Portfolio A1 Losing Altitude Quickly

First, an apology. Last week I was on vacation and made a best efforts attempt to keep the information for Portfolio A1 current. As you can see from the transaction log below, I posted an ‘update’ of the portfolio too soon and missed the signal to sell Amkor Technology (AMKR) and replace it with AST Test Limited (ASTSF), the Taiwanese semiconductor testing company.

As it turns out, ASTSF lasted only one week in the portfolio and is being dropped along with Navistar International (NAVZ) in an effort to find a way to stop the bleeding.

The task of propping up the portfolio falls to Western Refining (WNR) and PepsiAmerican (PAS) – two relatively conservative plays that appear to be ideally suited to minimizing further downside risk rather than maximizing any gains from a bounce.

In the meantime, the equity curve tells the story of the damage. The total return is now -13.7% and the peak to trough drawdown currently sits at -22.6%. This will be a very difficult hole to dig out of, but I still like the long-term performance characteristics of this portfolio and have no intention of cutting the portfolio off without at least a year’s worth of performance statistics from which to learn some lessons.

A snapshot of the portfolio is as follows:

Portfolio A1 Slips as AMKR Guides Lower

Amkor Technology (AMKR), which fueled much of the gains in Portfolio A1 from February through June, guided third quarter revenues and earnings below analyst expectations on Tuesday, triggering a 21% loss in the stock for the week. Now down over 37% from the June high, AMKR’s slide has turned this former big gainer into a 12% loser for the portfolio and has contributed heavily to the portfolio’s decline in the past five weeks.

While this kind of news would automatically mean AMKR would be dropped from any of my discretionary trading systems, the stock Portfolio A1 ranker has not yet seen fit to drop AMKR [Edit: My error here. AMKR was indeed sold; please see 8/12/07 portfolio update for details.] Since the portfolio does not make any decisions regarding changes in holdings during the week, this means the stock has a reprieve for at least another five trading days.

Not surprisingly, the portfolio’s aggregate performance has turned ugly in the past week as well and now trails the benchmark S&P 500 index by 6.1%, the largest performance gap to date.

This is a highly concentrated portfolio of just five stocks, with an average beta that hovers in the 2.0 range, so large drawdowns always loom as a possibility. If the broader markets fail to rebound in the next week or two, it will be interesting to see how the stock ranking system culls some of the losers and where it chooses to reallocate capital. In the meantime, as indicated by the system’s rules, this portfolio will continue to remain on autopilot during the trading week.

A snapshot of the portfolio is as follows:

Portfolio A1 Last Seen in Woodshed

While the SPX, DJIA and NASDAQ Composite all feel somewhere in the 4.0 - 4.7% range during the past week, Portfolio A1 plummeted 9.2%, dragging the portfolio’s aggregate performance down below that of the benchmark S&P 500 index for the first time in four months.

Southern Copper (PCU) was the only holding to fare better than the indices, losing 3.3% on the week. The next ‘best’ performers, Mobile TeleSystems OJSC (MBT) and Terex (TEX), fell 7.7% and 8.6 respectively. Two other holdings logged double digit losses on the week, with Amkor (AMKR) off 11.9% and Pinnacle Airlines (PNCL) plummeting 13.6% by Friday’s closing bell. Pinnacle’s performance is largely responsible for it being dropped from the portfolio and replaced by Navistar International (NAVZ), a stock I owned some 23 years ago when it was International Harvester. While the company has had some extremely difficult challenges in the intervening years, a recent $623 million contract award to the military vehicles division suggests considerable upside potential. Navistar lost only 1.0% last week and has the potential for a significant upside surprise in more favorable market conditions.

There are no other changes to the portfolio for the coming week.

A snapshot of the portfolio is as follows:

Portfolio Adds PCU and PNCL, Drops ORH and PBR

In yet another reminder that this type of portfolio is not aimed at the buy and hold investor, Portfolio A1 has decided to drop Odyssey Re Holdings (ORH) and Petroleo Brasileiro (PBR) and replace them with high flying Southern Copper (PCU) and Pinnacle Airlines (PNCL), a regional airline whose traffic is up 11.2% so far this year.

Technical and fundamental factors were both in play for this particular portfolio reshuffling. It was the technical performance (down 8.7% in the four weeks it was in the portfolio) of Odyssey that was its undoing, while PBR suffered from a slight downtick in some fundamental metrics that more than offset a 6.2% gain in the two weeks it has been in the portfolio.

These two changes bump the annual turnover rate in this portfolio up to 415% and send us back to the drawing board to find three stocks that can match the performance and continued promise of stalwarts Terex (TEX) and Amkor Technology (AMKR).

There are no other changes to the portfolio for the coming week.

A snapshot of the portfolio is as follows:

Portfolio A1 Swaps Oils: PBR for TSO

For someone who is largely a discretionary trader, one of the more difficult aspects of a fully mechanical trading system is sitting on the sidelines trying to get up the enthusiasm to root for stock that you wouldn’t otherwise follow. Rarely do I watch Portfolio A1 dump one stock in favor of another, pump my fist in the air and yell at my monitor, “It’s about time, dammit!” Today is one of those days, however, as I can let my lukewarm feelings about the refiner Tesoro (TSO) depart along with the stock, while at the same time welcome into the Portfolio A1 fold Petroleo Brasileiro (PBR), the state-owned Brazilian whose stock has traced almost a straight line over the past five years in rising from 5 to 65, all while generally paying a 2% dividend in the process. PBR has been a favorite of my discretionary portfolios for several years and I can only hope that it hasn’t gotten ahead of itself at this stage.

Speaking of newcomers, last week’s strong portfolio performance was led by newcomer Mobile TeleSystems OJSC (MBT), whose 7.5% weekly gain helped to more than double the portfolio’s advantage over the benchmark S&P 500 from 1.5% to 3.3%. With Russia and now Brazil, 2/5 of the portfolio is invested in ADRs; and when you consider that portfolio stalwart Terex (TEX) has a strong China component, it is worth noting that Portfolio A1's stock ranking system is unwittingly endorsing the BRIC growth thesis, albeit with limited exposure to India.

Now that my discretionary portfolio overlaps this mechanical portfolio as far as PBR, TEX and AMKR are concerned, it will be interesting to see if Portfolio A1’s performance changes dramatically, for better or for worse.

There are no other changes to the portfolio for the coming week.

A snapshot of the portfolio is as follows:

AMKR Continues to Power Gains in Portfolio A1

With another week of strong gains, Amkor (AMKR) now has logged a cumulative gain of 33% since Portfolio A1 began 4 ½ months ago.

Weakness across the balance of the portfolio – with the notable exception of Terex (TEX) – has resulted in the portfolio underperforming the S&P 500 benchmark over the course of the past two months. For the full life of the portfolio, the gains of 4.8% continue to better the S&P 500, but by a margin that has slipped to 1.5%.

I should note that with the fractional losses of the two holdings added last week, Portfolio A1 now has had a total of four winning trades and eight losing trades to date. This is important because the intent of this portfolio is not to aim for a high percentage of winners by hitting a lot of singles, but to seek out doubles, triples and home runs, with the expectation that there will be many instances in which the portfolio is stopped out of losing trades. Based on past performance of similar portfolios, my guess is that it will probably take a year or two before this approach is evident from the portfolio statistics.

There are no changes to the portfolio for the coming week.

A snapshot of the portfolio is as follows:

CNBC Million Dollar Portfolio Challenge: #61,448

Who turned up the gravity?

As if the -30.2% drop in i2 Technologies (ITWO) on Tuesday were not enough top off my humility tank, yesterday saw Amkor Technology (AMKR) shave another 1.9% off of my portfolio. Just for good measure, today’s pick, Open Text (OTEX), is currently tracking down 4.5%.

Somehow, I have managed to stay in the top 4% of the 1,594,583 contestants who are suddenly looming a lot larger in my rear view mirror.

I really can’t fault the earnings spike potential algorithm, as its top pick from yesterday, Charter Communications (CHTR), is currently trading up a little over 3%. In a contest like this one, though, half the fun is throwing caution to the wind and overriding what your stock picking system is telling you what to do – which is exactly what I intend to do again today.

For those who are worried about my casual disregard of CNBC dollars, you might be somewhat heartened to know that I am toying with a new kind of stop, a so-called behavioral stop. Don’t look for this term on Investopedia, however, as I just made it up. I define a behavioral stop as “metric-based trigger that is designed to force an individual from continuing on a course of repeating a particular self-destructive investment behavior.” For example: if I drop out of the top 10%, then I stop playing volatility roulette.

Now, let’s see who’s reporting after the bell today…

CNBC Million Dollar Portfolio Challenge: #41,667

Some days you can console yourself with thoughts of, “Well…it could have been worse…” Yesterday that particular consolation was not a straw available for me to grasp at, as my ‘all in’ bet on i2 Technologies (ITWO) turned out to be on the stock that had the largest percentage decline across the entire universe of NYSE, Amex and Nasdaq stocks. The damage was considerable, dropping me some 40,000+ places from the top 0.1% to the top 3%.

The gory details about ITWO’s earnings boil down to a significant earnings miss; a drop in maintenance revenues (often an indication that customers are unhappy with the software); and news that the 57-year-old CEO is retiring – with comments that the Board of Directors have “started looking for a replacement.”

A couple of interesting things happened along the way to this implosion. The most obvious one is that my earnings spike potential algorithm has to be considered a resounding success, as its last two selections have notched impressive gains and another stock it rated highly, ITWO, showed impressive volatility yesterday, albeit in the wrong direction. Yes, this is a Pyrrhic victory, but it is one that may pay some real money dividends down the road.

The other aspect of this is the emotional one. I have never tried paper trading and do not recommend it for those looking to learn how to trade. ITWO turned out to be the perfect case study. It cost me over a half a million dollars yesterday and my reaction was mainly that of amusement over the magnitude of the loss. Apparently, the entertainment value of CNBC dollars far exceeds the portfolio value.

If these were real world dollars, I would probably have agonized over the gap down in ITWO yesterday, hoped for a bounce (yes, I know you should never let “hope” enter into your trading calculus), then cut my losses as the intra-day pattern of lower highs and lower lows failed to reverse. At least that’s what I like to I think I would have done. In practice, too many investors, particularly inexperienced ones, cling to these horror stories and search frantically for any stray piece of information that can justify their instinctive response to hold on – with this pattern repeated over hours, days, weeks and sometimes months.

Without any dollars at risk or emotions involved in holding ITWO, I dumped it unceremoniously at the end of the trading day (no intra-day trading is allowed in this contest) and looked for another potential high-flier. Today my CNBC dollars are riding on the Amkor Technology (AMKR) bus; while AMKR has been doing wonders for my Portfolio A1 portfolio, today it is up 1%, consistent with the gains in the broader market.

Hey, at least you don’t hear me proclaiming, “Mission Accomplished...”

After Two Months, Portfolio A1 Is 5% Ahead of the S&P 500

Now that has been two months since Portfolio A1 was launched, I feel that sufficient time has elapsed to begin taking a cursory look at some of the portfolio statistics.

The first statistic that jumps out at me is annual turnover. While many may see a 327% annual turnover rate as high, this portfolio is designed to be actively traded, with the potential for turnover as high as 2000-3000% per year. So far, the system has culled three of the original five holdings. Of those three, only RIO has been a high performer since it was dropped from the portfolio. On the other hand, the post-sale performance of NTY and PCCC has been middling at best. So it appears that the system is doing a good job of cutting free losers – and I have no problem erring on the side of doing this too soon rather than too late.

In terms of the stocks that have been retained, four of the five current portfolio holdings are up at least 13% to date. The laggard, WCG, is up 2%, but it has only been two weeks since it was added to the portfolio. Again, this is just the type of performance I am looking for.

From a risk perspective, I look at maximum drawdown, which is the maximum peak to trough drop, regardless of time period. In the case of Portfolio A1, the 2/27 correction resulted in a 13% drawdown from the 2/26 high – a period during which the S&P 500 lost a little over 6%.

Though it is not included in the calculations on this graphic below, individual stock betas and correlations are an important component of portfolio risk. Four of the five stocks have betas in the 1.2 to 2.2 range; the fifth, AMKR, currently has a beta of about 5.0, which is partly responsible for why the current weighted average beta of the portfolio is 2.6. With the increased passage of time, I will look to the Sharpe Ratio as a means of measuring risk-adjusted returns.

Of course, total return and active return (defined as total return minus benchmark return, with the benchmark being the S&P 500 in this case) are two numbers that I keep a very close eye on. I am pleased to report that Portfolio A1’s return of 7% for the first two months is 5% better than the 2% return logged by the S&P 500.

There are no changes to the portfolio for the coming week.

A snapshot of the portfolio is as follows:

Portfolio A1 Update for 03/04/07

When I first announced that I would be using this space to talk about a live portfolio I was operating, I was more than a little concerned that the timing might not be ideal and that I should wait for a possible market correction before I rolled out a new portfolio. I based this opinion on my experience that the predecessor portfolios to A1 had demonstrated a greater propensity for outperforming the SPX benchmark in up markets than in down markets. Perhaps I should have listened to my gut…

Well, whether we have that correction already in hand or are in the early stages of a more substantial bear market, it is time to drill down on the A1 portfolio. As you can see from the attached equity curve below, A1’s performance has slipped below that of the SPX as a result of a week in which the five holdings were battered more severely than the indices. Due to last week’s performance, the system’s ranking of RIO (a favorite holding over the past two years or so) has dropped, triggering a sale. RIO has been replaced by RKT, a packaging company whose stock has tripled over the past year. RKT sports a relatively modest P/E 16 for 2007 earnings and a 1.9 PEG that puts it well below the industry average. In addition to a revenue growth story that is in sharp contrast to the industry trend, RKT has demonstrated continued pricing power it its markets. This is not a sexy stock, but the company appears to be executing on all cylinders and is attractively valued.

A glance at the equity curve suggests that this portfolio has a higher beta than the SPX; while this is case at the moment, largely due to the volatile AMKR, swapping RIO for RKT should decrease overall portfolio beta.

For the record, PCCC and AMKR are currently rated as the #1 and #2 stocks in this portfolio. In this challenging market environment, the performance of these two stocks should set the tone for the early performance of this portfolio and dictate the size of any drawdowns which may need to be scaled to return the portfolio to the green.

Finally, I should probably have already explained that this portfolio is a long only equity portfolio. It is not allowed to short stocks, buy or sell options, or avail itself of ETFs of any kind. As a result, the system does not make an effort to hedge any positions, regardless of the market conditions. The coming week should have a lot to say about how well this strategy is suited for the current market environment.