Disappointing last few months, but valuations are attractive now

Author: Mark Holder, Stone Fox Capital

Covestor model: Opportunistic Arbitrage

The best thing about the third quarter of 2011 is that it finally ended. The global growth stocks in this model were absolutely crushed, while large cap dividend stocks held up much better than in 2008. This led the model to seriously underperform its benchmarks.

The good news is that many stocks in the model – such as Alpha Natural Resources (ANR), Foster Wheeler (FWLT), Hartford Financial (HIG), and Terex (TEX) – reached levels similar to or as attractive as their 2009 lows. Considering that most of the companies have seen little to no impact from the financial crisis in Europe, I believe that sell off was unwarranted.

The bad news is that the risk still remains that the European Union will be unable to solve the crisis before it implodes, or that China’s economy might have a much-feared hard landing. I believe there’s a good chance that the market has already priced in either outcome. Given that this model remains highly leveraged in the effort to take advantage of the cheap valuations, the risk of more downside can not be ignored.

In summary, it has been a very disappointing few months – watching equity prices implode after so much progress had been made in the recovery off the 2009 lows. For investors not in the market yet, I believe this provides an opportunity to enter at more compelling prices. The recent substantial declines may have been more from a panic of a repeat of 2008, than due to any objective reality. Many indicators I use reached 2008/09 inflection levels, suggesting the panic may have run its course by the end of September.

The model remains committed to taking advantage of the opportunities presented.