Monthly Review February 2013 – Economic Uncertainty Rules The Day

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Graham Copley / Nick Lipinski



February 4th, 2013

Monthly Review February 2013Economic Uncertainty Rules The Day

  • In general, the Industrials and Basics rode the averted-fiscal cliff rally to a strong performance in January. Many bellwethers, including GE, DuPont and Caterpillar, reported during the month and were cautious about the demand environment in 2013. Paper stocks were punished after reporting poor earnings, shaving off some, but not nearly all, of the sector’s valuation premium.
  • Transports led the way for our group, outperforming the S&P in excess of 3%. The Metals and Mining sector posted the biggest lost, as investors continued to have concerns over the earnings recovery, and negative earnings revisions continued. Paper was the only other sector in our universe to significantly trail the S&P during January.
  • Over the past month we published our stock picks for 2013, as well as reports on the Coatings sector, and on DuPont. Our Coatings work highlighted the imbalance in current valuations with respect to its return on capital trend, while our DuPont analysis showed a potentially attractive opportunity in the stock.
  • Our model portfolios were essentially flat versus the S&P 500 over January. Hedged strategies for all three metrics were only slightly positive as our short and long portfolios moved nearly in lockstep. The January components are summarized in Exhibit 1 and the changes in the composition of the portfolios are shown in Appendix 2.

Exhibit 1

Source: SSR Analysis – Normal Value looks at valuation relative to historical norms and the SSRSI measures current valuation versus current return on capital and what movement in returns on capital is implied in valuation.

Exhibit 2

Source: Company Reports and SSR Analysis

Appendix 3
for the data underlying this exhibit.

Exhibit 3


The Industrials and Basic Materials sectors were prime participants in the New Year/post-cliff rally. In all, 29 of our stocks gained 10% on the month, helping the majority of our covered sectors to outperform the S&P 500, which itself gained 5% in January. Optimism did not spread to the Metals sector which contained four of the seven worst performing stocks in our universe. Paper also swung to a loss following earnings misses by MWV and BKI toward the end of the month. Conversely, the Conglomerates rode a wave of strong earnings to post a notable January performance. Packaging was essentially flat, even as Transports soared to the biggest monthly gain among the Industrials. E&C stocks were up as well on positive construction forecasts.

Best and worst performers at the company level in our coverage universe are summarized in
Appendix 1

Exhibit 4

Source: Capital IQ and SSR Analysis

A strong month for the Transports sector has the group closing in on one full standard deviation above normal value. The Trucking, Mail, and Rail subsectors all shared in January’s gains, but the strongest moves were concentrated in Trucking and Mail and we still prefer the Rail sub-sector on valuation relative to current earnings. Most of the sector’s valuation premium is coming from the Trucking subsector which is over two standard deviations from normal value. Paper’s underperformance brought it slightly back from the three standard deviations above normal mark. The beleaguered Metals space is far and away the cheapest of our covered sectors and rose past 1.5 standard deviations below normal value after its dismal performance on the month.

Note: part of the reason why almost all of our sectors look expensive on a relative basis is because other sub-sectors of the S&P are undervalued versus history – most extremely and most notably financials.

Exhibit 5 summarizes end-December sector discounts from normal value.

Exhibit 5

Source: Capital IQ and SSR Analysis

Values for our Skepticism Index are summarized by sector in Exhibit 6. Most of the negative value for the Conglomerates (exclusive of GE) is coming from valuation; a month of 2% outperformance for the sector has pushed it to nearly one full standard deviation above normal on our framework. A similar story played out over the month in the Transports sector. Valuations in the Metals space are moving severely out of line with current returns on capital. Previously published work noted that the Metals sector has outperformed the S&P by 10% in the six month period following a skepticism index value of 1.5 or above.

As a reminder, our Skepticism Index measures how in or out of phase current valuation is with current returns on capital. A positive number suggests that either valuation is discounting a decline in return on capital or the stock has upside. On the flip side, a negative number suggests that returns have to rise to justify valuation, or the stock has downside. Paper is not as extremely valued on this basis as, while valuations are well above normal, so are returns on capital.

Exhibit 6

Valuations Overestimating Current Returns on Capital

Valuations Underestimating Current Returns on Capital

Source: Capital IQ and SSR Analysis

Exhibit 7 is a very busy chart but shows how each sector and sub-sector breaks down by SSRSI component – valuation versus ROC. All things being equal, you want to buy sectors in the top right corner and sell those in the bottom left.

Exhibit 7

Source: Capital IQ and SSR Analysis

Portfolio Performance

We again tracked our model portfolios over the month, one based on our normal mid-cycle earnings screen, one based on our Skepticism Index and one based on the stocks that appeared on both metrics. Effectively, we bought the cheapest/most Skeptical and we sold short the most expensive/least Skeptical, as summarized in Exhibit 1 of
our January monthly
. The results are summarized in Exhibit 8, showing performance relative to the S&P, which was up about 5% month over month.

Our long and short portfolios performed in almost equal but opposite measure, rendering the hedged strategy for each metric only marginally profitable over January. Propping up the short portfolios were CMI (which gained 6% and currently screens as 2 standard deviations above normal value), SHW (5%, 3 SDs above normal), and WLK (16%, 3.5 SDs).

Exhibit 8

Source: Capital IQ and SSR Analysis

Appendix 2
we show the companies coming into our screens and leaving our screens – both for November and for December.

Macro Environment

At SSR we are not economists, nor do we seek to be. We look at the economic indicators that are publicly available and put them into context relative to the drivers within the industries we cover. We examine trends or fundamental influences and we then look at these relative to valuation with the goal of identifying mismatches between what is implied in valuation and what is expected to happen.

There is some question as to whether this month’s equity optimism is out of line with the larger economic reality. Towards month’s end, fourth quarter GDP came in at a surprise contraction of 0.1%. While this may have been attributable to a plunge in government defense spending which overshadowed consumer spending gains, the Fed remains wary of an economic slowdown and will continue to support the economy via bond purchases.

The most recent Macro data changes are summarized in Exhibit 9.
Exhibit 9

Source: Capital IQ, Government Publications, Bloomberg, SSR Analysis

Commodity Pricing

Metal pricing was mixed on the month. Copper saw strong gains while aluminum and steel were essentially flat. Prices for pulp were stable, while lumber pricing dipped back down after a sharp move up in December. Demand for lumber is expected to be strong in 2013, with Canadian supply rising to meet increased construction in China and the US. The gas-oil difference widened further in January, with crude oil up and natural gas down for the third consecutive month. Plastics got off to a strong start in the New Year as inventories decreased. Several plants are scheduled to restart production in the near term, which bodes well for supply moving forward.

US commodity prices and energy prices are indexed in Exhibits 10 through 14.

Exhibit 10 Exhibit 11

Source: Capital IQ, IHS, CRU Steel Price Index, Bloomberg, SSR Analysis

Exhibit 12

Source: Capital IQ, Bloomberg, SSR Analysis

Exhibit 13

Exhibit 14

Source: Capital IQ, IHS, Bloomberg, SSR Analysis

Expectation Analysis

Looking out to 2014 net income estimates, the Capital Goods sector now has the smallest increase versus 2011 levels. Its descent has been largely driven by Caterpillar; 2014 net income estimates for the company have come down by $2 billion since January 2012. Electrical Equipment, supplanted as the sector with the lowest forward net income growth estimates for the first time since we began publication of the monthly report, has seen little change in the index over that time frame. This groups’ valuation premium does not appear to be coming out of optimistic future earnings expectations.

Exhibit 15 & Exhibit 16

Source: Capital IQ and SSR Analysis

Exhibit 17 shows how these longer term estimates have changed over the month. Metals saw widespread negative revisions, explaining in part the sector’s poor performance in January. Paper again received the largest upward revisions, but this did not translate into market outperformance. Most other sectors were essentially flat month over month.

Exhibit 17

Source: Capital IQ and SSR Analysis

Capital Goods overcame cuts to 2013 EPS estimates to outperform the market on the month. The Metals space saw even more drastic cuts, which helped drive valuations lower. Looking more closely we see that the decline for Capital Good was mainly driven by Caterpillar, while the Metals sector saw downward revisions across the board (though Newmont was a notable culprit). The largest positive revisions were in the Paper sector based on further announced price increases for 2013 and the accompanying analyst optimism. However, these revisions were seen mainly in LPX which reports early next month. MWV and BKI came out with disappointing earnings results in January and 2013 EPS estimates were trimmed. The paper sector is priced for perfection today and should some of the expected price increases not materialize and should sentiment turn, the sector has meaningful downside.

Note that the numbers in Exhibit 18 differ from those in Exhibit 3 as the data is market cap weighted in Exhibit 18 and is a simple average in Exhibit 3.

Exhibit 18

Exhibit 19

Source: Capital IQ and SSR Analysis Source: Capital IQ and SSR Analysis

Mid-Cycle “Normal Valuation Analysis

Results of our valuation analysis for the end of November are summarized in Charts 20 through 30.

Exhibit 20

Exhibit 21

Exhibit 22

Exhibit 23 Exhibit 24 Exhibit 25 Exhibit 26 Exhibit 27

Source: Capital IQ and SSR Analysis

Exhibit 28

Exhibit 29

Exhibit 30


Source: Capital IQ and SSR Analysis


Our Skepticism Analysis by sector is summarized in the Exhibits 31 through 42.

Exhibits 31-33

Exhibit 31

Exhibit 32Exhibit 33

Source: Capital IQ and SSR Analysis

Exhibits 34-36

Exhibit 34

Exhibit 35

Exhibit 36

Optimism High

Source: Capital IQ and SSR Analysis

Exhibits 37-39

Exhibit 37

Exhibit 38

Exhibit 39

Source: Capital IQ and SSR Analysis

Exhibits 40-42

Exhibit 40

Exhibit 41

Optimism High

Skepticism High

Exhibit 42

Skepticism High

Optimism High

Source: Capital IQ and SSR Analysis

Research Published in January

January 3, 2013 – 13 Attractive, Bad or Overhyped Ideas for 2013 Assuming No Macro Changes

January 10, 2013 – A Lesson in Expectations: Is There a Bubble In My Paint?

January 25, 2013 – DuPont: The Uncomplicated Story and The What If?

New Screens: Dividends, Best & Worst Performers

In Exhibit 43 we show a screen of stocks with low value, high Skepticism and high dividend yield. Olin, Stanley Black & Decker and DuPont remain the only stocks to appear on all three screens.

Exhibit 43

Source: Capital IQ and SSR Analysis

Appendix 1

Note: AXLL is the new ticker symbol for Georgia Gulf Company, formerly GGC.

Appendix 2

Appendix 3’

Appendix 3

©2013, SSR LLC, 1055 Washington Blvd, Stamford, CT 06901. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein.  The views and other information provided are subject to change without notice.  This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results.

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