The Speculator
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7 stocks that bring out the animal in us
The market's rapid recent rise has rekindled the instinct to make a killing fast. Our studies suggest there's no better time of the year to do it. Here's where we'll start and why.
By Victor Niederhoffer and Laurel Kenner
"Every man has a wild animal in him."
-- Frederick the Great in a 1759 letter to the French writer Voltaire.
"Give us some more stocks we can make a killing on. Forget all that folderol you're always giving us about sociology, the arts and baseball. We've got to get even."
That's the gist of the message we're hearing more and more from our readers these days. Especially now that their friends, or at least their acquaintances, have made fantastic gains in the last 45 days or so.
Yes, indeed. From the dusty badlands of the Dakotas to the svelte corridors of Wall and Main, the animal spirits are rising. Investors want to go all out and make money fast. The Speculators themselves are suffused with these spirits and plan to buy the following seven stocks:
Redback Networks (RBAK, news, msgs)
Lucent Technology (LU, news, msgs)
ADC Telecommunications (ADCT, news, msgs)
American Tower (AMT, news, msgs)
Nortel Networks (NT, news, msgs)
Crown Pacific Partners (CRO, news, msgs)
Oak Technologies (OAKT, news, msgs) As with most things, however, the road is much better than the inn itself, and therefore we invite you to travel and learn along with us as we describe our journey.
A bullish time of year
Whether it be the last month of the year, or the last week of the year as a precursor to the January effect, it is hard to deny that the season of bullishness is imminent.
The Speculators took out pencil and envelope to ascertain exactly what the year-end tendencies are regarding animalistic spirits for the last 10 years. The results show two distinct patterns:- The S&P 500 ($INX) index has closed up nine times out of 10 in December over November. The Nasdaq Composite ($COMPX) doesn't climb as often -- just 67% of the time -- but, when it's up, it climbs with greater ferocity. In January, the roles seem to be reversed -- while the S&P 500 index is up over December an appreciable 78% of the time, the Nasdaq is up a more consistent 83% of the time -- and with higher returns to boot.
- The first week of January shows real optimism, with investors sending the Nasdaq 100 ($NDX.X) up by an average of 1.25% -- more than three times the rate of the S&P 500 index. It would seem that as the slates are wiped clean, investors are willing to give risk a chance and a sense of optimism yields a spring in the step in the middle of winter.
The results suggest that a pairs trade long the Nasdaq 100 and short the S&P 500 would be appropriate as of the end of November. But the Speculators eschew a pairs trade as an equivalent to betting on a favorite to show in a horse race.
Right time for taking risks
As far as we can see, there are two major reasons for the return of the animal spirits. First, from Oct. 9 to Nov. 15 -- that is, within the last seven weeks -- there has been a profusion of incredible rises in individual stocks. More than 65 of the stocks in the S&P 600 Small Cap Index ($SML.X) have gone up at least 50% in that period, and only about 100 of them are down anything at all.
Here are the 10 biggest gainers, all up 100% or more:
| S&P Small Cap 600's top 10 gainers | | Name | Ticker | 10/09/02 | 11/15/02 | % Chg | | S&P 600 Index | $SML.X | 170.73 | 197.04 | 15.4% | | | | Rainbow Technologies | RNBO | 2.91 | 7.92 | 172.2% | | Artesyn Technologies | ATSN | 1.18 | 3.17 | 168.6% | | Bell Microproducts | BELM | 3.61 | 8.12 | 124.9% | | Harmonic | HLIT | 1.03 | 2.29 | 122.3% | | Skyworks Solutions | SWKS | 4.16 | 9.039 | 117.3% | | Kopin | KOPN | 2.51 | 5.36 | 113.5% | | Mesa Air Group | MESA | 2.93 | 6.18 | 110.9% | | Advanced Energy Industries | AEIS | 6.18 | 13 | 110.4% | | Kulicke and Soffa Industries | KLIC | 1.95 | 4.01 | 105.6% | | Manhattan Associates | MANH | 12.94 | 26.43 | 104.3% |
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Source: Bloomberg LP
The other reason is widespread knowledge concerning the January effect -- the tendency in us for increased risk-taking near the end of the year. The one effect that is most clearly documented in this regard is the January effect. As the great sages, the keepers of the flame, the scorekeepers, the authors of the best book on investments ever, "Triumph of the Optimists," Elroy Dimson, Mike Staunton and Paul Marsh clearly document: "Small-cap stocks in January in the United States go up on average some 6% more than the market averages. These results however, are not for all countries and seasons."
Professor Dimson kindly updated his work on small caps as follows in an e-mail interview:
"Our evidence is that seasonality in the small-cap premium is an effect observed in the United States but not universally. Tech stock performance has strongly influenced the effect in both the small cap and big cap sector."
Our own research on price as a predictor of subsequent performance was reported in our June 21, 2001, article "5 high-priced stocks ready to shoot skyward." Based on an enumeration of 20,000 company years over a 15-year period using data from Value Line, we found that the correlation between the price of a stock at the end of a calendar year and the stock's price appreciation in the first quarter of the next year was a significantly negative 0.09. In other words, the lower the stock price by Dec. 31, the better the subsequent performance by the end of the first quarter in the next year.
Academic research on the relation between current price level and price appreciation is scant. The best we saw after an extensive search was the paper "January Effect -- A Re-examination" by Honghui Chen and Vijay Singal. Taking account of the tax regime change affected in 1986 under President Reagan, they study the potential for tax-loss selling for each year from 1987 through 1998. They conclude that the January effect is caused by tax-related selling in December as investors sell those stocks with capital losses as an offset to those with capital gains. In January, the losers earn high returns because the selling pressure has ceased.
In particular, they find that the stocks in the highest quartile of those having potential for tax-related selling earn 6 percentage points less in the last 5 days of December than in the first 5 days of January.
Our friend, the erudite statistician and reader Martin Knight, augments this explanation:
"Tax-loss selling in December is mostly done by individuals (institutions do it in October) and so is concentrated in small-cap stocks, particularly value, so general indexes like the S&P 500 are not a good measure. It's an excellent strategy in some years (like December 2000) but not last year and I would doubt this year either.
"For a truly profitable tax-loss season you need some combination of three factors:- Gains in some stocks elsewhere to motivate the tax-selling in the first place."
- Total despondency in a sector if not the general market, a feeling that the shares might never come back."
- Moderate success of the strategy in the recent past otherwise too much money will be there buying to cancel out the selling.
"At the end of 2000 we got the first one and the other two to an extent, while in 2001 we got none of them. You could say that 2001's December was in September for an obvious reason."
Practical animals
The greatest practical forecaster of all time, Sam Eisenstadt, Value Line's chairman of research for the last 50 years, has another explanation for what's happening. We spoke standing at the corner before the Blue Hill Troupe's magnificent performance of "The Most Happy Fella" last Saturday, and he opined: "The strong performance of animal spirit stocks recently is anticipation of the January effect. If December continues to display this characteristic, it'll move into November. Indeed, it seems to have moved into as early as October this year. This is normal behavior for a seasonal that everyone is aware of. I suspect in time it will disappear altogether."
The Speculators are always happy to stand on the shoulders of grandmasters like Dimson and Eisenstadt. However, they are not immune from certain animalistic passions of their own: They like to count and speculate themselves. Along these lines, they have over and over again made big profits by buying low-priced stocks at propitious occasions. Perhaps their best foray here came when they bought and recommended a basked of beaten-down Internet stocks in early 2001 and sold them after a month for an average triple-digit actual gain. (Their purchases of low-priced biotechs in the last year, however, have been a disaster.)
They were helped mightily in the successful Internet stock prediction, and similar ones they made in early 2001 and 2002, by the fantastic rise in low-priced stocks in recent years. During the first five months of 2001, for example, the lowest priced decile of Value Line stocks went up an average of 82%. Over time, the low-priced stocks in Value Line's universe have gone up much more than the average. However, because of the seasonality of these returns, their large variability, the possibility of a small survival bias and the absence of dividend calculations, this is not by any means a sure way to riches.
Inspired by the desire to make a profit and at the same time to provide scientific explanation to this phenomenon, The Speculators examined the relation between price level and subsequent performance in the companies that make up today's S&P 500.
We measured the change in price from the end of November to the end of January for each company for each of the last five years. The results show that the companies whose stocks have memberships in the Bottom 5, the Bottom 10, and the Bottom 20, ranked by price, clearly outperformed the Top 5, Top 10 and Top 20 member stocks and the S&P 500 index itself.
| Price appreciation from Nov. to Jan, ranked by price level of stocks | | Group of 5 | Group of 10 | Group of 20 | S&P | | 11/30/98 to 01/29/99 | | | | | | Lowest-priced stocks | 12.67% | 3.10% | 14.31% | | | Highest-priced stocks | 23.00% | 20.06% | 14.74% | 9.97% | | | | | | | | 11/30/99 to 1/31/00 | | | | | | Lowest-priced stocks | -2.50% | -2.97% | 4.10% | | | Highest-priced stocks | 44.48% | 28.12% | 18.63% | 0.40% | | | | | | | | 11/30/00 to 1/31/01 | | | | | | Lowest-priced stocks | 54.03% | 49.98% | 39.14% | | | Highest-priced stocks | -7.83% | -5.31% | -4.53% | 3.88% | | | | | | | | 11/30/01 to 1/31/02 | | | | | | Lowest-priced stocks | 15.74% | 4.62% | 0.33% | | | Highest-priced stocks | -1.24% | 0.79% | 0.49% | -0.81% | | | | | | | | November to January summary: | | | | | | Average price return per year low priced: | 18.64% | 12.61% | 12.51% | | | Average price return per year high priced: | 12.64% | 8.92% | 6.19% | 3.21% | | | | | | | | Superior returns per year over 5 years | | | | | | Low priced over high priced | 6.00% | 3.69% | 6.32% | | | Low priced over S&P | 15.43% | 9.40% | 9.31% | | | High priced over S&P | 9.43% | 5.71% | 2.98% | |
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Sample: From today's S&P members, the 5, 10 and 20 stocks that had the lowest and the
highest sticker prices on the start dates listed above in each November.
Source: Niederhoffer Management LLC, Bloomberg LP.
The excess return of the five lowest-priced members of the S&P 500 index, of over 15% a year, was particularly striking in this regard.
But this is not the path to easy riches, either. There is just too much variability involved.
A study of the performance of Value Line stocks classified by price at the beginning of year gives the following sobering results:
Stocks below $5 on 12/31/01:
Average = +9%
Std Dev = 62%
Stocks below $10:
Average = -15.3%
Std Dev = 52%
Stocks above $100
Average = +11.2%
Std Dev = 31%
The whole group:
Average = -16.2%
Std Dev = 32.5%
Clawing our way deeper
What's obviously required is something that combines all these disparate results. Something that takes account of the seasonality of the animal spirits, the tendency for those volatile low-priced stocks to outperform on average, with a high uncertainty. What we felt was in order was to take the 25 lowest-priced Value Line stocks as of Nov. 15, and then to further filter them by something that signaled to us that the companies themselves had some confidence in the stock, and whose financials did not have excessive accruals.
Fortuitously our recent columns gave some guidance in this regard. We wrote on Sept. 19 that "Empty shelves signal a rising stock"; on Sept. 26 suggesting that investors "Count on a company's cold, hard cash flow"; and more recently on Oct. 24 identifying "5 genuine buys on a Street of impostors".
We filtered the 25 lowest-priced companies through the prism of signaling reductions in inventory, improvements in accounts receivable and net insider buying. We put them all together and came up with a long list of stocks, the seven best of which we intend to buy at a propitious occasion in the future when the market takes an appropriate squall. (For us, 2% - 4% from a recent high is an appropriate squall).
We list below 24 stocks with the details on changes in accounts receivables and inventory for the most recently reported quarter of 2002 over the matching periods in 2001; and net insider activity for 2002 updated through Nov. 15, 2002. The seven stocks we will be buying are at the top of the list.
| Bottom 25 priced stocks on 12/31/01, filtered by fundamentals & insider activity | | Company | Symbol | Change in receivables | Receivables rank | Change in inventory | Inventory rank | Inventory + receivables rank | Net insider activity | | Redback | RBAK | -73.2% | 2 | -73.5% | 3 | 5 | Buyers | | Lucent | LU | -64.1% | 4 | -70.8% | 4 | 8 | Buyers | | ADC Telecom | ADCT | -66.8% | 3 | -48.9% | 6 | 9 | Buyers | | American Tower | AMT | -39.0% | 8 | -60.0% | 5 | 13 | Buyers | | Nortel | NT | -48.0% | 6 | -43.1% | 7 | 13 | Buyers | | Crown Pacific | CRO | -36.1% | 9 | -26.0% | 10 | 19 | Buyers | | Oak Tech | OAKT | -41.1% | 7 | -16.8% | 12 | 19 | Buyers | | Vitesse | VTSS | -30.9% | 12 | -35.4% | 8 | 20 | Buyers | | Digital Lightwave | DIGL | -80.1% | 1 | 4.9% | 23 | 24 | Buyers | | Priceline | PCLN | -36.0% | 10 | 0.0% | 19 | 29 | Buyers | | Foster-Wheeler | FWC | -5.7% | 18 | -15.3% | 13 | 31 | Buyers | | Rite-Aid | RAD | 10.2% | 23 | -12.1% | 15 | 38 | Buyers | | Sirius Satellite | SIRI | 0.0% | 22 | 0.0% | 22 | 44 | Buyers | | Extended Systems | XTND | -30.2% | 13 | -100.0% | 2 | 15 | None | | Amcast Industrial | AIZ | -4.6% | 19 | -26.7% | 9 | 28 | None | | Sapient | SAPE | -51.0% | 5 | 31.8% | 24 | 29 | None | | Kmart | KM | 0.0% | 21 | -23.1% | 11 | 32 | None | | OpenTv | OPTV | -25.5% | 14 | 0.0% | 20 | 34 | None | | Art Technology | ARTG | -34.0% | 11 | -100.0% | 1 | 12 | Sellers | | AES | AES | -18.5% | 15 | -14.6% | 14 | 29 | Sellers | | Atmel | ATML | -13.5% | 17 | -10.9% | 16 | 33 | Sellers | | Openwave | OPWV | -16.8% | 16 | 0.0% | 21 | 37 | Sellers | | Safeguard Scientific | SFE | 0.0% | 20 | -6.9% | 18 | 38 | Sellers | | Recoton | RCOT | 14.7% | 24 | -8.9% | 17 | 41 | Sellers |
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Source: Bloomberg LP, Niederhoffer Management LLC, Thomson Financial
Be sure to realize that probably three of these seven are going to fall rather dramatically; that there is considerable uncertainty concerning our speculations and the statistical and practical validity of the results reported above.
Nevertheless, the animal spirits exist in The Speculators as well as in our readers at this time of the year, and we plan to swing for the home runs to get even, or possibly a little bit more.
Final note
We have available a list of the 100 lowest priced Value Line stocks and the 20 lowest priced S&P 500 Index stocks ready for our readers' perusal at our Web site. Furthermore, we have the usual erudite comments of our readers and mentors, those with knowledge of time and place on this subject also available. For readers who wish to critique, augment, or praise our work, kindly e-mails us and we will send you the inventory, accounts receivable and insider trading analysis of these groups.
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