A Rising Tide Really Can Lift a Lot of Boats

by: Stephen Castellano

Earlier this week we suggested focusing on a few stocks as potential long, short or "contrarian" ideas based on our rankings in the Ascendere Long/Short Model Portfolio. It has not even been a full week since then, but the stocks have already moved significantly. As of the March 4 close, "high quality" long names are up 2.50%, "low quality" short or contrarian names have appreciated to less of an extent at 2.36%, the corresponding net long model portfolio is up 1.10% and the SPX is up 1.67%.

We thought it would be interesting just to post the rankings and price performance of the various stocks since the close of February 26, and to take a quick look as to perhaps why in some of these "low quality" stocks are outperforming right now.

Even adjusting for the sharp decline in Prudential Plc (NYSE:PUK), the "high quality" stocks are marginally outperforming the "low quality" stocks. The difference between the larger list of 90 high and low quality names is also in favor of quality, but not by much. The net long weighting which was signaled at the close of February 26 has helped the model long/short strategy.

We have read a few reports by some technical analysts and they have been pretty scary. It seems as if every technical analyst believes that the markets are on the cusp of rolling over. One of them thinks the global markets are on the verge of a 10% correction.

That could be true. They make compelling arguments. And from a fundamental point of view that could make sense as well, given the "unjustified" surge in the price of so many "low quality" stocks.

However, in response to that, what is going on now is really not much different from what was happening last year when, to the befuddlement of ourselves and many other observers, low-quality stocks surged for apparently no reason. But there was a reason, and a good one: Even as people were pulling out their hair and filing for unemployment benefits in record numbers, stocks were correctly anticipating an improvement in free cash flow and ROIC prospects roughly six months ahead of time -- even while operating metrics of these companies were tanking to record lows.

The chart below on on MGM Mirage (NYSE:MGM) may be a good specific illustration of how many share prices in the spring of 2009 anticipated a bottom in key operating metrics, which was not reported until the summer of 2009. This may be what is occurring now. And this is how fortunes are made and lost -- by betting on uncertainty. Perhaps the markets just do not care what is happening to the unemployment rate or consumer confidence, since they are already looking ahead six months and what they see in the future is much brighter than what many of us can rationalize today. In any case, all will be clear in retrospect. (Click charts to enlarge)


Disclosure: I am long a small amount of FCX call options.

This is not a solicitation to buy or sell securities. Investing in any equity entails a high degree of risk, including the risk of entire loss. We make every attempt to provide accurate and relevant information and analysis, but can make no guarantee.

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