Tuesday, March 8, 2016

Market Update - Looking Under The Hood Of This Rally

As part of our investment process, we're constantly looking for the stocks, sectors and asset classes exhibiting relative strength versus their peers and the overall market.  This exercise helps in understanding where the money is flowing in any given market environment.

We'll often separate industry groups into quartiles based on performance over a given timeframe and then dig within to find potential candidates for investment.  Our recent data in this area shows that the market bounce since the February 11th bottom has been led primarily by the most beaten down, "low quality" stocks and sectors.

As we've been running this data, our conclusions have been supported by studies published by the fantastic Bespoke Group and others.  For instance, last week, Bespoke shared the following stats that looked at the S&P 500's performance broken into deciles.  Their data showed that stocks that held up best from 12/31/15 to the 2/11/16 bottom have dramatically underperformed during this bounce.  Conversely, the stocks that performed the worst from the end of last year to the February bottom have done the best.  See below:

In our work, we'll break down industry groups in quartiles.   In one study, we first screened what held up best from Dec. 31st to the market bottom on Feb. 11th.  We then looked to see how those quartiles had performed from the market bottom and how many members of each landed in the top 1/4th of performers from Feb. 11th low to the end of last week.  The results are below:

1st qrt - These are the industry groups that performed best from Dec. 31st to February 11th - Only 8.3% are in top 1/4 of performance since the Feb bottom.

2nd qrt - 11.1%

3rd qrt - 30.6%

4th qrt - 50%

As you can see, these results are in total agreement with Bespoke's findings.  Another one of their studies, released just this morning, helps in furthering the thought that this has been a "low quality" rally.  They looked at the S&P 1500 and found that low priced stocks have hugely outperformed since February 11th.  A look at the chart below shows that the stocks that closed below $5/share on Feb. 11th (of which there were 52) are up an average of 58% since then!  Stocks that closed between $5-$10 are up an average of 31%.  But as you go higher in share price, the average return since Feb. 11th declines considerably.

As of today, the S&P 500 is up just over 9% since the February low of 1,810.  Yet looking back at the data of the last few years, we're still a few percentage points shy of the typical gain seen after the market has experienced a 10% or greater pullback.  Going back to 2010 there were 5 such instances (we included 2014's 9.8% drop in this study) and after their ultimate bottoms, the market rallied 15% on average before having its next "meaningful" decline.

A couple of things to note here:
1) Very small sample size
2) At Friday's highs, the bounce had gone 11% off the bottom
3) We've now met the study's minimum in terms of % gain from bottom (11%) and # of days (16).
4) We've now met 2/3 of the average gain based on this study and while there may be more upside in store, we think the easy money has been made.

Ryan Worch is the Managing Director of Worch Capital LLC. Worch Capital LLC is the general partner of a long/short equity strategy that operates with a directional bias and while emphasizing capital preservation at all times.

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