Playing Catch Up

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As we think about how to invest in the Industrials and Materials sector in 2014 we are proponents of the idea that the laggards will play catch-up.  We first wrote about this in November and have seen some success with the stock selections that we made at the time.  We have seen almost two full years of momentum in the space with investors sticking with the stories that have worked and expensive stocks, in our view, getting more expensive, while the out of favor stocks languished.  While there is generally a correlation between stock revisions and performance, that correlation was much weaker in 2013 than in 2012, suggesting that the benefit of the doubt was given to the “favorites” and not to the rest – see chart.

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This is shown more illustratively if we look at a couple of the paper/packaging stocks – which screen as expensive today and also screened as expensive a year ago.

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During the fourth quarter of 2013 we began to see a shift towards the underdogs, the stocks which have lagged, the stocks which in our view present the best valuation opportunities today.  In recent research we have highlighted our preferred names for 2014, and we use the same valuation methodology that drove our preferences for 2013.  Our 2013 selections did not work too well as the market essentially ignored value for the first 8 to 9 months of the year.  Interestingly, our 2013 favored names outperformed our least preferred names by 170 basis points in December 2013, and if this signals the start of a more valuation driven market we are encouraged that our approach will be much more successful in 2014.

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