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  • Volume I, Issue 19

LGR Newsletter

Volume I, Issue 19 (released on October 24, 2014)

Hello all!

Thanks for all the positive feedback for my in-depth analyses of individual companies -- and going forward I will alternate new Issues of this Newsletter with these research articles approximately every month. Each new research article I write will be counted as a new Issue of my Newsletter, so my research article on HOG will be considered Volume I, Issue 18 (not simply “part one” of Issue 18 as it was originally intended). I will use the “Write-up” sections of the regular Issues of my Newsletter to do quick follow-ups on my most recent research articles. These quick “follow-ups” will not be published anywhere else besides from my website, so everyone on my Newsletter Listserv will be able to get exclusive access to my thoughts on the stocks I write about shortly after my articles were published.

This Newsletter’s subscriber base has grown by over 35% since August 2014, and I want to continue this growth -- if you like what you read here, please pass it along and encourage others to subscribe to my Listserv. Also, feel free to forward anything that I send via email to whomever you choose.

With a lot of recent material to cover, this Issue will contain a Website Update, a Summary of the Market’s Performance (8/18/14 – 10/24/14), a Portfolio Update (8/18/14 – 10/24/14), and a Write-up section with very brief follow-up thoughts on two companies featured in recent research articles: Harley-Davidson Inc. (NYSE: HOG), and Life Time Fitness Inc. (NYSE: LTM).

 

Website Update:

I have made a lot of improvements to website recently, particularly format changes on the homepage, and one of the biggest improvements that I made was upgrading my website with iPage to increase its speed.  I hope to make further improvements in that regard going forward. I am NOT a website designer -- but if you see any features I could add, please let me know.

New Website Feature: Resource Guide

I have added the highly anticipated Resource Guide, which is a feature that many people asked for.  I helped create the “Two-Page Primer” on the Boston College Investment Club website by including some of my key ideas from my Resource Guide.  I hope that you will all find my Resource Guide to be helpful when researching specific stocks or just keeping up-to-date with the latest news in financial markets.

The Resource Guide was created with two purposes in mind: 1) to provide some easy definitions of commonly used terms; and 2) to provide a list of resources used to collect information related to specific stocks and financial markets in general. I will update the Resource Guide periodically. If you have any suggestions of terms or sources to add, please let me know -- nothing is ever finished when it comes to learning about financial markets!

Upcoming Website Feature: Community Service

I believe that it is important to give back to my community, and will be adding a page to my website that relates to community service.

 

Summary of the Market’s Performance:

(August 18 – October 24, 2014)

Since my last in-depth “Summary of the Market’s Performance” discussed data as of the stock market’s close on August 15th, all of the performance data that I use in this section will relate to its close on that date (8/15/14).

Since August 15th, all three major indexes have gone up slightly; the S&P 500, the NASDAQ Composite, and the Down Jones Industrial Average (DJIA) advanced by 0.49%, 0.42%, and 0.86% respectively. Amazingly, all three indexes’ performance over the last 49 trading days can be cut in half almost perfectly, in terms of the market’s positive versus negative price action. All three indexes reached new 52-week intraday highs on September 19, 2014, which was the 24th trading day since the last Issue of my Newsletter, and then all three indexes declined almost every single day until they reached significant intraday lows on October 15th (the S&P and the DJIA only had 4 positive days apiece during that time span, while the NASDAQ Composite had 6 positive days). That decline, which lasted almost exactly a month, caused the S&P 500, the NASDAQ Composite, and the DJIA to shed 147.91 points (7.36%), 364.47 points (7.96%), and 1,138 points (7.05%) respectively, from their closing values on September 19th to their closing values on October 15th.  Since then, the three indexes have experienced huge rallies, with the S&P 500 jumping 5.48% higher, the NASDAQ Composite surging 6.37% higher, and the DJIA moving 4.11% higher in only seven trading days.

This performance of all three major indexes’ performance since August 15, 2014, is shown in the following chart:

LGR Newsletter Volume I, Issue 19 Image #1

Source: Yahoo Finance (Interactive Charts)

As one can probably imagine, the huge performance gyrations that the three indexes experienced since August 15th were accompanied by a huge increase in volatility, as measured by the Volatility Index (commonly known as simply the VIX). After declining 7.91% from its close on August 15th to September 19th, the VIX skyrocketed 116.76% to close at 26.25 on October 15th. The VIX then declined 37.71% from there to close at 16.11 on October 24, 2014, which is still 22.51% higher than its closing value on August 15th. As one has begun to expect at this point, the VIX’s overall performance has almost perfectly mirrored that of the S&P 500, except in reverse (negative correlation). A chart of the VIX since its close on August 15th can be found below:

LGR Newsletter Volume I, Issue 19 Image #2

Source: Yahoo Finance (Interactive Charts)

  • Note: “The VIX is calculated from the prices investors are willing to pay for options tied to the S&P 500. It is often used to hedge stock investments because of the way it tends to rise as stocks fall, and vice versa” – WSJ.

As you may recall, if you were subscribed to my Newsletter back then or saw my Instablog Post on Seeking Alpha, I used the extremely high ratio of the S&P 500 to the VIX (“$SPX:$VIX” on Stockcharts.com) as support to back up why I believe a 10-15% correction in the S&P 500 is imminent. The chart I used at the time (Volume I, Issue 12) can be seen below:

LGR Newsletter Volume I, Issue 19 Image #3

Source: The Four Pillars Trading Solution Report (written by Geoff Goetz at www.billcara.com)

  • Note: The data in the chart is from April 11, 2014

When I wrote about the chart above, on May 26, 2014, the ratio of the S&P 500 to the VIX had closed at 167.30 on May 23rd (the previous trading day). Now let’s take a look at a much more up-to-date version of that chart, which can be seen below:

LGR Newsletter Volume I, Issue 19 Image #4

Source: The Four Pillars Trading Solution Report (written by Geoff Goetz at www.billcara.com)

  • Note: The data in the chart is from October 15, 2014

After peaking at 192.40 on July 03, 2014 (a “20+ year high for ratio!”), the ratio of the S&P 500 to the VIX has since declined significantly, and it closed at 121.95 on October 24, 2014. The important thing to keep in mind is that although the VIX experienced a huge spike recently, its recent close at 16.11 is still significantly below its long-term average of 20. I still view the situation described in the chart above as being bearish for the market (i.e. the S&P 500).

Additional Performance Summary (Russell 2000, Bonds, Gold, and USD):

The Russell 2000 has been having a tough time since mid-August. After failing to follow the three major stock indexes to a new 52-week high in September (with the Russell 2000 peaking on the third day of the month at 1,183.85 vs. a 52-week high of 1,213.55), the Russell 2000 proceeded to decline 11.04% from its close on September 2nd to its close on October 13th. The Russell has since lead the three major stock indexes higher from their collective “V-shaped bottom” in the middle of October, with a nice gain of 6.63% from its close on October 13th versus an average gain for the three major stock indexes of 4.72% over the same time period. Despite its surge in value from its low on October 13th, the Russell 2000 is still 2% below its closing value on August 15th, 5.14% below its closing value on  September 2nd, and 7.81% below its 52-week high.

Many investors look at the ratio of the Russell 2000 to the S&P 500 (“$RUT:$SPX” on Stockcharts.com), to compare the general performance of “small cap” stocks to the general performance of “large cap” stocks, because if small cap stocks are outperforming large cap stocks it generally means that investors are willing to take on more risk – “RISK ON” (bullish scenario) – and if small cap stocks are underperforming large cap stocks it generally means that investors are less willing to take on more risk – “RISK OFF” (bearish scenario). The fact that the Russell 2000 has been underperforming the S&P 500 (“RISK OFF”) has not gone unnoticed by Wall Street, and the topic has been debated for some time now. The Russell 2000/S&P 500 ratio was another piece of evidence I used to support my bearish prediction for the S&P 500, but the result of my prediction is still yet to be finally determined – although the S&P 500 technically declined 9.84% from its all-time high to its intraday low on October 15, 2014, nearing my projection of a 10-12% decline.

I only follow the bond market through long-term U.S. Treasury Bonds, to which I have exposure in my simulated portfolio through the iShares Barclays 20+ Year Treasury Bond Fund ETF (NYSE: TLT). This ETF tracks the price of long-term Treasury Bonds, and it has done very well for me so far this year. Since its close on August 15th, TLT has outperformed the S&P by a fair margin and posted a gain of 2.19% (not adjusted for dividends).

What was even more impressive was the “flight to safety” that occurred during the middle of September while the entire stock market was selling off. Beginning on September 19th, which was the exact same day as all three major indexes posted new 52-week highs, TLT experienced a huge rally that took it from an intraday low of $112.92 to an intraday high of $127.68 on October 15th (Stockcharts.com data). That means that while the S&P 500 experienced a decline of 9.84% from its intraday high on September 19th to its intraday low on October 15th, TLT rose 13.07% from low to high over the same time span. This type of negative correlation is exactly what I predicted would happen in Volume I, Issue 12 of my Newsletter.

I have been following the performance of Gold and the USD very closely over the past few weeks, and I have written about them frequently in the “Financial Newsroom” blog page on my website – please read these posts for further discussion.

Conclusion: I still believe that the S&P 500 is going to experience a correction, for the same exact reasons as I have stated in the previous Issues of my Newsletter. Foremost among those reasons is the situation depicted in the two charts below:

LGR Newsletter Volume I, Issue 19 Image #9

Source: The Four Pillars Trading Solution Report (written by Geoff Goetz at www.billcara.com)

  • Note: The data in the chart is from October 15, 2014

The chart above shows that investors were recently more bullish than they had been at any point in the last 20 years. That is probably what led to the situation seen in the following chart:

LGR Newsletter Volume I, Issue 19 Image #8

Source: The Four Pillars Trading Solution Report (written by Geoff Goetz at www.billcara.com)

  • Note: The data in the chart is from October 15, 2014

Excessively bullish sentiment has led to investors “trading on margin” in order to pursue larger returns on investment (ROI) in the rising market. This situation has gotten so bad that investors (as a whole) now have a lower amount of cash available to them than at any other point in the last 20 years!

The data seen in the two charts above is not new, but it is definitely very shocking to behold. EVENTUALLY the situation will need to reverse, and it is likely that investors will be all selling stocks at the same time. Individuals who are looking to preserve their money do not want to be “over exposed” to the long side when everyone starts selling at once.

It should be noted that there is still some evidence that leads me to believe that the market may actually head higher in the short-term. A recent report from MarketWatch indicates that Hedge funds, as a whole, underperformed the S&P 500 during Q3 2014, and I believe that these funds could end up being responsible for the market’s next move higher. Here is an excerpt from the MarketWatch report:

"Hedge funds on the whole underperformed the S&P 500 SPX, -0.24% in the third quarter although total industry capital rose, HFR said in its HFR Global Hedge Fund Industry Report released Monday. The HFRI Fund Weighted Composite Index, made up of more than 2,000 funds with at least $50 million under management, edged down 0.09% versus S&P 500's 0.6% gain. Total hedge fund capital during the period rose $18 billion from the previous quarter to record $2.82 trillion, in part due to market volatility towards the tailend of the quarter, HFR said. And for the first time since 2009, small and mid-sized firms saw greater inflow of funds than large hedge funds, reporting combined inflow of $11.7 billion versus $4.2 billion for larger firms who manage more than $5 bilion.” – MarketWatch (October 20, 2014)

All I know is that if I wanted professionals to manage my money and provide me with a high ROI, I would be giving my money to the smaller firms because they often have a more consolidated method for managing money. I also know that if I was managing a hedge fund and I had just underperformed the S&P 500, while still receiving more money from anxious investors, I would probably feel pressured to “reach for higher yield” by buying stocks with that I believed would give me a higher return so that I could “catch up” to the market.

Securities that have potential to provide higher returns also have higher risk so in the end it will not be “healthy” for the market to be driven higher in such a way, but it is still possible that the S&P 500 will achieve new highs if hedge funds collectively push it higher. Hedge funds’ collective underperformance is NOT a new development. An article came out in the Wall Street Journal that talked about the exact same thing a little over a year ago.

 

Portfolio Update:

(August 18 – October 24, 2014)

As one would expect, the past nine weeks have been very volatile for my portfolio. Below is a graph that shows the performance of my portfolio compared to the performance of the S&P 500, over the last nine weeks:

LGR Newsletter Volume I, Issue 19 Image #5

My portfolio underperformed the market while it was headed to new highs, but significantly outperformed the market during the four week period from September 22nd to October 17th, when financial markets experienced a significant amount of volatility. This indicates that my portfolio’s “Beta” over the last nine weeks was significantly below 1.

Further details:

Below is some information about my simulated portfolio, and a list of my five best performers, and five worst performers, for the past three weeks:

  • Starting balance (on 1/1/2014): $1,000,000.00
  • Current balance (on 10/25/2014): $1,038,804.66
  • Portfolio’s Return Year-To-Date: 3.88%
  • The S&P 500’s Year-To-Date: 6.29%
  • Number Of Currently Profitable Positions: 18
  • Number Of Currently Unprofitable Positions: 16
  • Percentage Of Positions That Are Profitable: 52.94%

My Five Best Performers For The Past Nine Weeks:

  1. Life Time Fitness, Inc. (LTM): +27.15%
  2. Altria Group Inc. (MO): +11.60%
  3. Sturm, Ruger & Company (RGR): +8.83%
  4. Northeast Utilities (NU): +8.33%
  5. Bed Bath & Beyond, Inc. (BBBY): +5.48%

My Five Worst Performers For The Past Nine Weeks:

  1. IAMGOLD Corp. (IAG): -37.06%
  2. Activision Blizzard, Inc. (ATVI): -31.38%
  3. First Majestic Silver Corp. (AG): -22.93%
  4. Silver Wheaton Corporation (SLW): -19.48%
  5. Freeport-McMoRan Copper & Gold (FCX): -16.17%
  • Notes: The percentage figures above represent changes in “Current PNL For Each Position” and they do not necessarily reflect the actual total return percentages for each stock over the last nine weeks. There are two stocks, Harley-Davidson Inc. (HOG) and Chesapeake Energy Corp (CHK), that have PNL figures that would put them in the “Five Best Performers” category but, because I did not hold them for the full nine week period, I decided not to include them above.

In addition, please see below for the latest “snapshot” of my simulated portfolio:

October 20 - October 24

October 20 - October 24

  • Note #1: Numbers as of October 24, 2014.
  • Note #2: 15.13% of my portfolio’s total value was in cash (as of October 24, 2014).

Seeing as earnings season is now very much underway, below is a quick snapshot of the few stocks that have reported earnings since August 18th:

LGR Newsletter Volume I, Issue 19 Image #7

  • Note #1: All of the performance figures use the stock’s closing price before the earnings report came out.
  • Note #2: Please understand that the data above is very limited, and there were many other factors (not listed) that contributed to each stock’s performance after it released its earnings report.
  • Note #3: Bed Bath & Beyond, Inc. (BBBY) and Smith & Wesson Holding Corporation (SWHC) reported fiscal second quarter (FQ2) and fiscal first quarter (FQ1) earnings respectively, which is why the little red tabs are in the top right hand corner of the cells for both stocks under the “Earnings Report Date” column. Although these two earnings reports were not after the “unofficial start to Q3 earnings season” (i.e. Alcoa’s earnings report date – October 08, 2014), they were still after August 18th so I decided to include them.

Conclusion: I am relatively happy with my portfolio’s performance over the last nine weeks because I was able to achieve my objective in that my portfolio outperformed the S&P 500 on the downside (no small feat!). My portfolio’s sector allocation, cash balance, and performance all reflect my view on the market (currently bearish) so I am not surprised that my portfolio has begun to underperform the S&P 500. I will continue to hold a large portion of my portfolio’s total balance in cash until I believe that it is the right time to deploy that cash (15.13% of my portfolio’s total balance was in cash as of 10/24/14). I am managing my simulated portfolio as though it was real money, and I would not want to risk my money (or anyone else’s money) by being excessively long equities at their currently high valuations. I am currently managing my portfolio with a mindset that I want to “preserve” my portfolio’s balance, and I am not so worried about underperforming the S&P 500 on the upside.

 

Write-Up: Updates On Recent Predictions

I provide below key updates on three of my prior predictions – HOG, and LTM.  Each summary provides my original prediction and investment thesis, together with a discussion of the stock’s progress since the prediction was made.

Harley-Davidson, Inc (NYSE: HOG)

  • Original Prediction (article): http://www.lgranalytics.com/volume-i-issue-18-part-one/
  • Date Prediction Was Made: October 13, 2014
  • Length Of Prediction: 1-2 years
  • Long or Short: Long (bullish)
  • Security's Price When Prediction Was Made: $56.49 (closing price on October 13, 2014)
  • Ideal Entry/Exit Price: HOG's opening price the following day (turned out to be $56.74)
  • Price Target (or expected percentage return): $68 (+20.44%) (12-month price target)
  • Performance Since Prediction Was Made: $63.35 (+11.65%) (closing price on October 24, 2014)

Investment Thesis for HOG:

  1. HOG dominates the motorcycle industry; its 50%+ U.S. market share increased steadily over the past five years and is near its all-time high, and this increase is highest with all-important young and foreign customers.
  2. HOG leveraged the Great Recession through a major restructuring that significantly increased productivity and reduced costs, while continuing to return value to shareholders.
  3. Economic recovery and improving consumer confidence will lift HOG going forward, in both U.S. and foreign markets.
  4. HOG is currently trading at a discount to its historical average valuation multiples, providing significant upside for long term investors.

Summary of HOG’s Recent Performance:

An increase of 11.65% to $63.35 (the closing price on October 24, 2014), since my article was published, reflects the market’s positive response to HOG’s release of its third quarter results on October 21st (pre-market). As one can see from the data in the earnings report table at the end of the “Portfolio Update section, HOG beat both Wall Street’s EPS and Revenue estimates by a healthy margin and the company proceeded to close 7.31% higher than it had the day before. While HOG’s EPS and revenue results were better than expected, they still declined by a slight amount year-over-year (y/y) due to lower shipment numbers to dealers. Although HOG’s shipment numbers weren’t too strong its retail sales numbers picked up the slack, and it was reported that “World-wide retail sales at Harley dealers in the latest quarter grew 3.8% from a year earlier, a performance that analysts considered strong because 2013’s third quarter was unusually robust, benefiting from the introduction of the Rushmore line of motorcycles. The latest figures also were a huge improvement from the second quarter, when retail sales were flat.” The figures showed the largest improvement in Asia, with “the number of Harleys rolling out of dealerships in the recent quarter [rising] 28 percent in Asia (minus Japan), 7 percent in Latin America, 3 percent in the U.S., and 2 percent in Europe.” Harley-Davidson’s CFO, John Olin, reported that the euro’s recent fall against the USD hurt the dollar value of HOG’s sales in the Eurozone, which make up approximately 12% of HOG’s total sales, and “if currency values stay around current levels, the stronger dollar will reduce fourth quarter revenue by 1.5% to 2%.”

The effect of HOG’s recent recall on earnings was largely muted, and roughly in-line with what I had expected it to be. I had that the recall may cost around $10-12 million, but one source placed it at $14 million. This one-time cost hurt HOG’s profit and contributed to HOG’s decline in EPS (y/y). Wall Street analysts had clearly priced in a larger cost for the recall, but very few financial news websites bothered to mention the recall at all. I will say that it is amazing how quickly the financial media can turn from bullish to bearish; before HOG reported earnings most financial news websites were fairly negative about the company’s prospects, but on the day that HOG beat earnings expectations there were so many positive news articles written about the stock that I can’t even find the old negative reports on the “Stocks” app on my iPhone anymore.

 

Life Time Fitness Inc. (NYSE: LTM)

  • Original Prediction: A 250-word excerpt from my Seeking Alpha PRO article on LTM can be found HERE. I wrote a follow-up article on LTM after its board announced it is considering converting its real estate assets into a REIT. That second article can be found HERE.
  • Date Prediction Was Made: March 17, 2014, and then reiterated on August 13, 2014
  • Length Of Prediction: 3 years; shortened to 12 months when prediction was reiterated
  • Long or Short: Long (bullish)
  • Security's Price When Prediction Was Made: $48.49 (LTM's opening price on March 18, 2014) Reiterated at $39.55 (LTM's closing price on August 13, 2014, and opening price on August 14, 2014)
  • Ideal Entry/Exit Price: $48.49 and then $39.55 for reiterated outlook
  • Price Target (or expected percentage return): Reiterated outlook gave a price target of $53 (34% higher than $39.55)
  • Performance Since Prediction Was Made: LTM closed at $52.51 on October 24, 2014 (+8.29% over original target, +32.77% over reiterated outlook)

Investment Thesis for LTM (from Seeking Alpha PRO article)

  1. Life Time Fitness is an excellent value stock poised for upside of 30-40% over the next twelve months.
  2. LTM strongly differentiates itself from its competitors by creating high barriers to entry in an industry that typically has few such barriers.
  3. As one of two publicly traded gym companies, LTM has experienced solid growth over the last five years and presents the best investment opportunity in the industry.
  4. The leisure industry benefits significantly in an improving economy, and LTM is well-positioned to leverage these positive economic tailwinds, with long-term growth potential.

Summary of LTM’s Recent Performance

An increase of 32.77% to $52.51 (the closing price on October 24, 2014), since I reiterated my outlook on August 13, 2014, reflects the market’s response to LTM’s public statement regarding the potential of a REIT spin-off. If you would like to learn more about how a REIT spin-off works, and how LTM’s REIT spin-off will likely work if the company decides to go through with it, then please check out my follow-up article on LTM.

LTM reported Q3 2014 earnings on October 23, 2014 (pre-market), and beat EPS estimates while missing revenue estimates. I’m willing to bet that investors didn’t even look twice at LTM’s financial performance (after they saw that LTM had incurred expenses related to the REIT spin-off exploration), and all they really focused on was LTM’s earnings call where they hoped news of the REIT spin-off would finally be released. Investors didn’t need to wait long, and only a few minutes into the earnings call (after having finished going over basic financial performance metrics) CEO Bahram Akradi made the following statement:

“Finally, I know many of you are very interested in the status of our exploration around the creation of the REIT. We are moving fast on all the tasks and analysis required to make a formal detailed proposal to our Board of Director as soon as possible, and we will provide updates when we believe it is appropriate or necessary. We remain highly confident in our ability to successfully execute the transaction.” – Seeking Alpha (LTM’s Q3 2014 Earnings Call Transcript)

The word “REIT” was mentioned 11 more times in the earnings call transcript, but besides from mentioning that “for the quarter, G&A expense increased 10 basis points versus last year third quarter as a percentage of revenue... due to REIT exploration expenses” LTM’s management team said that they have no other information to provide at this time. It seems as though Mr. Akradi’s statement about how LTM’s management team is “…highly confident in [its] ability to successfully execute the transaction” was enough to make investors happy, and LTM broke out of the tight consolidation range that it had been trading in since early September by rallying 6.55% during the day

LTM continued its climb on Friday, rising an additional 3.16%, and came within a $0.33/share of reaching my $53 price target. I believe my initial PT for LTM has been successfully reached, and I now view LTM as a HOLD with a price target at $56, prior to an official REIT spin-off approval announcement, and then $60 if the REIT spin-off is approved.

If you have any questions about this Issue of my Financial Newsletter please fill out the form below. I also appreciate receiving any comments you might have about what you just read, and I encourage you to send me ideas for topics that you would like to see me write about in the future. Thank you for reading! 

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