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Monday, November 06, 2006

Deterioration in Alpha Analysis

Our alpha analysis is deteriorating rapidly even though the major indexes are doing a relatively good job of minimizing extensive losses so far. Of the 1,716 issues analyzed this morning for alpha generation, only 346 are “buy” recommended, which is our lowest level since August 2nd. Even more significant is that nearly 50% of the securities are “short/sell” recommended, which illustrates the broad-based weakness developing.

The S&P 100 (OEF 8/4/06) remains the only “buy” recommended major market derivative after Friday’s close. The Russell 2000 (IWM) and other small-cap derivatives had been among our highest ranked over the last few weeks for beta exposure, yet they were downgraded to “sell” status this morning. However, I’d be fairly surprised if the small-cap indexes retain a “sell” recommendation for more than a week or two.

Obviously in market corrections small-caps are more susceptible to volatility, which explains why they are ranked towards the bottom of our analysis. But if this downtrend is only short-term in nature, basically giving the markets time to catch their breath, then small-caps might lead the rebound rally if it takes place. In the meantime however, having a disproportionate allocation in small caps could really drag down a portable alpha portfolio.

There are only three “buy” recommended sectors today, Biotech (IBB 10/6/06), Basic Materials (IYM 10/16/06) and Telecom (IYZ 7/24/06). Real Estate (IYR) and Transports (IYT), two sectors which generated significant alpha for us over the last few months, were downgraded to “short/sell” recommended status this morning.

Right now we’re somewhat stuck in limbo as we wait for the markets to either deteriorate to the point where we turn bearish, or consolidate and begin another bullish trend. Once we get that figured out, which should happen within days, we can adjust our allocation and portable alpha strategy.

A longer-than-expected correction or perhaps a bearish trend through 2006 isn’t necessarily a bad thing for portable alpha investors. The tools are available to generate alpha in both bull and bear markets, so we really don’t have a preference. In fact, I’d argue that it’s easier to generate alpha in a bear market, but that’s another post. Until then, we’re recommending extreme caution today and throughout the week until the markets become more discernable.

Long-Term Market Model – Bullish since August 23rd.

Investor Sentiment – We’re seeing a mixed message from the five sentiment indicators this morning. The VIX and VXN as well as the Index Put / Call ratio closed lower than Thursday’s values. The Total and Equity Put / Call ratios edged higher however. The VIX is trading slightly higher than last week’s reading, which I like to see.

Asset Allocation – 100% invested within the actively-managed, alpha producing portion of the overall investment portfolio. The Long-Term Market Model, which determines the asset allocation percentages, is weakening and approaching the level when it shifts to bearish stature. If the model continues its deterioration at the same levels of the last week or so, we could see a bearish indication within the week.

Beta Exposure and Portable Alpha Generation
Date = Date of AAS “Buy” Recommendation

Top Rated Major Market Derivative – iShares S&P 100 (OEF 8/4/06)

Top Rated Style-Box Derivative – iShares Morningstar Large Cap Core (JKD 8/16/06) is a “neutral” recommended derivative currently.

Top Rated Sector Derivative – iShares NASDAQ Biotechnology (IBB 10/6/06)

Today’s Top “Buy” Recommended Stocks
  • RTI International Metals Inc. (RTI 10/11/06)
  • Harman International Industries Inc. (HAR 10/9/06)
  • Veritas DGC Inc. (VTS 7/28/06)
  • Goldman Sachs Group Inc. (GS 9/12/06)
  • F5 Networks Inc. (FFIV 9/20/06)
  • Centene Corp. (CNC 10/20/06)
  • Sequa Corp. (SQA-A 10/5/06)
  • Robbins & Meyers Inc. (RBN 8/15/06)
  • Manitowoc Co. Inc. (MTW 8/10/06)
  • Plexus Corp. (PLXS 11/2/06)
Today’s Top “Sell” Recommended Stocks
  • Apollo Group Inc. (APOL 10/13/06)
  • Whole Foods Market Inc. (WFMI 11/2/2006)
  • Express Scripts Inc. (ESRX 9/22/06)
  • Red Robin Gourmet Burgers Inc. (RRGB 11/2/06)
  • Chico’s FAS Inc. (CHS 11/1/06)

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