Monday, January 17, 2011

Part 2 from

Smaller-Cap Stocks on Our Radar1/13/2011 1:48 PM EST
I already wrote a piece on my top picks for 2011, so I won't rehash that. But I want to throw out some other picks that I don't often write about. We normally play in the mid-cap and large-cap space, as these stocks tend to be less volatile (on average). But for our trading accounts, we do play in some of the smaller names, so I do have a few on my radar.

Meru Networks (MERU) is a provider of virtualized wireless LAN solutions, a space that is heating up and garnering a lot of attention. It has a $300 million market cap and very high growth rates. The stock has been publicly traded for less than a year, so is under most people's radar. It broke out on high volume the other day and is now on my radar.

MIPS Tech is a chip maker for home entertainment, telecom, networking and multimedia. It has a market cap of $800 million and very high earnings growth. This is another stock that has been moving higher on big volume increases, and that could bode well for further gains this year. The stock also ranks well on measures of profitability, relative strength, fund sponsorship, etc.

Radware is a $700 million market cap, Israeli provider of network security solutions. This is another hot space, and there have been many rumors of a suitor looking to buy RDWR. On its own merit, the stock ranks well on all of the measures of growth and profitability that we look for. But the kicker is that I believe that eventually it will get an offer high enough to accept, and that could be the cherry for investors.

IPG Photonics (IPGP) is a manufacturer of fiber-optic lasers, amplifiers, etc. Kind of like a small JDS Uniphase (JDSU). It has a market cap of $1.6 billion, so it's a little larger than the others, but the fiber-optic space is heating up, and IPGP's growth rates are heating up as well. The stock just broke out to new highs this week and could be a good addition on a pullback.

Position: Long IPGP, MIPS, RDWR

Q&A 1/13/2011 3:02 PM EST

Here are some questions I have received today from readers:
Andrew L.:
With the specter of higher yields, what are your ideas for fixed-income portfolios? Andrew, mostly what we are doing for fixed income is keeping maturities short on some corporate bonds when we can find acceptable yields. We have also been adding to our preferred stocks and hedging a portion of the interest rate risk with the ProShares UltraShort 20+ Year Treasury (TBT). On the fund side, we have been allocating to floating-rate funds (which should hold up better as rates rise) and dipping our toe in the water slightly in emerging market bond funds.

John G.:
What is your take on Doug's favorite long, Yahoo! (YHOO)? John, I love Dougie, but I am less enamored of Yahoo!. At the end of the day, I still think Google (GOOG) will outperform Yahoo! this year. Google was totally flat for 2010 (actually down 3%), so I think it will come back this year and provide solid returns. Google continues to take market share from Yahoo! and is doing a better job at diversifying its revenue streams, in my opinion. On a P/E basis, Google is still cheaper, and Yahoo!'s EPS are not even expected to grow in 2011. I prefer to stick with the leaders, and leave the turnaround situations to those with more patience.

What do you think about iShares Russell 2000 Index (IWM) and PowerShares QQQ (QQQQ) as shorts? Mo, I don't think these are good shorts while the market is making new highs and in a confirmed uptrend. When the market is trading below both its 50-day and 200-day moving averages, and those moving averages are no longer upwardly sloping, then I think they might be good hedges on a portfolio. Until then, they are just speculative trades and should carry tight stops with them.

John G.:
Who is the group of managers you polled for your annual forecast? Hedgies? Big firms? John, My group of participants includes many factions. I have a lot of guys that you read here on the pages of RealMoney Silver daily, I also have some institutional traders, as well as a handful of people running their own small investment advisory firms. So while my sample size may not be huge, it is well diversified amongst the various investor types.

Sentiment is on the complacent side of things.
Let's take a look at the sentiment backdrop. Again, here I look at several different types of indicators. I also should point out that while I think sentiment is a bit on the complacent side overall, I have found in my work that following the sentiment indicators works better in helping to time market bottoms than it does trying to time tops. Often that's because market tops are more of a process and take time, while market bottoms are often events (more short term).
Looking at the put/call ratios, the 10-day CBOE put/call is down to 0.77, which is on the low side of the equation. Last year before the flash crash, it got down to 0.75. The 10-day ISEE call/put ratio is more in neutral territory at 131.

The investment adviser surveys show higher levels of bullishness. The spread between the bulls and bears on the Investors Intelligence survey rose to 38% last week. That matches the highest level since October 2007, the height of the last bull market. The spread in the AAII survey eased back this week to 29%, but I should note at the end of December it spiked to 47%, which was the highest reading I could find going all the way back to 2004. Last, the Rydex Nova/Ursa ratio (of mutual fund market timers) also eased back to 0.586 from its recent highs -- it rose to 0.665 last year before the flash crash, for reference.

As such, I think that sentiment is on the complacent side of things. It was even more so at the end of December, and as such, I found myself in the camp calling for a correction. Earlier this week, Bank of America (BAC) put out its hedge fund survey, which showed long/short hedge funds had lowered their net long equity exposure at the end of last year from their normal 30-40% range to just 18%. As such, it looks like the correction camp became a little too crowded, and that may be one of the reasons we have not seen much of a pullback. But January is also a month well known for headfakes, so don't get too lulled into a sense of complacency. Overall, I would have to give sentiment a grade of C+, due to high levels of bullishness (which is bad from a contrarian perspective).

Constructive on the Macro Picture1/13/2011 4:01 PM EST
From where I sit, it looks like the economy will continue to gradually improve.
Last, I wanted to briefly touch on the macro picture. This is the fourth leg of the market stool, where we take into account the economy, interest rates, inflation, etc. On this front, I am constructive on the economy as it looks like a continued gradual improvement from where I sit.
Unemployment remains stubbornly high, but this is not a good data point to wait for when investing -- it lags.

The ECRI weekly growth rate continues to improve. Last week, it moved further into positive territory at 3.3% (a 33-week high), and we get another update tomorrow.
Interest rates are poised to move higher, but I don't think they will do so dramatically. Moreover, the reason they are moving higher is as a reflection of an improving economy. Over the summer when the double-dip crowd grew vocal, interest rates fell to levels that appeared unsustainable. So upon an improving economy, one should expect rates to drift higher to a more normalized level. Also, inflation remains low. I know there is some food and energy inflation, but the biggest component of inflation in the economy is labor costs, and those appear well anchored. Additionally, there remains considerable slack in the economy, so inflation is unlikely to be broad-based in the near future.

And with that, I want to again thank everyone for reading and also for the questions. Feel free to continue to email me with any questions or feedback. Tomorrow you will be back in the capable hands of Mr. Kass. Enjoy your evening.


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