PCA Retirement & Benefits - Mid Cap Value
Third Quarter 2011
PCA Retirement & Benefits:
Russell Midcap Value Index:
Difference
3Q11
-20.83%
-18.46%
-2.37%
PCA Retirement & Benefits:
Integrity Midcap Value Composite:
Difference
-20.83%
-20.45%
-0.38%
Comments (3Q 2011):
Stock selection in Technology, Utilities and Energy were the primary culprits for the underperformance. Sector weights were
a modest detractor as an underweight to Utilities, the best performing sector, was a headwind. Stock selection in Consumer
Staples was the largest contributor. Style attributes such as a higher beta and lower market cap were significant detractors,
while higher exposure to Price/Book stocks was a positive.
The largest detractors in Technology were our positions in Seagate Technology (STX) and Parametric Technology (PMTC),
along with not owning Motorola Mobility Solutions (MMI) which was up 71% after Google (GOOG) offered a huge
premium to purchase it. Seagate Technology (STX) dropped after guiding to weaker margins due to commodity costs and
issues related to new product ramps. Parametric Technology (PMTC) was weak as it offered slightly less than expected
guidance as they ramp sales hiring.
We lost 90 basis points in performance in Utilities through equal parts stock selection and an underweight to the group. An
underweight of almost 300 basis points hurt as it was virtually the only safe haven within equities beating the Russell Midcap
Value Index return by over 1600 basis points. Also, not owning some of the better performers in the index such as
Consolidated Edison (ED) and Progress Energy (PGN) detracted. The relative valuation of Utilities has been more expensive
only 5% of the time since 1953 (per Empirical Research Partners) and this has kept us from adding additional exposure.
Macro uncertainty, declining commodity prices and slowing growth expectations hurt a number of our oil services stocks
such as Basic Energy Services (BAS), Key Energy Services (KEG) and Complete Production Services (CPX). Subsequent to
quarter end, Complete Production Services (CPX) agreed to be taken over by a competitor for a sizeable premium.
The difficult macro backdrop led to good relative results for our Consumer Staples stocks. TreeHouse Foods (THS), a
manufacturer of private label food brands, was up over 13% as the weak macro environment should boost demand for their
products as consumers shift away from restaurants in favor of grocery store purchases. Dr Pepper Snapple Group (DPS)
continues to deliver solid financial results, while Hain Celestial (HAIN) offered better than expected guidance due to
acquisitions and good sales momentum.
Other significant contributors included Arch Capital Group (ACGL) and RF Micro Devices (RFMD). Strong operating
results, growth in book value and improving pricing opportunities are supporting Arch Capital Group (ACGL). RF Micro
Devices (RFMD) posted a small advance as results beat expectations and indicate increased share gains in higher margin
businesses. Conversely, MetroPCS (PCS), a wireless operator, was one of our largest detractors after reporting higher churn
and rising expenses. We sold the stock on this news.
Stocks not owned by PCA due to restrictions (attribution relative to Integrity Midcap Value representative account):
MGM Resorts International
Health Net Inc.
CBS Corp (Cl B)
Penn National Gaming Inc.
CIGNA Corp.
Wyndham Worldwide
LifePoint Hospitals
Humana
3Q11
+0.21
+0.06
+0.01
-0.02
-0.03
-0.09
-0.15
-0.17
Lorillard Inc
Watson Pharmaceutical
-0.20
-0.33
-0.70
Note: A higher relative cash position of 1% added +0.23
Outlook:
Plus Ca change, Plus c’est la meme chose.
The more things change the more they stay the same. As we wrote last quarter, many of the same macro issues that have
confronted investors over the last few years have come to the forefront. While a lot of things have changed over the last three
months, for the most part market psychology has remained the same. The two main concerns gripping the market right now,
in our opinion, are Europe and the US economy.
Last quarter we were optimistic. Some of that optimism has faded. Economic growth has been weak, hampered by a general
lack of confidence on the part of the consumer and business. However, we believe the economy has become the sideshow to
Europe and its potential financial crisis which is the main event.
We don’t see a whole lot of difference between current forecasted growth in the US and recession. Moreover, at current
levels, we feel the market already is discounting a significant slowing of activity. We’ve become neutral on whether the US
enters recession or not. Frankly, we don’t think it matters much from here. In addition, if we do have a recession, we don’t
believe it will be deep. It is hard for us to see how much worse things can get economically from here. The economy has not
really recovered, and there are no excesses to unwind.
However, the European crisis is a different story. A cascade of European sovereign defaults could cause a Lehman-like
failure and crisis across the developed world. That said, we believe this outcome is unlikely. Having learned from our crisis,
the Europeans know how to prevent one from developing. The challenge for investors is political will and timing. We have
two concerns. First, we wonder how bad it will have to get before European politicians act decisively. The longer they wait,
the more downside risk there is to the market. Second, timing is difficult. Unlike other structural/cyclical issues which have
roiled the markets in the past, the resolution to this crisis will be one of human decisions. This makes it impossible to time
as there are no reliable indicators to foretell when politicians will act.
With this in mind, we have taken some risk out of the portfolio. Since timing is difficult, we will let valuation be our guide,
developing a stable of companies we would like to own and the prices at which we think the risk/reward is tilted strongly in
our favor. We will execute those ideas as the opportunity arises. As of now, valuations have gotten cheaper but haven’t hit
many of our targets. We continue to actively monitor the situation.