Bombed companies lead way in stock surge

By Neil Behrmann

May 2009:-   The market is full of surprises.

During the depths of the bear market the general advice was to pick stocks with the best fundamentals---solid balance sheets and continued profitability.

In the vast majority of cases, however, shares of bombed out companies tended to be the best performers in the extraordinary surge on Wall Street and Europe exchanges. This is the historic norm at the bottom of bear markets as high risk shares, which have fallen most and are the most volatile, naturally revive with the biggest bounce.

“The rally has been particularly pronounced in very low quality stocks,” comments James Montier, London based market strategist of Societe Generale. Stocks with the poorest fundamentals have risen on average by around 56 percent in the past two months. In contrast shares of companies with the best prospects and balance sheets have risen by around 15 to 30 percent over the same period.

“This dash to trash stands in contrast to longer-term evidence showing it is generally value stocks with strong fundamentals that generate the best returns over time.”

Montier, carrying out research on the behaviour of Wall Street, London and European bourses has found that banks, insurance companies, hedge fund firms, mining companies and commercial property shares with huge losses, and large debts have outperformed other shares by a wide margin. Many of these stocks had been dumped and were at extreme oversold levels. But, the bounce in tandem with awful results generated considerable profits for bottom pickers whose timing was spot on. Of course those who jumped in too early would have experienced nasty short term losses as declines accelerated in volatile markets during the final phase of the downturn.


      Stock price gains                                                    



Revival from 2008/2009 lows

Fortress /FIG




Barclays Bank


Bank America












Rio Tinto





A major reason for the exceptional revival of the most vulnerable stocks was extensive short positions. Hedge funds, investment bank proprietary traders and others had sold short many of these and other vulnerable shares expecting to buy them back at a profit at lower prices. Instead the bears were trapped in the rally and had to buy shares back at a loss at much higher prices. Montier thus found that the stocks in the S&P500 with the largest short, or bear positions, soared by an average of 70 percent during the past two months. Those which hedge fund bears avoided because their businesses were sound, rose on average by 20 percent or less.

Hedge fund stocks foil bears

Ironically stocks of hedge fund businesses were also targets of the bears because of the implosion in the industry, extensive withdrawals and losses. The disclosure of the Bernard Madoff fraud in December also caused a rush out of hedge funds and hedge fund shares. Shares of Fortress a large hedge fund and private equity firm that manages around $27 billion plunged from $37 in 2007 to only 77 cents in December 2008, but since then have soared by 740 percent to $6.40. Blackstone another hedge and private equity firm which manages $91 billion, crashed from a peak of $38 to $3.55 but has since rallied by 270 percent to around $13.

The danger for latecomer jittery money managers and investors is that they could rush in and be whipsawed by an unexpected swift correction, warns Montier and other market strategists. Following such a move the best solution for those who wish to enter the market is to carry out intensive research and only choose sound companies with solid balance sheets and reasonable profit prospects in the current uncertain economic climate.

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