Strange Days

We promised July 14 would be an interesting day. It was.

An unleveraged market timing model portfolio that we manage, which is currently short the market with inverse ETFs, was a hair's breath away from stopping out and going to 100 per cent cash. We actually drafted a note in anticipation of this. Surely, we believed the market would rally on a positive July 13 Intel Corp (INTC) earnings report and investors would go neutral or long the market. But this did not happen.

At the market close on July 13, Intel Corp (INTC) reported an outstanding quarter. While some analysts commented that this represented a likely peak in the company’s margins, few focused on the outstanding operating momentum, which in our opinion is the correct view.

The strong Intel report is extremely positive for the market. It demonstrates that there is a lot of underlying activity in business though the more visible indications, such as hiring, are not yet occurring. But this will change at some point. Maybe not fast enough for many, but the economy is clearly not going to keel over.

On a similar positive note, Accenture (ACN), a global management consulting company which, among other things, installs and networks Intel-driven computers stated on its June 25, 2010 conference call that that it was seeing positive momentum, driven in part by efforts of companies to "...consolidate data centers, virtualize infrastructure" and to focus on "...risk management, strategic sourcing and global expansion", all with an emphasis on reducing costs.

This, too, indicates that there is much business opportunity and activities taking place beneath the surface. However, instead of investing in people, companies are currently investing in IT. It is much cheaper to do so, and when the time is right, all IT can be leveraged by new hires.

Yet the market declined anyway. Why? Because the market is being driven to a large extent by technical considerations and short term trading, which in turn is driven by fear. Since investors have been wrong 1000 times over in fundamental market calls over the last few years, they are turning to technicals.

When June retail sales were released prior to the market open on July 14, and it showed a -0.5% decline versus a consensus economist forecast for a -0.2 per cent decline, that was all it took for the market, seemingly primed for a tech-driven rally, to falter. The market did subsequently rebound, but when the Federal Open Market Committee released minutes from its June 22-23 report indicating increased incremental risk, the market sold off again.

In our opinion, the market is currently taking its cues from immediate data points and missing the big picture. While this is psychologically understandable in light of investors having been hurt in 2008 by not heeding short-term data points, in our opinion a longer-term view is the better one to adopt at this point.

Large, long-term, long-only investors such as mutual funds should use this volatility to build up big positions in quality technology names now. In our opinion, this is the time for billion-dollar investors to make their move. By the time there is clear evidence of an economic turn, these mutual funds will have missed the boat.

In a quantitative model portfolio report that we generate every week with updated stock rankings with our partner ValuEngine, we see there are seven quality technology companies with outstanding relative value and operating momentum, which at the same time are trading well below fair value that should be considered in addition to Intel. For example, a great quality name is Micron Technologies (MU). Micron is trading at less than 50% fair value, according to ValuEngine, and is a great long-term play. The stock sold off due to fears of a slowing DRAM market, but investors may be overlooking Micron’s ability to take market share in a slow market.

For smaller, shorter-term, long/short investors there continues to be little incentive to commit substantial resources to going long. The smart ones, who have learned from history, realize that fundamental market timing has failed multiple times over the last few years. Smaller investors should wait for confirmation of market direction and only then go long.

We are waiting for our models to indicate so. A rally based on acknowledgement of a positive undercurrent of fundamental momentum could last months. For anyone that manages less than a few billion dollars, there is no advantage to jumping in early.

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