Market Finds a Reason to Sell Off
On Friday, April 16, 2010 the markets sold off when news broke that SEC had charged Goldman Sachs (GS) with fraud. According to the Wall Street Journal the case depends on the contention that,
Goldman sold investors a product linked to the performance of certain mortgages without telling them that a hedge fund betting on the mortgages' demise helped design the product... that Goldman was reckless in deceiving investors.
The S&P 500 declined 1.61% that day, the biggest one-day decline since the 3.20% fall on February 4, 2010 and the first one-day decline greater than 1.0% since the February 23 drop of 1.21%.
The sell-off was probably tied in part to potential fears that additional fraud charges could be levied against other banks, which would hurt financial stocks in particular and perhaps indirectly lead to additional regulation that could reduce market liquidity. Also, investors may have simply used the news as an excuse to lock in gains following a fantastic run in the S&P 500 (up 14.66% from 1056.74 on February 8 to 1211.67 on April 15).
The sell-off may also reflect some growing unease regarding disappointing or less than blow-out numbers from some high profile names like Alcoa (AA), General Electric (GE), and Google (GOOG). It is also possible that a relatively disappointing preliminary report from MGM Mirage (MGM) may cap the recently growing enthusiasm for "low-quality" shares that were facing presumptively "easy" comparisons to last year.
Bears Growl Again
In turn, this one-day sell off is driving some pundits to point with renewed vigor to sovereign debt issues, technically overbought conditions, our precarious economy, and now the additional downtrend in commodities and benchmark currencies as a reason for a market crash. We have heard these arguments before, and while they seem intelligent and reasonable, all they have succeeded in doing has been to scare off some investors from participating in a double-digit six-week rally.
We Have Our Own Opinion About the Markets, But it Is Irrelevant
Our personal opinion -- as informed from our company-specific bottom-up analysis and observations -- is that this rally could continue or at worst level off, with some different characteristics. That is, perhaps there will be a flight to quality as opposed to an across the board sell-off. But our opinion is irrelevant to what we do in terms of allocating long/short weights to our monthly model portfolio strategies, which we discuss in other reports. We instead use simple but proprietary technical indicators updated daily to determine long/short weights. Such an approach may cause our strategies to underperform at key inflection points but they succeed in catching meaningful trends. We point to the net-long weighting in the Ascendere Long/Short Model Portfolio Strategies since the February 26 close as a case in point.
To elaborate further on our irrelevant opinion, we point to last week's suddenly wide bifurcation in returns between high-quality and low quality stocks. Since we have been tracking our weekly Focus List Update on March 5, we have noticed that a large number of "low-quality" stocks have moving higher than "high-quality" stocks. But this all changed last week when new stocks on our "low-quality" list declined 3.14% and new stocks on our "high-quality" list moved up by 0.38%. Perhaps this could indicate a flight to quality and increased risk aversion as opposed to an across-the-board sell off.
*We note that as of posting this, the SPX futures are down significantly as per CNN Pre-Market. We would note that extreme sell-offs tend to reward long/short hedged portfolios since low-quality stocks tend to sell-off more than than high-quality stocks.
Pay attention to stocks moving off the list
Separately, we would pay attention to stocks moving off the "low-quality" list as potential outperformers, and look at stocks moving off the "high-quality" list as underperformers. We noticed in recent weeks that "low-quality" stocks moving off the list as the result of higher analyst revisions have been outperforming significantly. We will soon begin methodically tracking this data in the near future.
Performance Summary for the Week Ended April 16, 2010
New "High-Quality" Stocks Return 0.38%
The nine new "high-quality" stocks on our weekly list returned 0.38% on average for the week ending April 16, a meaningful return compared to the 0.19% return for the S&P 500 (excluding dividends).
Additional factors placed CarMax (KMX), Regal Entertainment Group (RGC), Ares Capital Corp. (ARCC), Berkshire Hathaway Inc. (BRK.B) and Micron Technology (MU) on our "focus list", and together these five returned 0.27%.
New "Low-Quality" Stocks Decline 3.14%
13 new "low-quality" stocks on our weekly list declined 3.14% for the week, significantly below the S&P 500 return.
New stocks for the week, April 16 to April 23 2010
As of the close of April 16, 2010, there are 11 new "high-quality" stock ideas, three of which make our focus list. There are also 16 new "low-quality" stocks, including four focus list ideas.
New "High-Quality" Ideas
New "high-quality" ideas for the week include Dr. Pepper Snapple Group (DPS), Companhia de Bebidas Americas (ABV), Rayonier Inc. (RYN), Chimera Investment Corp. (CIM), Reinsurance Group of America (RGA), China Life Insurance (LFC), Plum Creek Timber (PCL), Alexandria Real Estate Equities (ARE), JP Morgan Chase & Co. (JPM), Bristol-Myers Squibb Company (BMY), St. Jude Medical Inc. (STJ).
The three focus list ideas in this group are DPS, ABV and JPM.
New "Low-Quality" Ideas
New "low-quality" ideas for the week include Goodyear Tire & Rubber Co. (GT), Starwood Hotels & Resorts Worldwide (HOT), Arch Coal Inc. (ACI), EOG Resources (EOG), Smith International (SII), Nasdaq OMX Group Inc. (NDAQ), Comerica Incorporated (CMS), Regency Centers Corporation (REG), Developers Diversified Realty Corp. (DDR), PerkinElmer Inc. (PKI), EMBRAER (ERJ), CNH Global NV (CNH), Sims Metal Management Limited (SMS), SCANA Corp. (SCG), Pepco Holdings , Inc. (POM), TransAlta Corp. (TAC).
The four focus list ideas in this group are SII, CMA, SMS and SCG.
About the Focus List Update
Focus List Update ideas, which we have only been tracking since March 5, 2010, are generated in a similar way to the Ascendere Long/Short Model Portfolio, which rebalances roughly 80-100 stocks on a monthly basis. Unlike our monthly model portfolio, we have not backtested the factors in our weekly focus list, but we would not be sharing these ideas unless we thought they could show some promise on average over time. We realize the higher frequency of this strategy may be introducing some noise to the process.
Perhaps one way to cut through the noise is to compare these weekly lists with lists from other sources. For example, a number of the stocks on these weekly updates have appeared on Goldman Sachs's Conviction Lists a few days or weeks later. Domtar Corp. (UFS) is the best example of this. We note that some of the best names on this list have preempted a number of sell side upgrades, as described in our "Nostradamus" report, and such stocks seem to show the most promise.
Risks and Disclaimers
Investing in stocks include a high degree of risk, including the risk of total loss. We are not soliciting the sale of any security. We do our best to provide relatively and accurate data and analysis, but make no guarantee.
"High-Quality" Stocks Off the "Buy List"
"Low-Quality Stocks Off the" Sell List"