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Mail call: Flare-out growth, Mr. P and the S&P
Modelman finds a bubble-era screen still working well, gets the latest from his eerily accurate market prognosticator and fends off the satellite worshippers yet again.
By Jon D. Markman
SuperModels columnist Jon D. Markman is on his second week of vacation, so he has turned the column over to his alter ego, Modelman, to answer reader mail. The letters are edited for grammar and may be condensed.
Hey Modelman: A lot of work went into designing and testing the Flare-Out Growth trading system. How has it fared over the last three years? I'm particularly interested in the monthly model.
-- Bill Reed
Hey Modelman: I would like to know if the Flare-out Growth momentum screens are available for readers now as you have provided in the past.
-- Silvio Ramirez. Valencia, Venezuela
Modelman: Longtime readers will recall that Flare-Out Growth trading system was the cornerstone of the SuperModels column back in the Bubblemania years of 1997-2000. After extensive testing and achieving excellent real-time results with monthly three-stock portfolios, I also described FOG in great detail in the first edition of my book, Online Investing, in 1999, and then updated it in 2001 with a timing component in the second edition of the book. The system uses the Screener at MSN Money to look for high-momentum stocks that are taking a breather before shooting back up again -- a pattern that chartists call a bull flag. The timing overlay simply states that the model is in effect only if the Nasdaqs 15-day moving average is higher than its 40-day moving average. Thus constrained, the model was only sporadically in effect during the bear market period of 2000 through 2003. It got caught in a serious whipsaw in 2002, losing a quarter of its value in a short time, but made up all that ground and more this year. In my columns, I have regularly identified FOG stocks in the Fine Print section whenever the model has gone into effect; for one, see the bottom of my April 9 column. Those five stocks are up 84% through August 15, versus a 14% rise in the S&P 500 ($INX) and 25% rise in the Nasdaq Composite ($COMPX).
I asked Jeff Mindlin, an analyst at Camelback Research Alliance (an affiliate of my fund and creator of MSN's StockScouter system), to rerun a historical test of the FOG system based on the criteria shown on Page 30 of the second edition of Online Investing. His study, detailed in the table below, confirms that the system has worked well since 1990, advancing 58% on average per year with a standard deviation of 40%. It scored a 70% gain in 2000, a 6.7% gain in 2001, a 23% loss in 2002, and a 35% advance this year through July. At the moment, the top five stocks are Primus Telecommunications (PRTL, news, msgs), Westell Technologies Inc. (WSTL, news, msgs), Concur Technologies (CNQR, news, msgs), Avaya Inc. (AV, news, msgs) and American Tower (AMT, news, msgs). Heres the screen. The parameters are:- Market cap > $100 million
- average daily volume > 1.5 million per day
- previous 1 month return > 0% and < 25%
- previous 3 month return > 0% and < 25%
- rank by FOG Index (previous 12-month % return minus previous three-month % return minus 3 times the previous 1 month % return) = high as possible.
| Flare-Out Growth: 1990 to 2003 | | Year | FOG Top 5 | S&P 500 | Nasdaq | | 1990 | -8.48% | -0.5% | -12.2% | | 1991 | 141.07% | 26.3% | 56.9% | | 1992 | 39.70% | 4.5% | 15.5% | | 1993 | 56.02% | 7.1% | 14.7% | | 1994 | 7.23% | -1.5% | -3.2% | | 1995 | 118.14% | 34.1% | 39.9% | | 1996 | 24.68% | 20.3% | 22.7% | | 1997 | -1.68% | 31.0% | 21.6% | | 1998 | 8.71% | 26.7% | 39.6% | | 1999 | 73.36% | 19.5% | 85.6% | | 2000 | 70.58% | -10.1% | -39.3% | | 2001 | 6.72% | -13.0% | -21.1% | | 2002 | -23.29% | -23.4% | -31.5% | | 2003 | 35.42% | 12.6% | 29.9% | | Feb-03 | 0.52% | -1.7% | 1.3% | | Apr-03 | 7.30% | 0.8% | 0.3% | | May-03 | 15.25% | 8.1% | 9.2% | | Jun-03 | 4.84% | 5.1% | 9.0% | | Jul-03 | 3.91% | 1.1% | 1.7% | | Annualized Mean Return | 58.4% | 9.5% | 21.1% | | Annualized Sharpe Ratio | 1.3404 | 0.3438 | 0.6796 | | Annualized Standard Deviation | 40.4% | 15.0% | 24.7% | | # months with negative return | 28 | 38 | 35 | | # months with positive return | 66 | 56 | 59 |
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Hey Modelman: I am a regular reader of your column, and enjoy your insights into emerging trends. I am interested in taking a position that plays on the IT outsourcing to India trend. I am specifically interested in Cognizant Technology Solutions (CTSH, news, msgs), one of your 20 picks for the second half. I would be interested in your views on the companies, as well as the bigger picture view of this trend.
-- Andrew Larsen
Modelman: The trend toward outsourcing Fortune 1000 companies information-technology services, including application development, to lower-cost workers in India and elsewhere will only strengthen in years to come. U.S. politicians, labor unions and politicians will continue to protest, but domestic companies facing low nominal growth rates will find the urge to boost earnings by trimming data-processing, accounting and other IT-related expenses irresistible. Cognizant, which commands a phenomenal network of Indian technology workers, has been particularly successful so far at amassing U.S. and European financial-services-industry clients, and is now expanding into retail, manufacturing and health care. However, as its clients have become increasingly savvy about the number of reliable companies capable of handling jobs in India, such as Wipro (WIT, news, msgs) and Infosys Technologies (INFY, news, msgs), pricing has become an issue and margins may suffer. Cognizant already is expensive, considering it does not actually make anything unique. Investors enamored with its growth rate should thus pause to reflect why it merits a price-to-sales multiple of better than 6, while domestic competitors such as Computer Sciences (CSC, news, msgs) and Electronic Data Systems (EDS, news, msgs) get sales multiples of less than 1. I listed it as a second-half pick because of its high StockScouter rating, but conservative investors should try to pick it up only on significant dips in price.
Hey Modelman: Why must you continue to hammer away at Sirius Satellite Radio (SIRI, news, msgs)? You are forcing the stock to go down! Are you selling short, hoping to buy it later at a lower price? You have already caused substantial losses for many stockholders. Remove all your articles. Work on some other stock you dont like for whatever personal reasons.
-- Charlie Capozzoli
Modelman: Little did I know, when I first wrote about Sirius, that I was wading into a cult of satellite worshippers. After writing this column and this column, I received dozens of e-mails complaining that I must be trying to sandbag the stock for personal reasons. Listen up, moonbeams: The appearance of an article does not move a stock with 900 million shares outstanding -- at least for more than a few hours, or at most a day. If an article adds a bit of new information to the knowledgesphere, it is quickly absorbed by market forces and neutralized by traders with contrary opinions. Sirius shares have declined lately because investors ardor for momentum stocks generally has waned in the summer. They are also still very pricey for a company that is not yet growing revenue and free cash flow as fast as bulls expected. One of the big problems for Sirius and its competitor XM Satellite Holdings (XMSR, news, msgs) is that -- unlike cable or satellite television, or the Internet for that matter -- they do not offer any unique content that is so outstanding consumers feel they must have it. Even in their earliest days, cable and satellite TV offered a compelling blend of sex, movies, sports and news to consumers tired of bland, limited network and local fare; the Internet offered sex, e-mail, chat and search. Satellite radio offers better radio, but nothing so necessary to the conduct of modern life that it has reached enough consumers gotta-have-it lists. Good as it is, it lacks sufficient word-of-mouth buzz to drive an epidemic of want. (The poetic profanity of its uncensored hip-hop music streams apparently doesnt stimulate the same broad appeal as raw pornography on cable or the Web.) Sirius and XM need a major draw that consumers cant get anywhere else: Maybe an exclusive radio sports contract (make every baseball, basketball or football game in the country available?), or an exclusive radio personality contract (Howard Stern or Rush Limbaugh?) or an exclusive record-industry deal to make new songs by leading artists only available on satellite radio for some period of time. On the other hand, its possible that just providing a better radio experience will be enough. And the best news for shareholders is that both companies have raised so much cash this year in secondary stock offerings and convertible-bond deals that there are no extinction-level events on the horizon that threaten to send shares to zero.
Hey Modelman: Your article on June 11 quoted Mr. P as saying the market would top out between then and June 17, and go down as much as 20%, or to the March lows. The S&P 500 topped out on June 17 and is now down 4.6%. It looks like Mr. P may have called another one. Whats his current view?
-- James Farley
Modelman: That was indeed one of Mr. Ps best calls: The S&P 500 hit 1,015.26 on June 17, and has not eclipsed that level since. If you recall, the market was going straight up at the time, and bears were throwing in their soggy towels. I got several e-mails then from readers crowing that the anonymous hedge fund manager I call Mr. P was finally going to be proved wrong. Yet his three-year record of alternately bullish and bearish pronouncements via my column is still unblemished. He is currently bullish on bonds; bearish on stocks; bullish on wheat and soybeans; and bullish on natural gas. More broadly, he notes that taxes are rising dramatically at the state level at the same time jobs are leaving the United States like a stanza in a Bruce Springsteen song. He believes this exodus is seriously eroding President Bushs base in the South and Midwest, providing an opening for Hillary Clinton to join the race for the presidency in 2004. He says the economy right now is held up only by the last remnants of mortgage re-fis and tax cuts -- and the only companies truly doing well are cyclicals selling to China. He notes that 11% unemployment in the European Union limits its consumers ability to buy more from U.S.-based multinationals. He notes that virtually all of the recent increase in U.S. industrial production has stemmed from an increase in the use of utilities due to the hot weather -- not factory production. (The media is out to lunch on this, he says.) As for his negative view on stocks, the 30-year veteran says, I have never seen so many people turning their backs on fundamentals and betting on hope. Eight months ago, they saw no hope. Now thats all they see. Its a Prozac market. He also notes that with bond yields up, the pressure on pension funds to boost returns by buying stocks is off. You can buy a 30-year bond at 5.52% and finance it with short-term debt at 1%; thats a 4.52-percentage-point positive carry -- the widest spread on Treasurys in decades. With risk-free returns like that, he remarks, who needs the risk of lending money or buying stocks?
Hey Modelman: I have two questions about how StockScouter works: How often are the ratings updated and how much of the overall ratings have to do with the four-letter-grade ratings?
-- Mike Hooper
Modelman: StockScouters numerical ratings on individual stocks are updated daily. StockScouters sector, investment style and market-cap preferences are updated weekly on Mondays here. The numerical ratings are a blend of two components: First, a core score, which is essentially an average of A-F letter scores for each companys fundamental, ownership, valuation and price action. Second, a risk score, which is a measure of six-month price volatility. Stocks rated 10 have both the best core scores and the least historic price volatility. This combination is a distinguishing characteristic of the StockScouter system. While most other rating systems try to adjust for risk at the portfolio level (e.g. via sector diversification), StockScouter attempts to adjust for risk at the individual stock level. For an example of a company that has rated a 10 for most of the past two years, take a look at Doral Financial (DRL, news, msgs), a small regional bank in Puerto Rico: Solid fundamental business performance combined with non-volatile price performance.
Fine Print
The best book I read on vacation was Its Not About the Bike: My Journey Back to Life, cyclist Lance Armstrongs memoir. If you compete in any sport or have been touched personally by cancer, youll find the book inspirational and insightful. . Standard & Poors kicked McDermott International (MDR, news, msgs) out of the S&P 500 Index yesterday, citing its low market capitalization. The replacement is Medco, a prescription-drug-benefit provider being spun out by Merck (MRK, news, msgs). As I have reported numerous times (e.g., here), stocks kicked out of the benchmark index tend to outperform both the index and their replacements. Investors think of the S&P 500 as a big-cap index, but McDermott has flopped around with a market cap under $1 billion for years. Its now around $274 million, which makes it pretty much a microcap. As of Monday, August 18, there are still six other companies with market caps under $1 billion in the S&P 500: Tupperware (TUP, news, msgs), Power-One (PWER, news, msgs), CMS Energy (CMS, news, msgs), Parametric Technology (PMTC, news, msgs), Visteon (VC, news, msgs) and Allegheny Technologies (ATI, news, msgs). Goodyear Tire (GT, news, msgs) and Thomas & Betts (TNB, news, msgs) are close to the line. Heres the screen. Learn more about Cognizant Technology Solutions at its Web site.
Jon D. Markman is senior investment strategist and portfolio manager at Pinnacle Investment Advisors. While he cannot provide personalized investment advice or recommendations, he welcomes column critiques and comments at jdm@oddpost.com. At the time of publication, he had a long position in Sirius Satellite Radio, but positions can change at any time.
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