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10 mid caps to help stuff your stocking
Mid-cap stocks pick up a little bounce at the end of the year, and we think we've found a way to cash in: Play the top performers through November for a December gain. Here are the names.
By Victor Niederhoffer and Laurel Kenner
(Scene: Speculators at work, barely visible behind computer monitors, stacks of books, piles of spreadsheets, Gilbert & Sullivan CDs and printouts of academic studies.)
Vic: Laurel, lets buy some mid-cap stocks. At year-end they seem to bounce.
Laurel: Isnt that, shall we say, a bit humdrum? I've never thought of you as a mid-cap kind of guy, Vic.
Vic: Well, I've traded the extremes my whole career. I've pyramided gold up from $300 to $600 and held 10% of the open interest at the time. I bought stocks below $1 with 100% of my net worth in the `70s and doubled my money. I bought high-priced Nasdaq stocks near the beginning of the millennium, only to see them stumble. Unfortunately, I shorted thousands of contracts of the dollar/yen as it climbed from 80 to 130, and I sold naked puts on the S&P futures a week before they closed the exchange. I was heavily long the stock market throughout the Long-Term Capital crisis. I've heard the owl, seen the elephant and ridden the screaming eagle. It's time for me to quiet down, to buy stocks with the resilience of high caps but the potential to gain like low caps.
Laurel: But Vic, mid caps sound so middle-of-the-road. Youve never settled for mediocrity before, as far as I know. If we start talking mid caps, readers might think we've lost our edge. Are we so bereft this week that we're reduced to middling ideas? Anyway, theres no such thing as mid caps; there are only former low caps hopefully on the way to becoming high caps and former high caps that fell by the wayside. Not to belittle you, but you have to stay young-hearted.
Vic: Laurel, please dont give up on me. Im not so bereft as I seem. The average person is wiser than all the sages and politicians in the world, and the same holds true of the average stock -- the mid caps. One should never be too highfalutin to consider them. Dont forget the wonderful line from Antoine de St.-Exuperys "The Little Prince": I must endure the presence of two or three caterpillars if I wish to become acquainted with the butterflies.
Laurel: Dont tell me you buy that old wives tale that mid caps provide low-cap returns at large-cap volatilities.
Vic: Laurel, I have been studying stocks for more than 45 years now, and I have been exposed to almost every deception that a few hundred dens of thieves could come up with. Im not quite that nave.
Laurel: Or that propaganda put forward by so many mediocrities that mid caps offer bargains because analysts dont cover them as closely as big companies.
Vic: No, I dont believe that. The markets too efficient, and that argument is just an excuse for starting new value mutual funds. I've got some other tricks up my sleeves. Remember that day in December (of 2001) when I first told you that stocks get perky around the end of the year?
Laurel: That was about low-priced stocks.
Vic: Yes, but not so fast. Its similar for the mid caps.
Laurel: All right, then. Statistics on the table.
(Vic starts pulling spreadsheets from the pile on the desk.)
Laurel (punching a few keys on the computer): Whats in the S&P Midcap 400 Index ($MID.X), anyway?
| S&P Midcap 400: Biggest and smallest | | Biggest | Market value (billions) | | Smallest | Market value (millions) | | M&T Bank (MTB) | $7.54 | | Atlas Air (CGO) | $94.9 | | Gilead Sciences (GILD) | $7.51 | | Sykes Enterprises (SYKE) | $127.6 | | Washington Post (WPO) | $6.97 | | Retek (RETK) | $240.9 | | Affiliated Computer Services (ACS) | $6.57 | | Metris (MXT) | $398.4 | | Symantec (SYMC) | $6.38 | | Quanta Services (PWR) | $259.2 | | Microchip Technology (MCHP) | $5.95 | | Transaction Systems Architects (TSAIE) | $261.7 | | Quest Diagnostics (DGX) | $5.66 | | InFocus (INFS) | $292.6 | | Weatherford Int'l (WFT) | $5.12 | | Carpenter Technology (CRS) | $298 | | Nat'l Commerce Financial (NCF) | $5.14 | | Solutia (SOI) | $306 | | IDEC Pharmaceuticals (IDPH) | $5.12 | | Unifi (UFI) | $315 |
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Source: Bloomberg L.P.
Laurel: Ive never even heard of Affiliated Computer Services. (Calls up a description.) Oh, wow. Affiliated does electronic commerce! Youve got to be kidding me, Vic. Nobodys buying e-biz stocks these days.
Vic: Affiliated Computer happens to be up about 50% since Oct. 9. Anyway, you dont have to like the stocks. Just the index.
Laurel: As I recall, the S&P Midcap 400 didnt do so well against the S&P 500 ($INX) in the last half of the 90s.
Vic: The S&P 500 beat the Midcap from 1994 through 1999, but the Midi did better than the big caps in 1992-1993 and 2000-2002. (Hands her a table.)
| S&P Midcap 400 vs. S&P 500, Annual return (1992-2002) | | Year | S&P Midcap 400 | S&P 500 | | 2002 (through November) | -10.90% | -17.20% | | 2001 | -1.60% | -13.00% | | 2000 | 16.20% | -10.10% | | 1999 | 13.30% | 19.50% | | 1998 | 17.70% | 26.70% | | 1997 | 30.40% | 31.00% | | 1996 | 17.30% | 20.30% | | 1995 | 28.60% | 34.10% | | 1994 | -5.50% | -1.50% | | 1993 | 11.70% | 7.10% | | 1992 | 9.50% | 4.50% |
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Source: Bloomberg L.P.
Vic: S&P introduced the Midcap 400 in June 1991. Through November of this year, the Midcap rose 272% in price, vs. 152% for the S&P 500.
Laurel: What about with dividends reinvested?
Vic: The S&P 500 has paid out about half a point more over the years, but that would only narrow the difference in performance by 5 percentage points or so. The Midi still looks superior.
Laurel: Say I decide to buy and hold the Midi. Whats the best way to do it?
Vic: The Midcap SPDR (MDY, news, msgs), an exchange-traded fund that acts like a stock, trades on the American Stock Exchange. Theres also the iShares Russell Midcap Index (IWR, news, msgs).
About 300 mutual funds specialize in mid caps. Morningstar breaks performance into mid-cap value, mid-cap growth and mid-cap blend. The value and growth funds, in the aggregate, are No. 3 and No. 4 in the five-year performance rankings for U.S. mutual funds, behind health and financial. The annual return on value and growth has been about 4% over the past five years, compared with an annual gain of 0.7% for large-cap value and a 1.2%-per-year loss for large-cap growth. You might also consider the Vanguard Mid Capitalization Index Fund (VIMSX), a no-load mutual fund with an expense ratio of 0.25%.
There are also S&P Midcap 400 futures, which have been trading on the Chicago Mercantile Exchange in both big and E-mini versions since June 19, 1991.
Laurel: $500 a point on the big contract, and $100 a point on the E-mini?
Vic: Right. But youd need sufficient reserves to ride out potentially huge margin calls in a down market.
Anyway, these excess returns arent necessarily the chink in the armor. It appears that the only time the Midi is worth buying is during the October-to-December quarter, when it goes up at an average rate of some 8%. During the other nine months, the Midi rises at a rate barely above 1% a quarter.
Laurel: Too late the phalarope, for this year anyway.
Vic: Not really. December has been particularly good.
| S&P Midcap 400 vs. S&P 500 | | Monthly seasonality, 1992-present | S&P Midcap 400 | S&P 500 | | Jan | 0.20% | 1.80% | | Feb | 0.80% | -0.50% | | Mar | 0.70% | 0.90% | | Apr | 1.80% | 1.30% | | May | 1.00% | 0.80% | | Jun | 0.20% | 0.40% | | Jul | 0.00% | -0.20% | | Aug | 0.10% | -1.30% | | Sep | 0.30% | -0.80% | | Oct | 1.40% | 2.50% | | Nov | 2.30% | 2.50% | | Dec | 4.20% | 1.70% |
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Source: MSN Money
Laurel: Hmm -- 4.2% for the Midi in December, compared with 1.7% for the S&P 500. But really, Vic, I never thought Id see you recommend a one-month trade with a mere 4% expectation, considering the commissions and the bid-asked spread youre always talking about, which would take a good part of that abnormal return away.
Vic: Ah, but theres another angle: tax selling. Mid-cap companies that have shown the best performance year-to-date tend to be held over to the next year so the investor doesnt have to realize the taxable gain. The best performers among the Midcap 400 from the close of each year through November tend to do very well indeed in December
Laurel: How well, Vic?
Vic: Over the last four years, well enough to put some Christmas gifts under the tree.
| S&P Midcap 400 | | December performance for 10 best stocks of first 11 months | | | Year | Top 10s December performance | | 1998 | 20% | | 1999 | 29% | | 2000 | 26% | | 2001 | 3% |
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Laurel: Not so good last year, when the Midcap Index itself rose 5%. Anyway, isnt the tax effect likely to be dissipated this year? So many stocks have big losses that everyones going to be able to sell as many big gainers as they want without having to worry about taxes.
Vic: You could have made the same argument about 2000 and 2001, when these stocks outperformed the S&P 500. Also, mid caps benefit when theyre eventually elevated to the S&P 500, as has been well documented by our editor (and MSN Money columnist) Jon Markman.
Laurel: Well, youve convinced me. Youre not getting old-hearted after all, and regardless, its better than the alternative. Exactly what are the 10 best companies this year that you plan to muddle into?
Vic: Laurel, remember there is tremendous variability in these stocks. And the results of our study suffer from being retrospective, i.e., looking back rather than forward. However, taking one consideration with another, I think we should buy these:
| S&P Midcap 400 | | 10 best performers year-to-date | | | | Company | YTD % chg | Market cap | | SanDisk (SNDK) | 92.7 | $1.9 bln | | Imation (IMN) | 90.7 | $1.4 bln | | PetsMart (PETM) | 87.5 | $2.6 bln | | Dreyer's Grand (DRYR) | 82.1 | $2.4 bln | | Coach (COH) | 74.6 | $3.1 bln | | Claire's Stores (CLE) | 71.9 | $1.3 bln | | PacifiCare Health (PHSY) | 67.2 | $970 mln | | Energizer Holdings (ENR) | 55.4 | $2.7 bln | | Agco (AG) | 53 | $1.8 bln | | Ross Stores (ROST) | 44.2 | $3.6 bln |
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Source: Bloomberg L.P.
Final notes
If youd like to see a full workout of this 10-best strategy for past years, visit our Web site at www.dailyspeculations.com. We will send a special bonus extension of the study to those who write us with augmentations, encomia or critiques. If youd like to see a list of all constituents of the S&P 400 Index, visit Standard & Poors Web site.
We often receive much abuse alongside the much-appreciated compliments. The reason is that we do not follow the pathetic practice of telling our readers to buy if they think the markets going up and to sell if they think its going down. We are unequivocal. Thus, when we are bullish we antagonize all the bears, and vice versa. But theres another reason: Yes, we have been too bullish this year. We never fail to emphasize that the 1.5 million percent returns that the authors Dimson, Marsh and Staunton (in Triumph of the Optimists) found for U.S. stocks in the 20th century seem appropriate to us for the 21st century.
We were killed on some of our own purchases of biotechs in October 2001 and beaten-up Nasdaq stocks in June 2002. Thus, we are pleased to report good results for the last two sets of stocks we bought. Our picks of Oct. 24 (5 genuine buys on a street of impostors) are up an average of 11% from the publication date. The seven low-priced stocks that we suggested as planned purchases on Nov. 20 (7 stocks that bring out the animal in us), are up an average of 40%. The smallest gain, 6%, was in ADC Telecommunications (ADCT, news, msgs); the others were in the 40% to 80% range. Thus, we are not always too bullish.
At the time of publication, Victor Niederhoffer and Laurel Kenner were long the 10 mid caps listed in their final chart -- SanDisk, Imation, PetsMart, Dreyer's Grand, Coach, Claire's Stores, PacifiCare Health, Energizer Holdings, Agco and Ross Stores.
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