The summit of European leaders towards the end of this week promises to be light on actual policy and strong on rhetoric. Many see the situation getting worse before it gets better and recent economic data out of the United States is starting to follow Europe on the way down.
Still, there is reason to be optimistic. The permanent European Stability Mechanism is due to come on line in July and China's stimulus measures may start to show through in economic data. The housing market in the United States is showing signs of stability and could begin adding to economic growth in the second half of the year.
There is a great deal of pessimism priced into the market, with the S&P 500 down about 7.5% from year-to-date highs and some commodities reaching bear market territory. While the markets still have to reconcile fiscal problems in the U.S. later this year, investors may be able to make some speculative profits over the next few months.
While the broader market may not reach the year's highs, a relief rally could easily return 5% or a little less than two-thirds of the point loss over the past three months. A gain of five percent is not going to excite many active investors, especially after losses of 7.5% or more, but there is a way you can amplify the return. When headline risks start pointing to a possible upside surprise, I like to look to high-beta stocks with positive revenue growth to magnify the returns in the general market.
High Betas and Positive Revenue Growth
Yingli Green Energy Holding (YGE) is poised to take advantage of the alternative energy growth in Asia. In an attempt to jump-start the economy, the government has approved over 200 new projects in May alone, many of them in the alternative energy space. The Chinese maker of solar power products is off its 3-month high by more than 34% and has a beta three times greater than the S&P 500. Solar manufacturers have been under pressure lately but the company managed to grow revenues by 17.4% in fiscal year 2011. Increased import tariffs into the United States could act as a longer-term headwind but strong growth in the Chinese market should support the stock near-term.
DryShips (DRYS) owns a fleet of carriers and tankers worldwide with a total carrying capacity of 3.4 million deadweight tons. Through a subsidiary, the company also owns and operates offshore and deepwater drilling rigs. Revenues in fiscal year 2011 were up 25.3% and shares trade for just one-fifth the book value. The company missed expectations in the first quarter on a drop in dry bulk rates for commodities but forecasted strength in its energy segment. Rates have improved lately and fuel costs have plummeted over the last quarter.
Kodiak Oil & Gas (KOG) is a small-cap oil and gas explorer operating in the United States. Earnings per share returned to profitability last quarter and fiscal year 2011 revenue jumped on acquisitions. Historically low prices for natural gas have weighed on the shares but the hot summer along the east coast looks to have put a near term floor in gas prices. The shares are down over a third since March and are relatively cheaper than peers at 2.1 times book value. Management was optimistic about its hedging program and well completion on the first quarter earnings report.
Las Vegas Sands (LVS) owns and operates some of the most recognizable resort and casino properties in the world. Shares are down almost 30% since 3-month highs even though the company has booked strong EPS growth over the last 11 quarters. Growth has been strong in the Macau and Singapore markets and has been recovering in Las Vegas. The company has a great balance sheet with a quick ratio of 2.3 times its current liabilities. Plans for a mega casino in Spain have been put on hold due to the eurozone crisis, reducing some short-term uncertainty.
Beta, the volatility of an asset relative to a benchmark, is an estimate of the amount a stock will increase or decrease given movement in the broader market. These four stocks all have betas above 3.0, meaning a 5% rebound in the S&P 500 could result in at least a 15% return in each issue. By placing bets in different sectors and industries, you reduce risks specific to a certain group.
Risks are from either continued weakness in the general market or company-specific issues. The holding period for the strategy is fairly short, a couple of months, so the risk to a company-specific headline is not as high as it may appear. We have selected companies with increasing revenues and relatively strong balance sheets, mitigating the risk to a catastrophic second quarter earnings release.
The greater risk to the strategy revolves around trying to call a turnaround in the general market. There are ways to hedge or mitigate the risks to a directional strategy. Selling call options will limit your upside return potential, but the premiums on these high beta companies are fairly high and selling the options will lower your cost basis. Buying put options will put a floor on your losses but can be expensive for high beta stocks. One strategy is to sell call options or buy puts on the broader market. This can allow you to participate in the gain on the stocks but includes risks inherent to an option strategy that is not perfectly matched.
I am looking for a short rebound into July as some uncertainty and fear come out of the markets. The relief rally may be short-lived however as I expect sentiment to turn as it copes with fiscal issues in the U.S. in August or September. Investors could look to high-beta stocks to amplify returns on a rally before unwinding or hedging their positions ahead of a possible downturn.