| The
Search for Counter-Cyclical Stocks |
Published: April 26, 2004
In an effort to diversify their portfolios, most
investors spread their money around by purchasing a variety of mutual
funds and common stocks. Many of the more thoughtful folks also take
great care to ensure that their stocks and funds aren't heavily weighted
in one particular industry group. They buy a few technology stocks, a
few industrial conglomerates, a handful of REITs, a few financial plays,
etc...
After carefully crafting this "diversified"
portfolio, they then kick back and wait for the profits to roll in. The
problem, however, is that many investors then expect their portfolios to
hold up well when the markets plummet. After all, they're well
diversified, right?
Wrong.
For starters, it's critical to understand that
diversification isn't exclusively dependent on the NUMBER of companies
you hold in your portfolio. Sure, it's important to hold a sizable
number of firms that operate in a wide variety of different industries.
However, doing so will NOT necessarily leave you with a well-diversified
portfolio that will hold strong when the broader markets nosedive.
Why?
Well, no matter how many stocks/funds your portfolio
contains or how many different industries you invest in, if the majority
of your holdings generally follow the performance of the overall market,
then your individual portfolio will also closely track the broader
market as well. Therefore, if the S&P heads sharply lower, then your
portfolio is likely to follow suit. With this in mind, if you got burned
by the market downturn from 2000 to 2003 and you want to do everything
you can to ensure that your portfolio doesn't get decimated again, then
this article is for you.
CAUTION IS THE NAME OF THE GAME
Looking ahead, with valuations already stretched and interest rates now
likely headed higher, the markets could come under some selling pressure
in the latter half of the year. In anticipation of this, you might want
to slowly begin to reposition your portfolio into a few more
conservative names. Another way to improve your portfolio's performance
during market downtrends is to purchase stocks that vary inversely with
the S&P. (In other words, stocks that generally head higher when the
overall market tumbles.) But in order to do so, you'll first need a
basic understanding of betas. (If you're already familiar with this
financial concept, then please skip the next two paragraphs.)
--------------------------
"Beta" is a basic measure of the systematic risk of a
particular security. It is calculated by measuring the volatility of
that security relative to a major market index -- usually the S&P
500. Although the specific equation and analysis used to calculate this
variable is beyond the scope of this article, the good news is that you
don't need to calculate it yourself. Since most major financial sites
list beta values for all securities they cover, you can usually just
look this variable up on the web.
When it comes to understanding betas, the important
thing to realize is that betas indicate how a security has moved
relative to the S&P on a historical basis. It's also important to
know that they generally fall somewhere in the neighborhood of
"1." A beta of exactly "1" indicates that in the
past, the security has usually moved in tandem with the S&P. So if
the S&P were to tumble -20% next year, then all things being equal
(and assuming that the stock behaves similar to how it has in the past),
chances are fairly good that a stock with a beta of "1" would
also decline about -20%. Meanwhile, a beta of greater than "1"
indicates that the security is usually more volatile than the S&P.
If the S&P were to fall -20% next year, then a stock with a high
beta would most likely fall even further. (It would also probably gain
more in an up market.) A beta between "0" and "1"
indicates that the security is less volatile than the overall market.
Meanwhile, securities with betas of "0" generally don't move
in tandem with the market at all. And last but not least, securities
with negative betas generally move in the OPPOSITE direction relative to
the overall market. These are the type of stocks we're going to focus on
today.
--------------------------
WHY FOCUS ON COUNTER-CYCLICAL STOCKS?
A number of prominent market analysts, including several bearish
observers on our StreetAuthority staff, are now of the opinion that the
S&P 500 is likely to pull back off its recent highs in the coming
months. And given that the S&P 500 has gained more than +40% off its
March 2003 lows, the index is certainly due for a correction. As such,
now might be a prudent time for you to diversify your portfolio by
adding a few stocks that generally move in the OPPOSITE direction
relative to the S&P (in other words, companies with negative betas).
With the above analysis as a backdrop, I recently
searched through our universe of 10,000 stocks to find companies that
met the following criteria:
1. Share price of above $2.00
2. Market capitalization of greater than $100 million
3. Average daily volume of greater than 100,000 shares
4. Beta of less than or equal to -0.40 (calculated based on the
past five years of market data)
My goal was to come up with a list of firms that are
fairly large and heavily traded, but whose shares generally move in the
opposite direction relative to the S&P 500. After running this data
through StreetAuthority's advanced scanning software, I came up with the
following list of companies:
| Company
(Symbol) |
Price |
Mkt
Cap |
Beta |
| Agnico-Eagle Mines (AEM) |
$12.12 |
1.0B |
-0.47 |
| Cedar Shopping
(CDR) |
11.65 |
190M |
-1.13 |
| Glamis Gold (GLG) |
14.40 |
1.9B |
-0.70 |
| Kinross Gold
(KGC) |
5.52 |
1.9B |
-0.80 |
| Southern Company (SO) |
28.76 |
21.2B |
-0.45 |
| Amedisys Inc.
(AMED) |
30.10 |
365M |
-0.50 |
| FTI Consulting (FCN) |
16.45 |
700M |
-0.43 |
| Cambior (CBJ) |
2.72 |
655M |
-0.55 |
| Bema Gold (BGO) |
2.53 |
805M |
-0.78 |
| American Dental
(ADPI) |
15.47 |
115M |
-0.43 |
| Willis Group (WSH) |
36.31 |
5.7B |
-0.51 |
After having my research staff take a closer
fundamental look at each of the above firms, we came to the conclusion
that all 11 of these counter-cyclical stocks are worth a closer look for
diversification purposes. Although I certainly would base my portfolio
around these firms, if purchased in small doses they should improve your
portfolio's overall returns when the market turns south. As always,
however, please make sure to do your own due diligence on each of these
firms to decide if they are right for your portfolio.
Editor's Note: We ran this same scan for
counter-cyclical stocks in our August 11th, 2003 issue of my Market
Advisor newsletter. Here's how the picks we identified at that
time have performed over the past six months:
| Company
(Symbol) |
8/8/03
Price |
04/25
Price |
Total
Return |
| Community Health (CYH) |
$22.13 |
26.08 |
+17.8% |
| Medifast (MED) |
13.66 |
8.88 |
-35.0% |
| Southern Co. (SO)* |
27.66 |
29.23 |
+5.7% |
| U.S. Concrete
(RMIX) |
4.50 |
6.26 |
+39.1% |
| Willis Group (WSH)* |
28.25 |
35.50 |
+25.7% |
| * Price adjusted to
account for dividends paid. |
We're encouraged by the returns these picks have
delivered over the past six months, and if the overall market heads
south later this year, then we expect the new picks that we identified
above to perform even better.
|
Please Note: The above article was merely a
small excerpt from an issue of our premium, long-term-oriented investing
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