The best way to make money in the first two-plus weeks of 2012 has been straightforward: Simply buy a basket of the stocks that were hardest hit in 2011. But with solid gains already on the books for so many of last year’s dogs, how long can this trend continue?
Examining the Numbers
First, let’s look at the returns for some of the highest-profile disasters of 2011. Almost across the board, stocks that crashed last year have outperformed in the first 10 trading days of this year:
|Research in Motion||RIMM||-75.06%||20.48%|
|MEMC Electronic Materials||WFR||-62.97%||15.74%|
|Bank of America||BAC||-59.03%||16.55%|
|S&P 500 Index SPDR||SPY||1.89%||3.06%|
|Green Mountain Coffee Roasters||GMCR||36.49%*||13.42%|
|* -49.75% in the second half|
This isn’t meant to be a comprehensive list but rather an illustration of the substantial rebound in certain stocks that made headlines for their poor performance last year. And the gains aren’t limited to the biggest names. In fact, the bottom 25 performers in the S&P 500 Index in 2011 delivered an average gain of 8.21% in the first 10 trading days of this year versus 3.06% for the broader index. Of those 25 stocks, 24 have posted a positive return, and 23 have outpaced the S&P 500.
Drilling down to the sector level, banks, asset managers, and solar stocks have been among the most notable leaders in this rally. The materials sector has also been a source of strong performance, and not just because of Alcoa (NYSE:AA). Steel stocks, as represented by the Market Vectors Steel Index ETF (NYSE:SLX), have gained 10.68% in 2012 after returning -32.92% in 2011.
The sector that has bucked this positive trend to the greatest extent is coal, which has been hit hard since the plunging price of natural gas is expected to have a substantial impact on coal’s profit margins. A prime example is Alpha Natural Resources (NYSE:ANR). After falling more than 55% in 2011 and finishing as the sixth-worst stock in the S&P 500, ANR has declined an additional 5.6% so far this year.
What Does This Mean for the Market?
Coal stocks notwithstanding, the nearly across-the-board rally of 2011’s losers helps illustrate that an uptick in any of these stocks should be taken with a grain of salt. In most cases, the gains are the result of the broader rotation into underperformers rather than stock-specific developments. As the CBOE Volatility Index (VIX) has plunged into the low 20s in recent weeks, it has opened the door for a move into beaten-up, higher-beta stocks that can provide upside for 1) institutional managers, who needed to reallocate at the start of the new year, and 2) hedge fund managers, who returned to action after sitting on gains to close out the prior year. With option premiums having come down so far, it’s again possible to reach for higher-beta names and protect the position with puts that are available at much lower prices than they were just a few weeks ago. As a result, many of these stocks have become easier to hedge — and thus more attractive.
The bottom line: If you’re nimble enough to have made money trading one of last year’s losers, be aware that the main driver of performance is the broader reach for beta that has propelled the market through the first two weeks of the year. This trend can turn on a dime — especially for stocks that have fundamental problems. Be alert for opportunities to take profits.