Robert Gay Luxury Liner October Monthly Investment Report (BKE, MXIM, HRS)

Author:  Robert Gay

Disclaimer:  Robert owns BKE, MXIM, and HRS in his Covestor Luxury Liner model.

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October 5, 2010:  The collection and analysis of the second quarter 2010 financial statements is complete now and a broad based acceleration in corporate wealth is clear. The average annual sales growth rate of the GEARS total market index is now positive and, over the past year, staged the sharpest “V” shaped improvement in the data record. Even with that unprecedented reversal, the average sales growth rate remains low and has recovered only to the cycle trough level of 2002. 

Concern about the sustainability and magnitude of the improvement may have had an influence on the stock market decline in recent months. I have taken that market weakness as an opportunity to take the Luxury Liner Model to a fully invested position and significantly net long. That strategy was designed to increase the market sensitivity of the model and the strong performance of the model during the market advance in September is testimony to the success of the change.

American public corporations are now more clearly in acceleration mode and the pattern is familiar. Historically stocks produce better investment returns than bonds when both sales growth and profit margins are rising. That dual strength in fundamentals appeared in the second quarter for the first time in many years.

The Luxury Liner model is now fully invested and there were few new financial statements reported in the month of September so transactions were few.

Traditionally American cyclical recovery is lead by companies in the consumer cyclical sector where evidence of a powerful improvement continues to build. The strong and broad improvement in the sales growth and gross profit margin of the consumer cyclicals group is of particular interest because of the high level of operating and financial leverage of the group. SG&A expenses and interest expenses continue to rise in the group during the second quarter. That has the effect of slowing the bottom line improvement relative to the top line and sets up a positive earnings surprise pattern in the sector average. The update for the retailers industry was complete in September and the top lie acceleration that began last year continued in the recent quarter both on average and more frequently. The model added to the retailer exposure this quarter but in September the only transaction was the sell for Buckle Inc.

In the past decade the Technology Sector has added a new component to the American cyclical experience. Since the steep share price decline of the technology group in 2000 through 2002, shares on average have been flat and recently weak taking valuation to near the 2008 low and near to the lowest valuation level since 1998. In the second quarter, sales growth was broadly strong and the profit margin advanced. The Luxury Liner added to technology positions with new buy transactions for Maxim Integrated Products and sold the position in Harris Corp.

Experience shows that investment decisions should be made as the market presents opportunities and in the last month, with share prices strong, more opportunities were sell decisions. That has taken the Luxury Liner model to a fully invested net long position and enhanced the sales growth characteristics of the model on average. If the stock market continues to advance in October, I intend to shift my focus to sell decisions. The last of the short positions has been covered now and I have converted completely to an ETF hedge strategy. The aggressive long exposure seems justified with corporate growth broadly stronger, but prudence dictates a larger short position if shares continue their advance.

To create a successful stock portfolio requires attention, consistency and discipline. Most of all, it requires an information edge. Years of research have shown that shares of companies that are profitable with rising shareholder wealth perform better. The Luxury Liner and all GEARS models are managed with that information edge.

I have created ISPACE-Investors Space for Truth where I make available a detailed, accurate, consistent, reliable and verifiable financial statement analysis for all companies in the GEARS coverage population and for industry, sector and index populations. I invite you to take advantage of our free registration.

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