Is the 'junk' stock rally ending?
Posted
Sep 17 2009, 05:14 PM
by
Anthony Mirhaydari
Rating:
With the major indices trading near new highs, there is evidence that the most recent phase of the advance was fueled by the lowest quality stocks. And it looks like the tide could be turning.
Some of this has been caused by a scramble into the riskiest holdings out on fear of missing out on the rally and a desire to maximize exposure to the broad market. Short covering has played a role too as many of the best performers are among the most heavily shorted names. While this doesn't preclude additional gains, it does call into question the longevity of the rally.
According to Matthew Rothman of Barclays Capital, the end may be upon us. In his words: "Quality continues to underperform sharply, turning in one of the longest losing streaks in the index's nearly sixty year history. Wednesday saw the streak end."
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Rothman maintains various quantitative stock indices, including one that focuses on quality. Others are based on characteristics like market sentiment and valuation. On the phone from New York, Rothman described his Quality Index taking into account things like historical profitability, earnings traits, and balance sheet structure.
However, there is no clear statistical link between the ending of a period where quality underperformed and any particular prediction on the direction of stocks in general or high quality issues in particular. Part of the problem is that it just doesn't happen that frequently. The most recent string lasted nine consecutive days. Rothman says that he has only seen 40 occurrences of streaks lasting seven days or more in the past 59 years.
A similar story is being told in the credit markets. Dave Klein of Credit Derivatives Research finds that high-beta companies are performing best in the credit default swaps market. The sectors looking the most extended are leisure, technology, telecommunications, and consumer cyclicals.
Should the market gods decide a selloff is in order, I would seek out quality names in the energy, healthcare, and media sectors based on where the respective credit default swaps are trading relative to equities.
My positions
My portfolio at Wall Street Survivor is up 3.7% for the week versus a 2.7% gain for the S&P 500. I was heavily focused on industrial and materials stocks like General Electric (GE) and Dow Chemical (DOW), but decided to assume a more defensive posture heading into options expiration this Friday. I still expect a slide in gold and silver prices.
Anthony Mirhaydari is a researcher for the Strategic Advantage investment newsletter. He can be contacted at anthony.mirhaydari@live.com. Feel free to comment below.
Related reading:
Gold set to lose its shine
Fear rises again on Wall Street
