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Stocks with a peace dividend
Bears are jumping on board as a postwar rally gets under way. One way to get the most out of it: Buy the lowest-priced, cheapest, worst-performing, most heavily shorted stocks in the S&P 500.
By Jon D. Markman
Its probably just a coincidence, but the rats and goons are fleeing their hideouts in Baghdad and Damascus at the same time that sellers appear to be scramming from Wall Street.
That happy concurrence may mean it is finally time for investors to poke their heads up from the foxholes theyve dug over the past few years and notice that the shooting has stopped.
Whether recent market strength is just a cease-fire in a long-term bear market or a lasting peace, no one really knows. But the homogeny of buying in recent weeks across all market capitalizations, most sectors and both the growth and value styles suggest that it could be time to stop fretting about the current state of the economy, declining employment, uneven earnings reports and the potential for new geopolitical troubles and instead recognize that the market knows all of this. Every bit of it. And it is rising, ever so gingerly, anyway.
One must be cautious, to be sure. Snipers, landmines and suicide bombers still lurk in the shadows of many corporate balance sheets. Earnings estimates for the second and third quarters are coming down on average, not rising. And a deadly complacency may be creeping in already, as the widely observed gauge of sentiment, the CBOE Market Volatility Index ($VIX.X), shows that a euphoria has so seeped into options buyers' attitudes that they are willing to pay an exceedingly high premium for bullish bets.
Yet these are controllable phantoms, not permanent demons. At present, serious economic woes such as factory overcapacity and rising joblessness may not have been resolved to the upside. But investors, taken collectively, attempt to preview the future, not review the past. And since the start of the year, anticipating better business to come in a more peaceful and prosperous post-terrorist world, more stocks have risen than fallen. After a multi-month hiccup before and during the war, the prescient Weekly Leading Index of the Economic Cycles Research Institute resumed its upward path in the past two weeks, diminishing the likelihood of a second round of recession.
Its not just the broad market averages, dominated by large-cap stocks that are on the move. Using the MSN Screener, you can see that in all but one way that you can cut the deck of stocks, quite a few more are up than down in the past four months. (Click here.)- Among stocks with market capitalizations between $100 million and $1 billion and prices above $2, 1,322 are up for the year and 1,182 are down through April 17.
- Among stocks with market capitalizations between $1 billion and $10 billion and prices above $2, 610 are up for the year and 546 are down.
- Among stocks with market capitalizations greater than $10 billion and prices above $2, 163 are up for the year and 132 are down.
- Among the 1,817 stocks that MSNs StockScouter system has identified in the growth style, 1,057 are up for the year and 759 are down.
In other words, if you had randomly picked 10 stocks for your portfolio this year, you were likely to have chosen more that went up than down. And youd be showing a profit even though the start of the year was a scary time to invest, following one of the worst Decembers in history.
Turning toward the bull
Several former bearish analysts and investment professionals, meanwhile, have made sweeping turns in their approach in recent weeks in tune with the rebound: - Valu-Trac, an institutional investment-analysis model that has rated all major indexes Avoid for the past three years, late last week turned tentatively bullish on U.S. equities as it determined that for the first time since the spring of 2002, price momentum in the S&P 500 Index ($INX) had stopped falling. The noteworthy positive turn does suggest a base is being built and that the primary bear market may finally be coming to an end, said Erik Hess, analyst at International Strategy and Investment, who studies the system.
- Lowrys, the nations oldest institutional technical-analysis service, told subscribers March 17 that the bear market appeared to have come to an end. It has stuck with that view through several steep pullbacks since. Its selling pressure index has declined to 10-month lows, suggesting that the amount of stock offered for sale has been steadily declining, while its buying pressure index has risen to new rally highs. This shows that investors are not willing to part with their stocks at current price levels, forcing buyers to bid up prices to complete their trades, the service said in a recent report. Lowrys, which had been emphatically negative prior to mid-March, now considers the U.S. equity markets to be in a primary buying zone, a period of increasing demand and diminishing supply that generally yields a low-risk time to accumulate stocks.
- John Hussman, one of the few growth fund managers to post double-digit gains in the past three years due to a bearish point of view, said in his weekly report to shareholders Sunday that he sees a good chance for a full-featured shift in trend uniformity in the weeks ahead. Hussman, whose Strategic Growth Fund (HSGFX) has more than $400 million in assets, judges market climates by their valuation and trend. He continues to think stocks are overvalued, but he now thinks that for the first time since Sept. 1. 2000, stocks have a shot at going up in unison. He told shareholders that he had begun to remove hedges, or derivative bets against the market to preserve capital. In prior bear-market rallies, he said he had removed 20%-40% of hedges; this time he plans to remove 60% of his hedges.
You may well wonder why, if everythings so great, market leaders such as Microsoft (MSFT, news, msgs), Intel (INTC, news, msgs), Cisco Systems (CSCO, news, msgs) and Wal-Mart Stores (WMT, news, msgs) have barely budged after decent earnings reports last week. And the answer may be that all is not well -- and bulls are about to get their heads handed to them. But if you happen to agree with these three that the worst of the fight is over, shake loose the self-doubt and grime and look forward into the prospects for calm.
Tough stocks for a postwar rally
To exploit the notion that peace is at hand and a better economy should follow, conservative investors could simply buy a low-cost mutual fund that tracks the Wilshire 5000 index, such as the Vanguard Total Stock Market Index (VTSMX). But a more intellectually advantaged way to show both true grit and imagination should permit you to hypothesize the types of stocks that should go up the most over the next few months or years.
In several recent columns, I have proposed ideas from Robert Drach, Valu-Trac, "Momentum Kings," defense and aerospace and War Rally Soldiers. All of these ideas are still valid, in my view. All but the momentum stocks could be used as the basis of potential 12-18 month holdings.
For the most oomph in a relatively conservative portfolio, consider the War Rally Soldiers again. The previous bunch rose 20% from Feb. 10 to April 21 despite holding Healthsouth (HLSH, news, msgs), which was down 96%. It was amply counterbalanced by Williams (WMB, news, msgs), which is up 119%. The theory for these names: Take positions in the lowest-priced, cheapest, worst-performing, most heavily shorted stocks in the S&P 500 index. (Here's the screen.) If the market goes up 10%, these will probably go up 20% or more as fund managers and others equitize their cash by buying the index. Stocks with the lowest prices generally advance the most in these circumstances; short-sellers provide fuel for the up-move; and their low valuations make them minimally palatable.
| Postwar rally soldiers? | | Name | April 21 price | Price/sales | Beta | % chg 12 mos. | Short ratio | | Sprint PCS Group (PCS, news, msgs) | $4.46 | 0.38 | 3.57 | -63.2 | 22.0 | | AES Corp. (AES, news, msgs) | $4.62 | 0.29 | 1.81 | -42.0 | 19.0 | | Calpine (CPN, news, msgs) | $4.22 | 0.21 | 1.94 | -66.2 | 18.0 | | Goodyear Tire & Rubber (GT, news, msgs) | $5.22 | 0.06 | 1.05 | -78.6 | 17.0 | | Avaya (AV, news, msgs) | $2.59 | 0.2 | 3.89 | -56.1 | 13.0 | | Gateway (GTW, news, msgs) | $2.60 | 0.19 | 2.29 | -63.6 | 12.0 | | Mirant (MIR, news, msgs) | $2.27 | 0.03 | 1.68 | -86.3 | 9.0 | | Andrew (ANDW, news, msgs) | $6.88 | 0.73 | 1.41 | -60.2 | 7.0 | | Solectron (SLR, news, msgs) | $2.99 | 0.2 | 2.89 | -63.0 | 6.0 | | Qwest Communications (Q, news, msgs) | $3.48 | 0.39 | 2.74 | -45.9 | 6.0 | | Lucent Technologies (LU, news, msgs) | $1.58 | 0.54 | 2.5 | -65.0 | 6.0 | | Visteon (VC, news, msgs) | $6.60 | 0.05 | 1.31 | -58.7 | 5.0 | | Williams Cos. (WMB, news, msgs) | $6.59 | 0.54 | 1.35 | -74.7 | 5.0 | | Dynegy (DYN, news, msgs) | $3.28 | 0.21 | 1.5 | -89.0 | 4.0 | | LSI Logic (LSI, news, msgs) | $5.01 | 1.02 | 2.52 | -69.7 | 3.0 |
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Fine Print
John Hussman provides his views weekly on the Web in a lively commentary. View them here. ... Pepsico (PEP, news, msgs) rose 6.5% on Thursday after a solid earnings report. As I suggested in my Feb. 26 column, Why Pepsi could really pop, most of the strength came from its Frito-Lay and Quaker Oats divisions. Earnings rose to $777 million, or 45 cents a share, in the three months ended on March 22 from $689 million, or 38 cents per share, a year earlier. The results beat Thomson First Call's average analysts' estimate of 42 cents per share. Operating profit at Frito-Lay jumped 6% as the firm benefited from innovative spin-offs and repackaging of older brands, such as Twisted Cheetos, Munchies Snack Mix and Cool Ranch-flavored Baked Doritos. Soft-drink volume in North America region fell 2%, largely due to fall-offs in Pepsi and Mountain Dew sales. Quaker North American division posted a volume gain of 5 percent in the first quarter, led by its breakfast business. The company said cold winter weather boosted demand for oatmeal. .Defense stocks earnings reports are coming in strong, as suggested in my column, A short list of defense stocks to go long. Particularly impressive were reports from L-3 Communications (LLL, news, msgs) and Lockheed Martin (LMT, news, msgs). Read here and here.
Jon D. Markman is senior investment strategist and portfolio manager at Pinnacle Investment Advisors. While he cannot provide personalized investment advice or recommendations, he welcomes column critiques and comments at supermodels@jonmark.com. At the time of publication, his fund was short Goodyear Tire & Rubber, but positions can change at any time.
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