Election Aftermath & Latest Portfolio Reviews
James Cloonan did not perform any portfolio reviews this month, so there are no changes to either the AAII Model Shadow Stock Portfolio or AAII Model Fund Portfolio.
Presidential politics and mixed economic data played a key role in the stock market in October. By now we know that Donald Trump will take office as the 45th president of the United States on January 20, 2017. Based on most polls, this was a come-from-behind victory over Hillary Clinton. Trump’s performance also helped Republicans maintain majorities in both the U.S. House of Representatives and U.S. Senate, albeit by narrower margins in both.
In the aftermath of the election results, global markets saw significant swings, first to the downside and then to the upside. As AAII Journal editor Charles Rotblut wrote, “Big, unexpected events commonly trigger strong emotional reactions.” The key is to not to allow your emotions to get the better of you. A level-headed analysis of your short- and long-term needs and goals will guide you through turbulent times.
As it turns out, though, the results of the election confirmed what has become a rather reliable market indicator. The S&P 500 fell 2.2% during the three months ended October 31. According to CFRA, since 1944, whenever the S&P 500 fell during the three-month period ended October 31 leading up to the presidential election, the incumbent person or party was replaced 86% of the time, with the sole exception being 1956. Adding in 2016’s results, this indicator’s accuracy has risen to over 90%.
October in Review
Market volatility increased and prices weakened in October as many investors took a wait-and-see approach to the stock market. According to CNBC, a survey by Spectrum Group in October 2016 found that 36% of millionaire investors planned to move to the “investment sidelines” due, in part, to the uncertainty surrounding the presidential election. That was up from 26% in September’s survey.
Just prior to the November 8 election, AAII surveyed its readers to see whether the outcome of the presidential election would change their outlook on the stock market. By an overwhelming margin—73.2% to 20.3%—respondents said that the election would not change their outlook on the stock market.
While investors indicated that the election would not impact their outlook on the market moving forward, it was apparent that investors were taking some money off the table ahead of November 8. Individual investors’ cash allocations rebounded to a five-month high in October, according to the October AAII Asset Allocation Survey. Fixed-income allocations also rose, while equity allocations declined. Cash allocations rose 0.4 percentage points, to 18.7%. This is the largest allocation to cash since May 2016. However, even with the rise, cash allocations remained below their historical average of 23.5% for the 59th consecutive month.
As of the end of October, the third-quarter corporate earnings season was going better than expected. According to FactSet, as of the end of October, the blended (actual results for companies that have reported combined with estimated results for companies yet to report) earnings growth rate for the S&P 500 in the third quarter was 1.6%, which was above the year-over-year estimated decline of 2.2% at the end of September. If the index reports growth in earnings for the quarter, it will mark the first time the index has seen year-over-year earnings growth since the first quarter of 2015.
October economic data was generally positive. Employment growth was solid, with 167,000 jobs added in September. In addition, hours worked and wages both increased. In addition, business confidence rose in October, as the ISM Manufacturing and Non-Manufacturing indexes both rebounded from September declines. However, durable goods orders fell in October, perhaps signaling a willingness by businesses to postpone large purchases. Finally, the first estimate of third-quarter GDP was 2.9%, well above expectations. Spurring growth were increases in exports and inventories, which were aided by the weakening U.S. dollar.
In the end, though, stocks moved lower in October, despite generally better-than-expected corporate earnings. The Vanguard market-cap weighted S&P 500 index fund (VFINX) fell 1.8% in October after clawing out a 0.01% increase in September. The Guggenheim S&P 500 Equal Weight ETF (RSP) slid 2.4% for the month, indicating that larger stocks outperformed smaller stocks in October. Contributing to this argument was the fact that the PowerShares Russell 1000 Equal Weight ETF (EQAL) fell 3.1% for October.
Looking at the S&P market-cap indexes for October, larger stocks outperformed smaller stocks. The S&P 500 index was down 1.8% in October, closing on October 31, 2016, within 2.9% of its all-time high set on August 15, 2016. The S&P MidCap 400 index fell 2.7% in October, while the S&P SmallCap 600 index lost 4.5%.
Reversing last month’s trend, value dominated growth across all market cap segments in October, as the S&P 500 Value index fell 1.5%, versus a 2.1% decline for the S&P 500 Growth index. Looking at the S&P MidCap 400 style indexes, the Value index was down 2.1% versus the Growth index, which lost 3.3%. Lastly, the S&P SmallCap 600 Value index shed 3.7% in October while the Growth index was down 5.2%.
Looking at sector performance in October, it was evident that investors went “risk off” in search of yield, even though yields on U.S. Treasuries climbed during the month. The two-year Treasury Note yield rose to 0.84% in October from 0.75%, while the 30-year Treasury Bond yield rose to 2.6% from 2.3%. According to SectorSPDR.com, only three of the 11 S&P Select SPDR ETFs were up in October: Financial Services (XLFS) and Financials (XLF), both of which were up 2.3%, and Utilities (XLU), which gained 0.9%. The prospect of rising interest rates also helped boost financial stocks in October, which typically generate higher earnings as interest rates rise. As of the close of the market on November 10, the CBOE FedWatch Tool had the probability of a rate increase following December’s Federal Open Market Committee (FOMC) at 71.5%.
Presumably expecting a Clinton victory in November, Health Care (XLV) was the weakest sector in October, losing 6.5%. Following close behind was Real Estate (XLRE), which finished the month down 5.5%.
Model Shadow Stock Performance & News
The AAII Model Shadow Stock Portfolio, which is a real-money portfolio of micro-cap value stocks, fell 3.6% in October. Breadth for the portfolio was negative, as only 10 of the 30 holdings in the Shadow Stock portfolio posted gains for the month. One of the Shadow Stocks—VOXX International (VOXX)—climbed more than 15% in October, posting a 37.1% gain. On the other hand, two saw losses in excess of 15%. Overall, the Model Shadow Stock Portfolio’s performance was roughly in line with the DFA U.S. Micro Cap Fund (DFSCX), which was down 3.5% in October.
Here are some news highlights from October for the current holdings in the actual AAII Model Shadow Stock Portfolio:
|•||AV Homes Inc. (AVHI) announced results for its third quarter ended September 30, 2016. Total revenue for the quarter increased 34%, to $205.4 million, from $153.8 million in the same period last year. Net income and diluted earnings per share increased to $11.9 million and $0.49 per share, respectively, compared to net income of $5.5 million and $0.25 per share year over year. The I/B/E/S consensus earnings estimate for the third quarter was $0.35 per share.
|•||CSS Industries Inc. (CSS) announced results for its second fiscal quarter ended September 30, 2016. Net sales were $101.3 million during the quarter compared to $111.5 million during the same period last year, a 9% decrease. The decrease is largely attributable to timing, as a higher portion of the company’s known Christmas 2016 sales volume is with retailers who have requested product shipments during the third fiscal quarter. Earnings per diluted share during the quarter was $0.77, 37% below the second quarter of fiscal 2016 and below the I/B/E/S consensus estimate of $1.27 per share.
|•||Flexsteel Industries, Inc. (FLXS) reported first-quarter fiscal-2017 financial results. Net sales were $112 million for the quarter ended September 30, 2016, 11.4% below the first quarter of 2016. The company’s adjusted earnings per share fell 17.6%, to $0.61 per share, compared to $0.74 per share during the first quarter of fiscal 2016.
|•||Global Power Equipment (GLPW) confirmed that it expects to become current with its Securities and Exchange Commission (SEC) reporting obligations no later than December 31, 2016. Becoming current includes the filing of an Annual Report on Form 10-K for 2015 (with audited restated consolidated financial statements and related information for 2014 and 2013 and unaudited restated selected financial data for 2012 and 2011). Becoming current with the SEC also includes filing three 2016 Quarterly Reports on Form 10-Q.
|•||Marlin Business Services (MRLN) reported third-quarter 2016 financial results. The company reported adjusted earnings of $0.35 per share, 27.9% below the third-quarter of 2015 and below the I/B/E/S consensus estimate of $0.36 per share. Net interest income and fee income after provision for credit losses was $17.56 million, 2.1% above the third quarter of 2015. Total third-quarter origination volume was $128.3 million, up 25.9% year over year.
|•||PC Connection Inc. (CNXN) reported third-quarter 2016 adjusted earnings of $0.54 per share, excluding non-recurring items, up 8% year over year. Third-quarter revenue rose 4.1%, to $708.5 million, compared to the same period last year. Gross margin increased by 29 basis points to 15.4% due to strong performance in advanced technology solution categories, which contributed to a 14.7% increase in gross profit.
|•||PCM Inc. (PCMI) reported financial results for the third quarter of 2016. The company reported non-GAAP earnings of $0.52 per share, above the I/B/E/S consensus estimate of $0.31 per share and above 2015 third-quarter earnings of $0.12 per share. Third-quarter revenue grew 44.5% to $584.9 million, compared to the same period last year. Looking ahead to the fourth quarter, the company projects non-GAAP earnings per share to be in the range between $0.40 and $0.48 and revenues to range from $565 million to $580 million.
|•||Rocky Brands Inc. (RCKY) announced financial results for its third quarter ended September 30, 2016. Third-quarter net sales increased 4.6% to $73.2 million compared to $70 million in the third quarter of 2015. The company reported adjusted earnings per share of $0.16 per share, below the I/B/E/S consensus estimate of $0.17 per share.
|•||Ultra Clean Holdings Inc. (UCTT) reported its financial results for the third quarter ended September 23. Total revenue for the third quarter of 2016 was $146.2 million, an increase of 19% compared to the same period a year ago. Non-GAAP earnings were $0.17 per share, or $5.7 million, beating the I/B/E/S consensus estimate of $0.12 per share. Looking forward, the company expects revenue to be between $146 million to $151 million and non-GAAP net income per diluted share to be in the range of $0.17 to $0.20.
|•||VOXX International Corp. (VOXX) reported net sales for the fiscal-2017 second quarter of $159.3 million, an increase of $5.1 million, or 3.3%, compared to the same period a year ago. The company reported second-quarter 2017 adjusted earnings of $0.12 per share compared to a loss of $0.18 per share in the second quarter of 2016. This I/B/E/S consensus estimate projected VOXX to have a loss of $0.01 per share.|
Year to date, the AAII Model Shadow Stock Portfolio is up 10.1%, compared to the S&P 500 as represented by the Vanguard 500 index fund (VFINX), which is up 5.8%. The DFA U.S. Micro Cap Fund (DFSCX) is up 6.7% for the 10 months ended October 31.
Since its inception in 1993, the AAII Model Shadow Stock Portfolio has a compound annual average return of 15.3% versus the Vanguard 500 Index fund, which as gained 8.9% a year, on average, over the same period.
There are no changes in the Model Shadow Stock Portfolio this month.
Fourteen companies passed the Individual Investor’s Shadow Stock Screen (*IISSP) in Stock Investor Pro as of October 31, 2016. This was an increase from 13 stocks that passed at the end of September. Of these 14 passing stocks, three are in the actual Model Shadow Stock Portfolio—AV Homes Inc. (AVHI), Beazer Homes USA (BZH) and Key Tronic Corp. (KTCC). One current holding, TravelCenters of America (TA), fell off the currently qualifying list from last month as its 26-week relative strength ranking fell below the 50% minimum required for initial consideration for the Model Shadow Stock Portfolio. However, weakening relative strength is not used as a sell signal for the portfolio. Qualifying companies are those held in the Model Shadow Stock Portfolio that currently meet the initial purchase rules. (They are designated as “qualified” in the notes column of the Model Shadow Stock Portfolio table.)
Two stocks are currently on probation for generating negative normalized earnings over the last 12 months (trailing four quarters). Ducommun Incorporated (DCO) has been on probation since reporting its third-quarter 2015 earnings. However, it has yet to report negative quarterly earnings in any subsequent quarter while its trailing earnings have remained negative, which is why it has remained on probation. The L.S. Starrett Company (SCX) saw its trailing 12-month earnings go negative following its fiscal fourth quarter that ended June 30, 2016. As a result, this company is also on the earnings probation list.
The next quarterly review of the AAII Model Shadow Stock Portfolio will take place in early December. We will inform members of changes to the AAII model portfolios via special email alerts and web notices. Be sure you are signed up to receive these free notices by logging into AAII.com, going to www.aaii.com/email and selecting the Model Portfolios Update email. Any changes that may be made will also be discussed in Jim Cloonan’s Model Portfolios column in the January 2017 issue of the AAII Journal.
Click here to see the current AAII Model Shadow Stock Portfolio purchase and sell rules. The size and value limits are subject to revision depending on prevailing market conditions.
Model Fund Portfolio Performance
The AAII Model Fund Portfolio dropped 3.0% in October, compared to a 1.8% loss for the SPDR S&P 500 ETF (SPY). The Model Fund Portfolio has gained 6.8% year to date, while the SPDR S&P 500 ETF is up 5.8%. Since its inception in June of 2003, the Model Fund Portfolio has a compounded annual average return of 8.2%, while the SPDR ETF has an 8.1% average annual return over the same period.
There were no changes to the Model Fund Portfolio this month. The Model Fund Portfolio was discussed in Cloonan’s Model Portfolios column in the November AAII Journal. There, Cloonan also answered questions regarding the new Level3 Portfolio. The next quarterly review of the Model Fund Portfolio will take place in February 2017.
Click here to learn about how the current mutual funds and exchange-traded funds (ETFs) in the AAII Model Fund Portfolio were chosen.