening monetary policy.
  11. I don’t worry about the budget deficit; it is part of the overall current account deficit, which I do worry about – particularly the fact that investment income we receive from abroad is exceeded by that which we pay out.  This shift occurred in 2006, and is unprecedented for at least 50 years.
  12. Inflation is above the FOMC’s comfort zone, even with the bad way that the government measures it.
  13. Private equity is overlevering otherwise stable assets.  That is bullish for the public markets in the short run, but unsustainable in the intermediate term.
  14. Merrill had to withdraw a CPDO in February; to me, this means that corporate default spreads had reached their absolute minimum.
  15. According to Bloomberg, Moody’s says that $82 billion in corporate bonds will mature between now and 2009, and 61% is rated B1 or less.
  16. Actual volatility of stock prices has risen relative to implied volatility.  Further the average holding period of stocks has declined markedly over the last four years, to around seven months, according to the WSJ citing Bernstein.
  17. Margin debt is at its highest level since the 1920s, though as a percentage of market capitalization, it is lower than it was in 2000.
  18. Troubles in subprime and Alt-A lending are leading to declines in US residential real estate prices.
  19. Mortgage equity withdrawal is declining significantly in 2007.  The higher quality the loan, the lower the equity extraction generally.  A reduction in subprime and Alt-A affects this considerably.

Not to Worry

  1. In general, stocks are better buys than bonds at present.  The earnings yield exceeds the 5-year Treasury yield by 120 basis points.  Note though, if profit margins mean-revert, bonds will be the better asset class.
  2. At present, there is no lack of financing for CDOs and private equity, and corporations are still buying stock back aggressively.  Investment grade corporate bond issuance is robust, surpassing the amount issued in 2006 YTD. On the other hand, high yield has slowed down considerably.  (CDO mezzanine and subordinated debt spreads have widened though, particularly for asset-backed deals.  The arb spread has not been so wide in years.)
  3. Many new BBB bonds are coming with change in control covenants.
  4. The VIX hasn’t closed above 20 yet.
  5. Investment grade corporate balance sheets are in relatively good shape.
  6. The relationship of earnings yields to corporate bonds is a fuzzy one. From the seventies to the nineties, P/Es moved inversely to bond yields.  Not so, so far, this decade, or in the 1960s.  If bond yields rise due to growth expectations, P/Es may follow along.
  7. Money supply growth is robust in the US and globally.  In the short run it is difficult to have a bad market when money supply growth is strong, and measured inflation is low.
  8. There is a still a desire to purchase US assets on the part of foreigners; the recent fall in the dollar has not affected that.
  9. My view is that we won’t have a recession in 2007, and that we might have one in 2008.
  10. ECRI forecasts inflation falling in the US, together with decent growth in 2007.
  11. Proxies for systemic risk have been receding, though they are considerably higher than one month ago.
  12. Export sectors are finally showing some decent growth, partly due to the weak dollar.
  13. IPOs are outweighed by LBOs and buybacks.  With a few exceptions, IPO quality doesn’t seem too bad.
  14. Global demographics favor net saving because of the various baby booms after WWII.  Excess money growth is going into the asset markets for now.
  15. Most M&A deals are for cash, which is usually a bullish sign.  M&A waves typically crest with a bevy of stock deals.  Deal premiums are not out of hand at present.
  16. According to the ISI Group survey state tax receipts are quite robust, indicating a strong economy.
  17. Also according to ISI Group, China is now a net coal importer.
  18. Commodity indexes, scrap steel pricing, and Baltic freight rates are still robust.
  19. Foreigners are buying some of the excess US homes as second homes.  Having a residence in the US offers flexibility.

I did not aim for nineteen of each, I just went through my research pile, and summarized everything that was there.  To me, this is a fair rendering of the confusing situation that we are in today.

The Broad Market Portfolio was up a little less than 50 basis points today.  Leading the charge were Dow Chemical and Sappi.  Trailing the pack were  Grupo Casa Saba, Industrias Bachoco, and Deerfield Triarc Capital.

One of the things that I debate about as I write for RealMoney is how public to be when I disagree with Cramer.  I’ve had a very good call on the FOMC for the past four years, with very few mistakes, and Cramer, in his view that the FOMC will loosen because of the present weakness in the stock market, because of subprime lending, seems misguided to me.  I differentiate between what I would do if I were the Fed Chairman, and what I think the current Fed Chairman will do.  My use of a political pain avoidance model has worked well for me over the last six years.  I no longer assume that the FOMC will want to do the right thing; they do what leads to the least political risk.

Also, I want to avoid becoming so bullish or bearish that I don’t listen to reason.  This is a pit for those that write about the markets, particularly if one is sensitive about being wrong.  Well, I will be wrong, hopefully just every now and then.

The course of action that is the most intellectually lazy is becoming a perma-bull or perma-bear.  It makes life simple because you can dismiss a large amount of the data.  It’s easier to write when you can focus on the same likely future difficulties/successes again and again.

I choose the hard route, trying to be fair about likely outcomes, and not overstating the case.  It doesn’t make for good journalism, but it makes for good investing!

PS — I will post on the last phase of my portfolio reshaping tomorrow.

Full Disclosure: long DOW SPP SAB IBA DFR

Here’s the file for my progress on the portfolio change so far. Because of the data license that I have from Bloomberg, no numeric data fields from Bloomberg are listed here; only fields that I have calculated.

The grand rank is a weighted average of the ranks of the other variables, where a low number indicates desirability. Rsi Px 52week rank is a measure of price level. 0 means a 52-week low, and 100 means a 52-week high. NOA is net operating accruals; 0 means a low level of accruals on the balance sheet. 100 means there are a lot of accruals on the balance sheet.

Rsi Px 52week rank, NOA, Price-to-Sales, and Price-to-Book get a double weight. Everything else gets a single weight. I vary the weights each period based on what concerns me. When I am more bearish, I overweight the things that I am overweighting now.

Tomorrow I should have my portfolio changes. I choose 2-4 companies in the top half of my portfolio to replace 2-4 companies in the bottom half. Why do I do it this way? It forces me to make trade-offs, tossing out appreciated positions, and adding in promising names.

The broad market portfolio was only up 10 basis points today, against greater moves for the major averages. Leading the charge on the downside was Fresh Del Monte. Nothing was materially up, aside from Griupo Casa Saba.

There’s a lot of “I told you so” going on in the pundit-sphere at present regarding subprime mortgages. Those that have read me at RealMoney know that I have been talking about the problems there for the past 2-3 years. I will say this, the shrillness of the Johnny-come-latelys on the issue almost make me want to reconsider my opinion.
I’ll have the results of my comparison of competitors to my portfolio available tomorrow. I’m still scrubbing the data.Full disclosure: Long FDP SAB

The Broad Market portfolio was up a little more than 2% this week. The economic sensitivity of the portfolio helped, as did the Latin American names in the portfolio: SABESP, Cemex, Industrias Bachoco, and Grupo Casa Saba.

The week was characterized by a retreat from perceived systemic risk As the week went on risk went from general to localized. The true offenders in the subprime lending world were taken out and executed, and the rest of the market recovered.

I have been sounding bullish of late, but I want to caution you regarding the dangers of this present market. Though this panic did not spread to the market on the whole, it is possible that a future crisis might be more virulent. Remember, the current market prosperity relies on free trade in goods and services; any interruption of that could lead to a major decline. Bad FOMC policy is another risk here as well. Profit growth has slowed significantly as well. There are reasons to be concerned, but if you are concerned, tweak your portfolio toward less risk. Don’t leave the party entirely, but choose stocks with strong balance sheets and cheap valuations, and raise a little cash.

Full disclosure: SAB IBA CX SBS

I have several industry rotation models.  Some are short-term, others are longer term.  My main one is in the back of my head as I analyze where the pain is growing, and nearing maximum intensity.  (If anyone wants me to share shorter term models, I can do that.  I don’t use them much though.)

For me, the idea in industry rotation is to find stocks that fit one of two paradigms: 1) strong companies in troubled industries, and 2) well-run, cheap companies in industries where favorable trends are over-discounted.  My main model attempts to address the former.

My model has 6 1/2 years of Value Line industry rank data.  It asks the following questions:

  1. What is the industry’s current rank?
  2. Relative to your rank history, where is your current rank compared to the maximum and minimum ranks?
  3. How many standard deviations are you above or below your average rank? and
  4. Compared to past history, what percentile is your Value Line rank compared to prior dates in history.

The results from these questions are weighted and turned into a grand rank. From highest to lowest, the weights go 1, 4, 3, 2 for the questions listed above.  This spreadsheet lists the final results.   Now the new ranks can be used in two ways, in value mode, or momentum mode.

Value Line ranks are a product of three factors: price momentum, earnings momentum, and analyst surprise.  They are momentum driven.  My model attempts to refine that, and give investors two ways to play the market.  If you like fast momentum-style trading, buy the companies in the red zone near the bottom of the list.  If you’re like me, buy the companies in dead industries in the green zone at the top of the list.

So what did I do here?  The list of industries entitled “dig through” I deemed interesting from the “green zone.”  I ran a screen on them to get a few more names for this current portfolio reshaping.  Here are the tickers:


Okay, so now I have two things ready to go: I have the full list of tickers that I will compare against my current portfolio.  I also have what my main industry rotation model recommends.  I call my methods “quantitative assisted,” because I use my intellect to overrule them when I think it is needed.   The next step is lining up all of the candidates against my current portfolio to help decide who to add in , and who to kick out.  More on that on Monday.

This is a little out of the ordinary for those who frequent my blog, but here is something that my wonderful wife and I use to help our children learn math. If you did not already know, we homeschool our eight children. We are not big on math drill; we think word problems teach reasoning far better. But to do word problems effectively, the ability to have instant recall of the 100 math facts in addition, subtraction, multiplication and division is crucial.

We have our children work at it until they can get it perfect in five minutes in third grade, and three minutes in fifth grade.

To use the spreadsheet (right-click and use “save link as” to download), select the tab that you want to work on. “little add, and “little subt” are the 64 math facts with no number greater than 10. To use the sheet, hit the F9 key to recalculate the sheet, which places all the problems in a new random order. (You’ll never get 2 sheets the same.) Then hit the print icon. F9, print, F9, print, etc… pretty soon you’ll have a lot of unique sheets for drill purposes.

Use and distribute as you see fit. I just want to see children who are good with their math. And, if it works for you, let me know.