Easing Up on Equity Risk Going Into 2011

by: Jx Capital

Absent a Rip Van Winkle-like bout of post-Thanksgiving somnolence, an attuned investor is by now aware of the increasingly ebullient sentiment among both retail and institutional equity market participants. An article addressing this point in the December 20th issue of Barron's caught my eye in particular. Ten strategists were polled, and the most pessimistic of the bunch, Douglas Cliggott of Credit Suisse, projected 1,250 for the S&P 500 index at year end 2011. David Kostin of Goldman Sachs was most optimistic with a projection of 1,450. The group's average was 1,373.

Such market sentiment is good reason for considering stocks least affected by recent market pullbacks and adding some of those stocks to or increasing their weights in net-long portfolios. I book-end the three chief S&P 500 pullbacks in 2010 between January 19th and February 8th (-8.1%), April 23rd and July 2nd (-16.0%), and August 4th and August 26th (-6.8%). A screen of S&P 500 stocks' beta values over these three time periods produces the following top 15 names, in ascending order of the extent to which the S&P 500's returns impacted their daily returns:

  1. DeVry (NYSE:DV)
  2. Airgas (ARG)
  3. Apollo Group (NASDAQ:APOL)
  4. CareFusion (NYSE:CFN)
  5. Fidelity National Information Services (NYSE:FIS)
  6. Family Dollar Stores (NYSE:FDO)
  7. Wal-Mart (NYSE:WMT)
  8. Bristol-Myers Squibb (NYSE:BMY)
  9. Frontier Communications (NYSE:FTR)
  10. Newmont Mining (NYSE:NEM)
  11. SAIC (SAI)
  12. Baxter International (NYSE:BAX)
  13. Safeway (NYSE:SWY)
  14. Hormel Foods (NYSE:HRL)
  15. Genzyme (GENZ)

Screen Methodology
Beta coefficients relative to the S&P 500 were calculated over a continuous time period covering all three market pullbacks. Daily, dividend-adjusted closing prices were used. Names with statistically insignificant results (i.e., F-stat<3.682) were then discarded from consideration, and the remaining stocks' beta and r-squared values were multiplied to arrive at scores. The lower the score, the weaker the relationship, comprising both direction and magnitude, between S&P 500 returns and those of a component stock.

Above all else, the above-mentioned stocks represent a lead list for further, fundamentals-based due diligence. Quantitative investment approaches used in isolation can easily lead to sub-par results.

With that safe harbor statement made clear, the two for-profit colleges seem like interesting, contrarian possibilities. Their sector has been beaten up mercilessly this year for good reasons, but valuations may have undershot fair values. A testament to these trades being "crowded" happened about two months ago when a person at a charity fundraiser suggested shorting Corinthian Colleges (NASDAQ:COCO). Looking at COCO's chart, I should have dropped everything and ran, nay, sprinted to establish a long position. When your barber gives you a stock tip, do the opposite. And quickly.

Wal-Mart, Family Dollar Stores and Safeway intuitively seem like good places to hide should any number of downside macro catalysts rear their ugly heads, as are the pharmaceutical names. Further supporting my intuition is Kroger (NYSE:KR) just missing the top 15 list, coming in at #16. Lastly, Hormel Foods produces products anyone would want to own in copious quantities when provisioning their fallout bunkers, and the company is worth a closer look.

My optimism for 2011 is closer to that of Credit Suisse than Goldman Sachs, and though I intend to retain a net-long bias in Q1 to hopefully ride the many upward-pointing market undercurrents, I also intend to take some risk off the table at least until some clear catalyst emerges for the next leg up. It's feeling really toppy out there.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. This article reflects the author's personal views and should in no way be construed as investment advice or a solicitation of any kind.