MGM Mirage Leads 'Low-Quality' Stocks 'Higher'

by: Stephen Castellano

Just a few days ago, we remarked upon Harley Davidson's (HOG) "faith-based" upgrade by RBC Capital Markets, which was based on growing positive anecdotal evidence as opposed to company-specific data, and how we expected such upgrades to become increasingly prevalent. We mentioned other "low-quality" names on our focus list, such as Toll Brothers (TOL) and MGM Mirage (MGM), implying these as some additional possibilities.

We mention this because Thursday, MGM Mirage joined the list of surging "low-quality" names by giving itself its own upgrade, leading all stocks in our model portfolios by moving up 10.34%.

In an April 7 article, Felix Salmon of Reuters summed up a view held by many investors - that the recent surge of "junk stocks" has been driven by "increased "risk appetites" or "randomness." But in fact, as we pointed out yesterday in a comment below that article, we contend that what has been happening has been logical and not at all random. Coincidentally, we cited MGM as an example. To repeat most of that comment here:

Many of these “low-quality” stocks ranked very poorly back in March and still do today on many fundamental factors. But the key drivers of valuation — ROIC and cash flow growth — bottomed at this time last year, and have been improving. MGM Mirage is a case in point.

What I think many of these quant models may have missed is that relative fundamental factors are irrelevant following a huge market correction. What simply matters is that there is some incremental improvement in ROIC and cash flow prospects, which can justify at least a partial return to some kind of long-term mean.

It’s hard for even industry experts to get behind a “low-quality” company at inflection points like last March, and I am not pretending I did so myself. But I think a delayed reaction to this is starting to happen now, and that we will see more of it — take a look at the recent upgrade of HOG for example.

In any case, I do agree that it’s more prudent to try to partially participate in a market rally by focusing on “higher-quality” stocks.

I just posted an article on such a strategy and some others.

About the Model Portfolio
The Ascendere Long/Short Model Portfolio Strategies are "tactical tilt" portfolios that buy the highest quality stocks and sell the lowest quality stocks while maintaining a net long or net short position at all times. They are composed about 80-100 stocks and rebalanced monthly.

Investors focusing on daily moves could find monitoring our model portfolio useful, as a proxy for what is working in the market in general as viewed through the lens of "high-quality" versus "low-quality" stocks.

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Disclosure: No positions