The Markets Look Forward

Hockey player Wayne Gretzky always skated to "where the puck is going to be - not where it is." The markets also look forward. Despite moribund economic activity, the S&P 500 posted a +15.6% gain for the 3Q and is now up +31.5% over the last six months. During the 3Q, financials (banks, insurance companies, REITs) were up +25.1%. The industrial and materials sectors kicked n each gaining +21.0%. The only laggards for the 3Q were telecommunications and utilities up in the low single digits.

In Gold Leaf portfolios, Hospitality Properties, the hotel REIT, was up +71% in the Q. Stratasys, the 3D rapid prototype manufacturer, gained +57%. The Cohen & Steers REIT returned a +38%. While a handful of our holdings declined in value (notably PPDI), what is remarkable is the number that posted positive double digit gains. PPDI is a third party drug testing company and one of our larger holdings; in fact, we added more of it during the 2Q. The stock was down -5% in the 3Q on continuing concerns about the cancellation rate of their backlog. We conclude that this is a temporary phenomenon reflecting cost cutting by the major pharmaceutical companies. Given the aging population and the preventive benefits that drug regimens provide, it is likely the company will see a demand uptick.

During the Q we sold three stocks - two because they had reached fair valuation and one to acknowledge a broken company. We sold Watsco (the HVAC distributor) at a PE of 34X which is high. Undoubtedly, the well run company will continue to grow into that PE, but 34X is nearly twice its average ratio. Tractor Supply (the rural man's Wal-Mart) was sold at 20X which is line with its long PE history. We additionally wanted to cut our exposure to consumer stocks at a time of consumer retrenching. Temecula Valley Bancorp was sold as the bank was taken over by the FDIC. Despite out having met with management before we bought the stock, we underappreciated the housing devastation that California's central valley would witness.

After factoring in our usual "margin of safety," we found few securities that appeared to be attractive in the Q. As we wrote in the previous newsletter, banks still need to 'fess up to the commercial real estate problems. The housing market still has headwinds: the expiration of the $8,000 tax credit and the hidden inventory of 3 million homes that should be in foreclosure. What demand we have seen has mainly been created by the government (cash for clunkers) and is not sustainable.

Gold Leaf is an independent Registered Investment Advisor that buys stocks in cash positive companies with sustainable competitive advantages. As an independent firm, Gold Leaf provides objective investment management. Our goal is to protect client assets on the downside while participating in most of the market's upside.