July 2018 Portfolio Manager Review
For the month of July, the AdvisorShares Ranger Equity Bear ETF (NYSE Arca: HDGE) returned -3.08% in market price while the S&P 500 gained 3.72%.
Rising rates bode poorly for the stock market. Noted market analyst, the late Martin Zweig, analyzed equity market performance during periods of rising interest rates. Rising rates affect corporate earnings through rising interest expense. They also affect investor behavior in that margin loan costs increase as well, often leading investors to sell to reduce margin balances. In past letters, we have highlighted that margin debt is near record highs. That continues to be true.
Rate hikes when investors are this stretched can lead to sudden and sharp margin liquidation. Martin Zweig coined the phrase “3 Steps and a Stumble”. He noted that when the Fed raised rates three times, the market tended to drop soon afterwards. The Fed raised rates in March and June this year. The Fed says it will raise rates twice more in 2018. This chart from NDR shows when the 3 steps and stumble rule was followed by declines in the Dow Jones Industrial Average going all the way back to 1915. The stock market could be overdue for a major downturn.
Source: Ned Davis Research Inc.
July brought some caution to financial markets. Some of the most speculative behaviors were toned down somewhat. While the market remains overvalued and investors are too optimistic, some of the wildest froth has settled.
Investors’ preference tilted sharply away from growth stocks, especially after Facebook’s earnings report where they cut sales and earnings forecasts. The higher the forecast growth rate, the worse the stock’s performance in July. This marks a change from prior months when investors paid almost any price for growth.
Stocks were grouped and ranked by the relevant factor as of the end of the prior month and the returns computed for the month just ended. Stocks chosen were based on Two Rivers Analytics' universe of stocks. © Copyright 2018. All Rights Reserved Two Rivers Analytics. Further Distribution Prohibited without prior permission.
The returns to stocks of companies showing high returns on equity and invested capital marks another dramatic turnaround. In low quality rallies, high ROE company stocks tend to get left behind. This month, they rallied.
For the month of July 2018, the largest realized and unrealized gains were LogMeIn, Inc. (LOGM), Skechers U.S.A., Inc. Class A (SKX), Prestige Brands Holdings, Inc. (PBH)and Dycom Industries, Inc. (DY).
LogMeIn, Inc. (LOGM) stock plunged -21.50% after reporting quarterly earnings. The company managed a modest “beat,” but issued guidance for the full year that fell far short of expectations. They admitted that the integrations with acquired GoToMeeting was going badly and that they were losing customers. We exited the position after earnings.
Skechers U.S.A., Inc. Class A (SKX) stock plunged -7.63% on earnings. The company changed its revenue recognition method which, in conjunction with late period sales, increased the risk of a top-line disappointment. In addition, inventory build-up raised our concerns about underlying demand and resultant margins. We are still short and have added on the most recent bounce.
Prestige Brands Holdings, Inc. (PBH) stock slid -6.90% during the month. The company displays weak organic growth coupled with earnings quality issues. The company’s low inventory reserves call into question the sustainability of its gross margins. We have elected to maintain this short position.
Dycom Industries, Inc. (DY) stock eased -5.66%. Three of the company’s main customers show deterioration in receivables quality, calling into question the quality of revenues. Unbilled receivables continue to grow, which also raises concerns about revenue quality.
The largest realized and unrealized losses for July were Knowles Corp. (KN), Align Technology, Inc. (ALGN) and Aerojet Rocketdyne Holdings, Inc. (AJRD).
Knowles Corp. (KN) stock spiked 13.46% on earnings. The earnings beat forced us to reevaluate our concerns regarding inventory turnover slowdowns, and we covered our position.
Align Technology, Inc. (ALGN) rose 4.24%. Expectations are high for this company. We are concerned that the company is pulling forward sales, particularly in the youth business. We exited the last position at a small loss but intend to put on a new short at the right time.
Aerojet Rocketdyne Holdings, Inc. (AJRD) spiked 14.28% in July. Absent a change in contract estimates, the company would have missed earnings estimates. Low quality earnings coupled with flat backlog raise concerns about the ability to meet estimates in coming quarters. The company had enjoyed a 100% market share. However there is new competition from Blue Origin, a new company that has better engineering and better rockets. The weak back log is a red flag.
Brad Lamensdorf, Co-Portfolio Manager of HDGE
Top 10 Holdings
|Ticker||Company Name||Portfolio Weight %|
|AJRD||AEROJET ROCKETDYNE HOLDINGS||-4.26%|
|XRAY||DENTSPLY SIRONA INC||-3.54%|
|GCP||GCP APPLIED TECHNOLOGIES||-3.35%|
|TPX||TEMPUR SEALY INTERNATIONAL I||-3.22%|
|OSIS||OSI SYSTEMS INC||-3.21%|