New Year, Same Fears, New Market Direction
New Year, Same Fears, New Market Direction
After completing a year where it was difficult for equity investors to post positive returns, we enter 2012 with the same macro issues that affected 2011 equity markets. Concerns over European sovereign debt are likely to remain for most of 2012, albeit with slow progress. Countering this are attractive valuations for US equities. Add in a presidential election year with its potential for policies supporting economic growth and we have a mixture that can swing investor sentiment. The volatility caused by these and other macro items in 2011 resulted in negative returns for the small cap indexes. Our focus on bottom-up fundamental analysis enabled us to post positive returns that were significantly above our benchmark.
We expect Europe to muddle through their debt issues in 2012, which may cause a mild European recession this year. But we are more confident than ever that a US double dip will not occur. Supporting our positive thesis on the US economy is the stronger than expected labor report for December. Although traditionally a lagging indicator, in this weak recovery marked by slow labor growth, any positive labor trends in hours worked and new job creation provide the fuel for improving consumer behavior. Positive consumer activity has been generally weak in the economic recovery from the Great Recession, and that is why we look at changes in consumer sentiment for insight into changing consumer behavior.
As the chart above indicates, consumer sentiment is close to post recession highs after recording a low in mid 2011. With fewer new unemployment claims, those employed are witnessing less layoffs; and after tightening household budgets for the past few years, we expect higher growth in consumer spending during 2012. However, given the high unemployment rate, such a change in consumer activity is likely to be imbued with setbacks. Ahhh, more fuel for volatile investor sentiment this year.
We expect the major driving forces for equity markets in 2012 to be the improving US economy with greater consumer participation, the potential for job creating economic policies and strength in non-European trading partners. We may even witness the passing of the European debt concerns in the second half of 2012.
We are delighted to post performance of 664 basis points above the Russell 2000 benchmark in 2011, for our fully invested Singular List model portfolio. Two names on the Singular List were acquired in 2011, and many outperformed due to better than expected earnings. For December, the S&P 500 was up 0.85%, the Russell 2000 was up 0.47% and the aggregate Singular List was down 2.3%. The Long-Only Singular List was also down 2.3% in December. For 2011, the S&P500 was virtually flat at -0.02%, the Russell 2000 was down 5.5% and the aggregate Singular List was up 0.82%. The Long Only Singular List was up 1.2% in 2011.
We added one new name and dropped one name from the Singular List in December. We dropped coverage of BioSante Pharmaceutical (BPAX) after release of disappointing results from the Phase 3 clinical trials. The new compound worked as expected, but the placebo effect was very strong such that the likelihood of FDA approval was significantly diminished. Other compounds under development for cancer indications are more than a year from the initiation of a Phase 3 clinical trial.
We initiated coverage of PhotoMedex (PHMD) with a BUY rating. PHMD designs and manufactures laser and light based products for use in healthcare and personal care. The company has been successful in the professional healthcare market and has merged with Radiancy, which has similar technologies but is very successful in the consumer market. We expect the product synergies along with complimentary end-market expertise will lead to new innovative new product development and consistent revenue growth.
Our top five performers in December were from a variety of industries, and most beat recent earnings estimates. The top performer in December was Synovis, up 47.7%. Earnings were well above our analysts forecast and the company agreed to be acquired by Baxter and traded up to the acquisition price. Arabian American Development was up 30.5% in December. Revenues and earnings in Q3 were both well above our analysts’ forecast, and the new mining operation remains on target. Our analyst increased the price target. Orchids Paper Products was up 21.3% in December. Revenues and earnings were stronger than expected in Q3, and the company raised the dividend. REX American Resources was up 20.3% in December. Q3 earnings beat our analyst’s expectations on lower than forecasted revenues. Cover-All Technologies was up 20.0% in December. The company missed our analysts earnings forecast in Q3 due to a delay in booking license revenues. The company remains well positioned for a strong 2012 with the growing pipeline of license revenues.
Our worst performers in December were from a diverse set of sectors. BioSante Pharmaceutical was down 81.3%. The company reported Libigel clinical study results that met expectations, but the placebo effect was very strong. As a result we do not expect FDA approval and we dropped coverage. CrowdGather was down 35.3%. Earnings met our analyst’s estimate in Q3 and website traffic increased 20% from Q2. Seabridge Gold was down 29.3%. The company missed our analyst’s Q3 earnings estimate due to non-cash charges. Seabridge recently completed a compliant resource estimate at one project, resulting in an 18% increase in indicated gold resources. PhotoMedex was down 16.5%. The company announced completion of the merger with Radiancy. OYO Geospace was down 15.0%. The company reported earnings below our analyst’s expectations in its Q4. Our analyst remains positive on the company given the new wireless GSR product and strong demand for efficient seismic work in the oil & gas industry.
Our top five performers for 2011 were Arabian American Development, up 117.4%; PriceSmart was up 83.0%; Synovus was up 72.8%; US Home Systems was up 57.6%; Market Leader was up 56.3%. We continue to look to improve our equity research performance, and as we enter 2012, we perceive attractive valuations for a number of companies in a variety of sectors. We are diligently completing our work to present these names in the first quarter. We believe the European debt concerns have caused market valuations to remain low, and we expect economic growth in the US to tick up during 2012. We expect there may be several potential positive surprises in 2012 including better than expected US growth, improving consumer and manufacturing activity, eventual resolution of European debt issues, and better than expected growth in China. We look forward to another year of above benchmark performance, and we thank our clients for your support of independent equity research in the small cap space.
Greg Garner, CFA
Senior Equity Analyst