A Junk Stock Rally

The quality of this rally is low…. The move is powerful but the underlying raitonale weak.

- Greg Feirman, Top Gun FP Client Note: The Facts Are Stubborn, April 27

[The bounce was] in extraordinarily dubious quality names. These were names you would have had to have a lot of courage to be invested in [prior to the rebound].

- Mathew Rothman (subscription required), Global Head of Quantitative Equity Strategies, Barclays Capital

The Wall Street Journal hit the nail on the head in an article on the front of yesterday’s Money & Investing section: “Can A Rally Last On Diet of Junk? Low Quality, Low Priced Companies Have Ruled the Day - So Far, At Least” (subscription required), Tom Lauricella, The Wall Street Journal, C1, April 27.

As you can see from the chart from the WSJ article, the rally has been led by financials and consumer discretionary companies: up 76% and 43% since March 9, respectively - compared to a 28% gain for the S&P 500 overall. These are the companies with the worst fundamentals.

Four of the five biggest contributors to the S&P’s rally have been: JP Morgan (JPM), Wells Fargo (WFC), Bank of America (BAC) and General Electric (GE). E*Trade (ETFC) is up 319%, Citi (C) 204% and Huntington Bancshares (HBAN) 200%. PF Chang’s (PFCB) has more than doubled while McDonald’s (MCD) is up just 4%. Walmart (WMT) hasn’t particpated in the rally at all - up just 1% since March 9.

This kind of market action suggests speculation and unsustainability to me.

Comments

[Jasper M:]

"This kind of market action suggests speculation and unsustainability to me."
While I agree, I cannot help but mentally apply that last statement to a lot of recent financial history, not just since the March bottom.

One drawback of a relatively free and prosperous society is a lot of stupidity can survive amongst the plenty. In this case, I mean bad corporate governance and bad public policy. These stupidities periodically kill the prosperity, and threaten the freedom. And here we are again.

Apr 28 05:19 PM

[Gregorian:]

Market is based upon confidence. Why dont we just pretend everything is ok?

Apr 28 05:51 PM

[cash:]

>>One drawback of a relatively free and prosperous society is a lot of stupidity can survive amongst the plenty.

Could not agree more, Jasper. Take any big company, even the well run ones. There is a lot of chaff that rides on a few productive workers. You can get rid of a quarter of the workforce and the 'real' value added will not decrease. What keeps them there is the usual mediocrity that is rife in big organizatons. Few managers & CEOs have the vision/drive for continuous improvement.

Apr 28 06:03 PM

[dcb:]

If a market is driven by short covering, and someone buying bad companies to force short covering this is exactly the kind of rally you would see.

Apr 28 07:39 PM

[Francisco M...:]

Here comes Cetin again with a claim that has absolutely no basis. Yes, an Obama/Geithner induced rally that will soon end up in a catastrophy because it is built on the basis of hot air. I would not bet on a recovery anytime soon. Everybody is really holding on whatever they have and tomorrow is not guaranteed either. But again, Mr. Cetin, what would you know. You are still living with mommy and daddy with absolutely no clue about the real world.

Apr 28 09:25 PM

[Speedspirit:]

Cetin the amout of responses you have and your continued misconception of reality leads me to believe your are on either Goldmans payroll or the adminastrations. Which is it?



On Apr 28 05:13 PM Cetin Hakimoglu wrote:

> Usually in a new bull market the beaten-down speculative stocks tend
> to outperform.

Apr 28 09:39 PM

[CJJ:]

I love how the doom and gloomers call out anyone pointing out a contrarian point of view to their own as "misconception of reality" and "claims with absolutely no basis"...
Why don't you all realize that the market is down almost 50%. It was down almost 60%...That the markets were pricing in depression prices.
Just because typical servere contractions see a huge over-reaction to the downside before returning to the norm doesn't mean this time that will occur. I love how doom and gloomers get to say "this time is different" and at the same time say "this time is the same" when it suit their thoughts.
None of you is right or wrong because predictions are cheap and impossible.
Over the last 16 months the doom and gloomers are right. Over the last 2 months Cetin is right. Who cares really unless your timeframe was 16 months or 2 months.

Apr 28 10:49 PM

[Jasper M:]

Speedspirit:
"on either Goldmans payroll or the administrations"
Is there a difference? : )

Apr 29 01:05 AM

[LAM:]

Uhh, because it's not?


On Apr 28 05:51 PM Gregorian wrote:

> Market is based upon confidence. Why dont we just pretend everything
> is ok?

Apr 29 09:49 AM

[kelm:]

It is true that a rally cannot last on junk. The stocks you cite have been beaten down severely and people, whether traders or long term investors, are picking them up in the hopes they are so big and there is so much effort being put into saving them that they will make money over time. For the rally to continue leadership needs to change. having looked data a lot of charts lately I am seeing many profitable companies that are profitable that have been beaten down severely making chart patterns that indicate impending breakouts. Yes, many are under $10 but after the kind of market route we have seen, the cheap stock = cheap quality argument has a lot less weight.

I do not for a moment believe we are in a new bull market but I think this rally will surprise for some some time to come.

Apr 29 10:08 AM

[mikeyk:]

don't know much about cetin but don't understand why some are getting on his back. it makes sense that when stocks are so beaten up and out of favor they are the ones that initially outperform because that is where the marginal buyer is more likely. take Coca Cola, great company, great share price, great value, but everyone already owns Coca Cola and its share in your portfolio is larger today than it was 12 months ago (it has fallen less than your other stocks from the peak, and when you sold to meet redemptions, you sold the weaker companies) so who will be buying it today. The banks on the other hand were so out of favor and so unloved and so heavily shorted that it just got to a point where there were no more sellers left. A bit of good news and some change in sentiment and we have seen what happens. Whether the rally will last or whether the leadership will change and if so, how, now those are different questions.

Apr 29 10:55 AM

[happyfella:]

Right on .. the rally is built on quick sand..Last year i did better than most with a average of all my accounts a yearly gain of 29%.This year ,mostly cash and hedging all longs to capture 8% dividends and corporate bonds. I missed this 24% rally, because there is still too much over supply of empty buildings and factory capacity.coupled with the fact that printing money is only a remedy to avoid current pain.
asb

Apr 29 11:22 AM

[Michael Del...:]

The rally may be built on quicksand, but you can still make money if you are nimble. And down at my bank, they don't ask me "You didn't make this money because of a low quality rally, did you?"

If this rally only lasts another month, so what? If you like to buy a stock and hold it for two years, maybe you should be sitting in cash right now. But if you want to buy something and keep a tight stop on it, taking what the market will give, why not play now?

Apr 29 06:12 PM

[CLH:]

These stocks are not junk. They have been depressed by the out of control fear of frightened investors. There is no rational reason for this fear.

Apr 29 09:13 PM

[givargi:]

Hmm... So we are now back to 98 levels on the Dow and S&P, and in the meantime have lost more manufacturing, have burdened ourselves with immense debt, wasted our money and resources on activities that have left no long term value, and have tarnished our reputation as a world leader.
We are not finding new natural resources.
Companies can no longer reduce labor costs in Asia as these costs have bottomed.
And we no longer have viable consumer market.
You need three things for capital creation :1) cheap labor, 2) cheap resources, 3) consumer market. We are running out of all of them.
We are entering a long period of economic stagnation, and personal pain.
MARK MY WORDS! You'll feel it too!!!

On Apr 28 10:49 PM CJJ wrote:
> Over the last 16 months the doom and gloomers are right. Over the
> last 2 months Cetin is right. Who cares really unless your timeframe
> was 16 months or 2 months.

May 01 12:26 AM

[Al-USA:]

givargi wrote:
"
You need three things for capital creation :1) cheap labor, 2) cheap resources, 3) consumer market. We are running out of all of them.
"

A good description of the state of capitalism, a crisis of over-production (or demand destruction). This will play out in years though, and while 2010 will hit like a "ton of bricks", outside any external massive demand stimuli, 2009 will be the last year to "party" for the last of the trapped longs.

So, if your 401k was reduced to a 201k, use 2009 to get out with, perhaps, a 301k. Such a chance might not come again in a generation, or at least until 2023, according to the proprietary investment rate model by Thomas Kee.

Good luck to all, and yes, if you're a nimble trader, as long as the market is open, there are opportunities to make some cash.

Recent Policy Decisions and a Greater Depression
seekingalpha.com/artic...

May 01 01:46 AM

[sethmcs:]

What we really need is new technology and new industry to move the economy ahead. Electric car anyone?

May 07 01:48 AM