Why Off the Bottom Is a Tricky Game

Now, with all that was said Thursday, the recent worries about the economy have led to some weakness in the overall market, especially the commodity stocks. As of mid-day Friday, the Oil Services Holders (symbol: OIH) was down 21% from its June peak, the Energy Select SPDR (symbol: XLE) was off 22%, and the Market Vectors Agribusiness (MOO) was off 15%. And many individual coal and shipping stocks have been pummeled.

To me, though, these stocks aren’t down because of economic fears. Instead, I believe it’s just the “off-the-bottom” phenomenon–that is, when stocks that have fallen 80% or 90% during the past year begin to rally, it can be exciting and fun for a while … but it rarely persists for longer than a couple of months before things peter out.

Why? Overhead. In plain English, overhead is potential selling pressure from investors who own the shares at higher prices. You see, if a stock is at multi-year price highs, everybody has a profit, so every investor is happy. But when a ton of investors (and I’m talking about institutions here, not your average Joe or Sally with 100 shares) own shares at higher prices, they tend to sell during rallies, hoping to get out even, or at least, recouping much of their loss.

Thus, while it’s always tempting (and occasionally profitable) to jump on the off-the-bottom bandwagon, it’s a tough game to play. I received plenty of calls and emails asking about this, that and the other off-the-bottom stocks during April and May, but most of those are currently sitting at two- or three-month lows.

But what about ever-declining oil production and China’s endless building efforts that are sucking up the supply of copper, steel, coal and the like? Well, all that might be true, and who knows, maybe in the long-term these commodity stocks and sectors will build solid launching pads and make another sustainable advance, a la 2006 or 2008. But, really, all those facts I just listed are already known by everybody–and in the stock market, the obvious and well known rarely works.

So let this be a lesson to you: Off-the-bottom situations, no matter how good the story, will always have to battle with overhead resistance, making any advance choppier and unlikely to last. That doesn’t mean it’s impossible to make money off these stocks, but your margin for error will be small, and you have to be quick on your feet. Over the longer run, you’re better off focusing your attention on the leaders–those near their 52-week price highs, not near their 52-week lows.

Comments

[Tom Armistead:]

Your opinion is not consistent with what James O'Shaughnessy observed - that those who persist in buying popular stocks at high multiples will eventually suffer large losses. At some point the supply of greater fools dries up. That was what happened when the tech bubble burst.

I had very good results buying mostly small well capitalized tech stocks off the 3/9 bottom. I sold a fair amount as the market rallied, not because they were up to their fair value but because I wanted to increase cash. Many of the stocks involved have held their values well.

I think an analysis of the fundamentals of the sectors you are interested in would be far more useful than advising would be investors not to buy low.

Jul 12 01:35 PM

[Nathaniel C:]

We had a commodity bubble collapse in JUL 2008. It takes a long time for bubble stocks to recover. Look at the tech bubble in 2000. MSFT, INTC, and CSCO are still below their peaks even though they have grown earnings every year. I do not expect commodity names to come back for a long time.

Jul 12 03:26 PM

[Living4Divi...:]

Stocks are the clear winner going forward - I just wrote about this on SA:

seekingalpha.com/artic...

Jul 14 04:56 PM