Bad Economic News: A Buyer's Paradise

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Includes: SPY, XLB
by: Brian Kahn

We got it! Confirmation that the Fed is still involved came through Wednesday in the form of Fed Governor Yellen and was backed up Thursday by Fed Chairman Bernanke.

What does this mean for investors? To me, (and using past performance as an indicator), until it stops working, buying stocks on dips that are fundamentally and technically oversold is attractive.

Now, I am not saying that I will turn a blind eye once I hold the position. Again, in my opinion, these days, an investor has to have a "trader's mentality." Let me explain. For years, I have been calling for stagflation, where growth and prices move sideways. The only reason that hasn't happened is the coordinated efforts among central banks and the International Monetary Fund to support the markets (and countries!). At some point (and I am not claiming to know when that point is), the markets may finally succumb to Europe and a general slowdown in worldwide growth and not react positively to Quantitative Easing, Austerity Measures, Bailouts, etc... If you think about the past 18 months, the SPX is only up a few percentage points. So unless you are investing with some form of market timing, you may want to see how your portfolio has performed as compared to the broad SPX (NYSEARCA:SPY) index.

Another point about investing in this "new economy": not every sector or stock is equal, so due diligence and some familiarity with your investment choices are necessary. To clarify, I am not talking about getting too specific with earnings, short ratios, although there is nothing wrong with that. I am talking about the company and the sector it is in and how the worldwide economy and interest rate decisions affect that company.

Let's look at some specifics:

Materials Select Sector SPDR (NYSEARCA:XLB): I know I mentioned this in my last article, but at certain fundamental levels, I think this sector (and these companies) become attractive again. I wrote that article on May 18, and XLB was priced at $32.77 and today it is priced at $34.43. If you look at historical pricing, the 18th was the low price as it declined from a year-to-date high of almost $38.00. Remember that we had the May (un)employment data that came in well below expectations on June 1st. Even with that report dropping equity prices, XLB hung in there and held above its May 18 low. It was fundamentally and technically oversold in the low 30s and was attractive to investors. Now, given what I just said about unemployment and knowing what we know about the continued problems in Europe means as an investor, I am looking at value on the way in AND on the way out. A move up in XLB from $32.77 to the current price of $34.43 is 5%. Five percent in 3 weeks is quite attractive to an investor in markets that only move up when "rumors" of central bank intervention come about.

Chesapeake Energy Corp (NYSE:CHK): This stock set its recent low on May 17. Do you see a pattern? It has risen 34%. Thirty four percent! We all know the markets don't like greed, so what measures are you taking to protect a 34% move? You could lighten up on the position and book profits, move stops up, purchase protective puts, sell covered calls (or any combination of these).

The examples above show a sector and a stock that were absolutely crushed over the past few months. When the markets finally found fair value, these examples also found fair value. The point of the article is understanding what sectors and stocks have dropped and more importantly, the percentage they have dropped. Then you do the fundamental and technical analysis to build a trading plan around your expectations on the upside potential. Of crucial importance, the possibility of further downside movement must be analyzed because at any moment, a blast of bad news could move equities swiftly to the downside, causing you to exit a position and wait for better values.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: I am short June out of the money puts on CHK and if they move to in the money, I would analyze at that time if taking ownership by being put the stock is appropriate.