While the three market indexes made respectable gains again this week, underneath those averages certain individual stocks are exploding upward. If you happen to own any of these “story stocks” you may be enjoying outsized capital gains that are leaving the indexes, mutual funds and ETFs in the dust.
In my opinion, we are in that tail end of market rallies where investors and speculators look for special situations having already bid up all the well-known names. After 12 months of market gains, everything from Apple to Zales has recovered in price to what I consider fair value. Yet, there are hundreds of companies that have not participated in this rally, either because the fundamentals of these companies have not been attractive or their prospects were just too risky given an uncertain economic environment.
Now that most investors are beginning to believe that the economic recovery is here to stay, at least for the next year or two, investments in high risk areas like biotechnology, penny stock companies, start-ups, potential takeovers and even companies that have been or are on the brink of bankruptcy have come back into favor.
“We call then assets plays,” says John Roque, managing director of WJB Capital Group, in Manhattan. “The big guys figure it’s better to buy their stock, which is a heck of a lot cheaper, than buying their assets, outright.”
Last March, when the rally off the bottom began, there was a rush into the markets and most securities rose in tandem. Company earnings were dismal at the time so every purchase was made with a hope and a prayer. Back then, I was writing that the bottom of the S&P 500 would be 684. I believed that at that level stock prices were selling at a discount that reflected Armageddon and I didn’t believe that was in the cards.
At that point, mutual funds and exchange traded funds was an easy way to gain exposure to the markets and these securities did exceptionally well. As the rally matured, however, certain sectors and/or styles did better than others. Small cap stocks, for example, did better than large or mid cap stocks while the financial, technology and materials sectors outperformed others.
As the numbers improved and investors gained some added visibility on the murky economic picture, certain sectors came into favor and others dropped by the wayside. We call this sector rotation. Mid-cap stocks joined the rally as small caps became somewhat pricey.
In the first quarter of this year, with the averages rebounding over 70% off the lows, most of the blue chips and even the secondary names had been bid up in price. Investors have gravitated to individual stocks that have not had the price gains other more well-heeled companies have experienced.
At the same time, earnings matter again. Investors are beginning to ask which companies will earn more than their competitors and when. Will that phase III drug of XYZ actually come to market? Does bank A have what it takes to regain its former glory and at what price should I buy it?
This is a good sign. It means that markets are returning to normalcy. Next week first quarter results will kick off. There are some concerns that stock prices have already discounted a batch of good earnings results. I suspect in some cases that will be true, although not in every case. My target for the S&P remains in a range of 1,200-1,235. At that point I expect another correction. Until then, enjoy.