Stronger-Than-Expected Corporate Earnings, Economic Data Propel U.S.
Stocks in July


U.S. stocks kicked off the second half of 2016 with strong gains in July. Having absorbed the shock caused by the EU referendum (Brexit) at the end of June, corporate earnings and economic data were the primary drivers of stock prices in July. Through the end of July, 63% of S&P 500 companies had reported their quarterly earnings and the blended (reported and estimated) earnings decline of 3.8% was better than the anticipated 5.5% decline as of June 30. In addition, 71% of S&P 500 companies had reported a positive earnings surprise—their actual results exceeded the consensus estimate from analysts. This is above the five-year average of 67% positive surprises.

July also saw a spate of mostly positive economic news, as the U.S. economy continued its slow and steady trajectory. The manufacturing and service sectors saw better-than-anticipated growth and the June jobs data exceeded expectations. Furthermore, the residential and commercial real estate markets continued their steady growth, and there was a surprising increase in retail sales. One of the few bumps in the road was second-quarter GDP growth, which initially came in at 1.2% on an annualized basis, falling well short of consensus forecasts.

With the second-quarter earnings season winding down, the markets will shift attention to the September meeting of the Federal Open Market Committee. After leaving interest rates unchanged in June, many economists doubt that the Federal Reserve will increase rates this year, especially in the aftermath of the Brexit vote. Currently, the CME Group FedWatch is estimating a 12% probability that the Fed will increase interest rates in September.

The Vanguard 500 Index fund (VFINX) posted a 3.7% gain in June and the S&P 500 index closed just 0.07% below its all-time high of 2,175.03.

All segments of the stock market participated in July’s upswing. Small- and mid-cap stocks outperformed large-cap stocks during the month. The S&P SmallCap 600 index gained 5.1% during July, while the S&P MidCap 400 added 4.3%. The equal-weighted Guggenheim S&P 500 ETF (RSP) was up 4.2% in July and is up 10% year-to-date, while the market-cap weighted SPDR S&P 500 ETF (SPY) was up 3.7% in July and is now up 7.6% for the year.

Growth-oriented stocks performed better than value-oriented stocks in the mid- and large-cap segments in July. The S&P MidCap Growth index rose 4.5% in July compared to a 4.1% gain in the S&P MidCap 400 Value index. The S&P 500 Growth index climbed 4.7% in July compared to a 2.7% gain for the S&P 500 Value index. Among small-cap stocks, however, value edged out growth, as the S&P SmallCap 600 Growth index was up 5.0% and the S&P SmallCap 600 Value index gained 5.2% for the month.

Looking at the sectors within the S&P 500, the top two performing sectors were information technology (up 7.9%) and materials (up 5.1%). In contrast, the weakest sectors were energy (down 1.9%) and consumer staples (down 0.7%).

In the Model Shadow Stock Portfolio, 22 out of 30 stocks were up in July.

Here is a sampling of relevant news items for the companies currently in the Model Shadow Stock Portfolio from July:

Global Power Equipment Group (GLPW)
Global Power announced that it anticipates that on or about September 30, 2016, it will file an annual report on Form 10-K for its 2015 fiscal year, which will include its annual and quarterly consolidated financial statements and related consolidated financial information for 2015. The 2015 Form 10-K will also include audited restated consolidated financial statements and related information for 2014 and 2013 and unaudited restated selected financial data for 2012 and 2011. The company intends to file quarterly reports on Form 10-Q, which will include the quarterly financial statements for its first and second quarters of 2016, shortly thereafter. The company plans to provide further notice once definitive dates are established for the filings for the first and second quarters of 2016. Once current on its filings with the Securities and Exchange Commission, the company will host a teleconference to bring investors up to date with the status of its businesses and go forward strategy. The company also plans to reapply for a listing on the New York Stock Exchange.
Key Tronic Corp. (KTCC)
Key Tronic Corp. announced financial results for its fourth quarter ended July 2, 2016. Fourth-quarter total revenue was up 3%, at $123.9 million, from $120.4 million a year ago. Net income for the fourth quarter was $2.1 million, or $0.20 per diluted share, compared to $2.3 million, or $0.21 per diluted share, in the fourth quarter of 2015. This was a positive 11.1% surprise over the I/B/E/S consensus earnings estimate of $0.18 per share. For the coming first quarter of fiscal 2017, Key Tronic expects to report revenue in the range of $117 million to $122 million, and earnings in the range of $0.16 to $0.21 per diluted share.
Marlin Business Services (MRLN)
Marlin Business Services reported second-quarter financial results for the period ended June 30, 2016. Total second-quarter originations were $121.5 million, up 30% from a year ago. Second-quarter net income was $4.5 million, or $0.36 per diluted share, an 8% year-over-year increase from $4.15 million, or $0.32 per diluted share. Earnings were 9.1% above the I/B/E/S consensus estimate of $0.33 per diluted share. For its full-year business outlook, Marlin expects its origination volume to be in the range of $460 million to $480 million; credit quality is expected to remain strong, with a continuation of recent positive trends; and full-year return on equity is expected to continue to grow as new strategic initiatives gain traction and scale.
PC Connection, Inc. (PCCC)
PC Connection released its financial results for the second quarter ended June 30, 2016. Net sales for the quarter increased 7.7%, to $676.2 million, compared to $627.6 million a year ago. Adjusted net income for the second quarter increased by 7.1%, to $13 million, or $0.49 per diluted share, compared to the adjusted net income of $11.79 million, or $0.44 per diluted share, a year ago. This was above the I/B/E/S consensus earnings estimate of $0.463 per share.
PCM Inc. (PCMI)
PCM reported second-quarter 2016 adjusted earnings per share of $0.66, up 154% from a year ago and above the I/B/E/S consensus estimate of $0.38 per share. Second-quarter revenue grew 21%, to $581 million. Looking forward, PCM expects third-quarter sales to be in the range of $545 million to $560 million, and adjusted earnings per share to be between $0.29 and $0.35. Guidance for full-year adjusted earnings per share is expected to be in the range of $1.51 to $1.64 on estimated 2016 net sales of $2.2 billion to $2.23 billion, or a sales increase of 32% to 34%.
Rocky Brands Inc. (RCKY)
Rocky Brands reported a second-quarter 2016 loss of $0.23 per diluted share, or $1.8 million, a decline of 188% from a year ago and below the I/B/E/S consensus earnings estimate of $0.24 per share. Second-quarter revenue fell 8.8%, to $62.6 million, compared to the same period last year.
Seneca Foods Corp. (SENEA)
Seneca Foods reported a fiscal first-quarter 2017 loss of $0.01 per share, or $0.1 million, down 103% from a year ago. First-quarter revenue grew 11.6%, to $252.6 million, compared to a year ago. The Gray & Company and Diana Fruit Co. acquisitions last year represent $19.7 million of the sales volume increase.
SigmaTron International (SGMA)
SigmaTron International reported fiscal-year (ended April 30, 2016) adjusted earnings per share of $0.49, up 123% from a year ago. Fiscal-year 2016 revenues grew 10%, to $253.9 million, compared to a year ago. Net income increased 131%, to $2.08 million, compared to the prior fiscal year. Fourth-quarter 2016.
Ultra Clean Holdings Inc. (UCTT)
Ultra Clean Holdings reported second-quarter 2016 adjusted earnings of $0.10 per share, a 43% increase from a year ago and above the I/B/E/S consensus estimate of $0.075 per share. Second-quarter revenue increased 10.4%, to $129.8 million.
VOXX International Corp. (VOXX)
Voxx International reported a first-quarter loss of $0.18 per share, down 500% from a year ago and below the I/B/E/S consensus estimate of a loss of $0.10 per share. First-quarter revenue fell 5.4%, to $155.5 million, compared to a year ago.

Overall, the Model Shadow Stock Portfolio gained 6.2% in July and is now up 9.5% year-to-date. The DFA U.S. Micro Cap Index fund (DFSCX) gained 5.0% during July and is up 8.1% for the year. Since its inception in 1993, the Model Shadow Stock Portfolio has a compound annual average return of 15.5%, while the Vanguard 500 Index fund has gained 9.0% a year, on average, over the same period.

The Model Fund Portfolio’s 6.0% gain in July compares to a 3.7% increase for the SPDR S&P 500 ETF (SPY). The Model Fund Portfolio has gained 9.1% year to date, while the SPDR S&P 500 ETF is up 7.6%. Since its inception in June of 2003, the Model Fund Portfolio has a compound annual average return of 8.5%, which is slightly better than the 8.4% return of the SPDR ETF over the same period.

The new Level3 Passive Portfolio, which James Cloonan introduced last month, was up 4.3% in July. This surpassed the SPDR S&P 500 ETF’s gain of 3.7%. Since its inception since the end of May, the Level3 Passive Portfolio has posted a 5.7% gain, compared to the 3.9% gain for the SPDR ETF over the same period.

August Portfolio Updates

Based on current market conditions, there were no rule changes to the Model Shadow Stock Portfolio this month. Twenty-six stocks passed the Individual Investor’s Shadow Stock Screen in Stock Investor Pro as of July 29, 2016, down from 28 at the end of June. Four stocks in the actual Model Shadow Stock Portfolio qualified for purchase as of the end of July: Key Tronic Corp. (KTCC), L S Starrett Co. (SCX), Salem Media Group (SALM) and Willis Lease Finance Corp. (WLFC). 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.)

No stocks currently in the portfolio are approaching their value or size limit. However, three stocks are currently on probation for producing negative normalized earnings over the last four quarters: CDI Corporation (CDI), Ducommun Incorporated (DCO) and LMI Aerospace Inc. (LMIA). If any of these companies have another quarter of negative earnings prior to 12-month normalized earnings becoming positive, they will be sold at the next portfolio review.

The next quarterly review of the AAII Model Shadow Stock Portfolio will take place in September. Any changes to the portfolio will be highlighted in the September AAII Model Portfolio Update email and in Jim Cloonan’s quarterly model portfolio commentary in the October issue of the AAII Journal.

Click here to see the current purchase and sell rules. The size and value rules are subject to revision depending on prevailing market conditions.

There are no changes in the holdings of the Model Fund Portfolio this month. However, as Jim Cloonan mentions in his column in the August issue of the AAII Journal, there will be upcoming changes in the portfolio rationale, which will likely bring about changes in the holdings in the near future. The next portfolio quarterly review will occur in October and Jim Cloonan will discuss it in his column in the November AAII Journal.

Click here to learn about how the current mutual funds and exchange-traded funds (ETFs) in the AAII Model Fund Portfolio were chosen.