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Summary Deep value, out-of-favor stocks bounced back strongly in the holiday-shortened Christmas week. As part of my premium research service on Seeking Alpha, I am tracking an equity focused “Concentrated Best Ideas Portfolio.”. The Concentrated Best Ideas Portfolio was up 7.43% for the week, while the S&P 500 was up 2.83%. Since its inception on Dec. 7, 2015, the Concentrated Best Ideas Portfolio is up 7.51%, while the S&P 500 is down 1.30%. The three most crowded, intertwined trades could be unwinding and recent price action may foreshadow emerging 2016 trends. “To buy when others are despondently selling and to sell when others are avidly buying requires the greatest fortitude and pays the greatest ultimate rewards.” – Sir John Templeton – 1958 “Knowledge is limited. Imagination encircles the world.” – Albert Einstein Introduction On November 17th, 2015 Reuters published the latest BAML global fund manager survey. It showed that the most crowded trade , by far, among fund managers was long the U.S. Dollar, followed by the related trades of short commodity stocks and short emerging market equities. As a value investor and a keen follower of behavioral analysis, I have been attracted to the opposite side of these trades. In particular, commodity stocks have caught my eye for several years, as valuations have been historically cheap. I illustrated this in a recent article on U.S. Steel (NYSE: X ), which showed that its current price-to-book ratio and price-to-sale valuation ratio are substantially below U.S. Steel’s prior year-end 2008 comparable metrics. This is true across a wide variety of companies, particularly in the material, energy, and emerging markets space, despite the S&P 500 Index, as measured by the SPDR S&P 500 ETF (NYSEARCA: SPY ), trading within shouting distance of its all-time highs. I have highlighted the bifurcated market in several articles, including ” 2 Distinct Markets ,” and I am highlighting the undervalued firms in a series titled ” Too Cheap To Ignore .” For the last several years, historically cheap valuations have been a “value trap,” and investors wading into this deep value space have been punished severely, including your humbled author. Patience and persistence are usually rewarded in life and investing, and this is doubly true in deep value investing. Thus, I have kept researching the undervalued, out-of-favor firms, and I launched a premium service on Seeking Alpha, titled ” The Contrarian ” to try to take advantage of this unique opportunity from a research and portfolio strategy perspective. The premium research service launched on Seeking Alpha on December 7th, 2015, and so far, so good as the portfolios have significantly outperformed the broader markets, including a 90% cash portfolio, whose premise I wrote about in an article titled, ” Why A 90% Cash Portfolio Will Probably Outperform .” Within the service, there are several portfolios that have been put together. One of the equity focused portfolios is called “Concentrated Best Ideas Portfolio”, and it is primarily composed of deep value stocks. While the portfolio remains approximately 40% in cash versus its inception value, it was up strongly last week, registering a gain of 7.43% versus the SPY gain of 2.83%. Since its inception on December 7th, 2015, the Concentrated Best Ideas Portfolio is up 7.51%, while the SPY has declined 1.30%. The outperformance is the tip of the iceberg in my opinion, as I believe value stocks are set for their day in the sun after lagging their growth counterparts for a majority of the current bull market, and the performance to close 2015 may be foreshadowing what is to come in 2016. Concentrated Best Ideas Portfolio Update This portfolio screenshot is from “The Contrarian” premium research service. The portfolios in “The Contrarian” are updated whenever trades are made, and there are weekly updates with commentary. The following is this week’s update for the Concentrated Best Ideas Portfolio and commentary. (click to enlarge) It was a strong, holiday-shortened week for the market, and a very strong week for the “Concentrated Best Ideas Portfolio”. Material and energy stocks bounced back, with Peabody Energy (NYSE: BTU ), Teck Resources (NYSE: TCK ), Freeport McMoRan (NYSE: FCX ), CONSOL Energy (NYSE: CNX ), and Westmoreland Coal (NASDAQ: WLB ) all up more than 10% for the week. Overall, I am very pleased with the terrific relative and absolute outperformance, over the S&P 500 Index , by the Concentrated Best Ideas Portfolio during its first three weeks of inception. The results are even more impressive, considering that 40% of the portfolio’s starting value remains in cash. Since the portfolio’s inception, SunEdison (NYSE: SUNE ), Westmoreland Coal , and CONSOL Energy are leading the way, with respective gains of 67%, 42%, and 28%. The outsized gains coincide with the beginning of a reversal in the major three trades that have been put in place by the investing mainstream (long the U.S. Dollar, short commodities, and short emerging markets). Once these three intertwined trades reverse in earnest, the undervalued, out-of-favor, heavily short names will have more room to run, as headwinds turn into tailwinds. Mounting evidence of a reversal lies in the fact that the batting average of the Concentrated Best Ideas Portfolio is an impressive 67%, with 8 out of 12 positions showing gains. Building on this, the 8 “winners” have outsized gains, while the drawdowns of the “losers” have been more modest. Conclusion – With the Market Overvalued, Focus on Portfolio Strategy The underlying theory and thesis behind a deep value portfolio, is that a few “winners” can drive a deep value portfolio higher, offsetting the inevitable losses from companies in the deep value basket that never recover. In certain time frames, like 2008/2009 for financials, consumer discretionary names, and the broader market in general, and 2015/2016 (today) for commodity, energy, material, and emerging market stocks, the batting average can be higher for a deep value focused portfolio, as the extremely depressed valuations present an environment where a broad rebound in deep value stocks is possible, and perhaps even probable. While deep value stocks remain historically cheap, the forecast for broader market returns from today’s price levels looks dicey, as illustrated in a table that I have put together using data from GMO : (click to enlarge) The sell-off of commodity oriented stocks, which started in April of 2011, has driven the valuations of these companies to levels that are significantly below their 2008/2009 bottoms. In a recent article on U.S. Steel, I highlighted how cheap the price-to-book and price-to-sales valuation ratios have become today, even compared to year-end 2008 levels, which were extremely depressed due to the historic sell-off in the broader stock market. To close, the last month of 2015 is hinting at a reversal of the previously crowded trades that could carry over into 2016. The three trades (long the U.S. Dollar, short commodities, and short emerging markets) are intertwined, and the reversal could be a self-reinforcing cycle, the opposite images of the seemingly never ending unwind. With a rebound in out-of-favor names for the last five years looking probable due to their low absolute and relative valuations, and an overvalued broad bond and stock market, now is the time to be contrarian, or at least add a little dose of contrarian thinking to your portfolio. For more information, please click here . Scalper1 News
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