October 18th, 2012

Seeking Greener Grass

Something we learned long ago is that the big money pro’s are like sheep, they like to move in herds (hence the name of my recently published book, Run with the Herd).  They’ll move together bidding up the price of stocks in select industries until they reach unsustainable heights and then abandon them to move their money into areas that they previously ignored, starting the process over again.

To some extent, these money flows are truly based on strong fundamental factors but, at other times, it is a function of fashion and effective sales.  One large investor comes up with a believable theme and others buy into the story.   They begin pushing the stocks of companies up and down that supply chain higher.  The sales pitch story is told over and over so often that it soon most begins to resemble generally accepted truth that “goes without saying.”

Our voices in either agreeing with the herd or loudly shouting the absence of the kings clothing is drowned out and all we can do is run with the herd and make sure we get out of the way when they decide to abandon those stocks.  Demand for the shares outstrips supply in a continuously reinforced loop.  Until, that is, someone wakes up to the heights of those prices causing a mass and rapid exit from the stocks. That was true of the ethanol stocks, solar energy, Chinese internet and emerging markets stocks of the past.  I’m sure the future will not be much different than it has been in the past.

The market’s advance over the past twelve months has been driven mostly by the herd’s purchase of the beaten down stocks of construction and homebuilding, and bank and financial stocks. The S&P 500 advanced 21.4% since last October 17 but, during that time, only 209 stocks, or 41.8% have advanced as much (4 stocks were added during the past twelve months).  Of those 211 stocks, a disproportionate number were in the sectors most impacted during the previous  Crash, namely Financial and Banks and Construction and Homebuilding:

Ah, if we only had had the courage to buy those “falling knives” a year ago we would be know heading to a Caribbean island rather than getting our snow boots out of the closet or trying to find the tire chains in the garage.

Over the next twelve months, it’s likely that the herd will begin abandoning the winners of the past year and begin putting together equally compelling, timely stories about other industry in which the stocks are still at depressed prices, not having yet recovered.  In my sifting through the rubble of the past five year’s worth of markets, I’ve identified the following areas and stocks that were devastated during the housing/financial crisis crash of 2007-09 but haven’t yet been dramatically bid up (I’ve recently wrote about some of these here before but it’s worth repeating):

  • Oil and Gas (DVN, DNR, CHK, MUR, VLO, NE)
  • Coal (BTU, CNX)
  • Steel and Materials (A, X, NUE, ANR, TIE)
  • Defense (BA, GD)
  • Electric Utilities (ETR, AES, FE, POM, PPL)

These are all S&P 500 stocks.  The market’s moving higher will depend on whether stocks like these can find support.

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