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Monday, July 13, 2009

Did investors throw the baby out with the bathwater?

When the market rallied from the March lows, there were a lot of bears who said that it was a "junk rally". They pointed out, rightly, that everything was going up, good stocks and bad stocks, companies with decent earnings prospects and companies without a prayer.

Since stocks peaked a month ago, markets have been falling steadily. Now we have the flip side of the coin: good companies are seeing their stock prices fall right along with weak companies.

Just to show how exaggerated the situation has become, I ran one of our custom screens. This one identifies those stocks that have shown both year-over-year and sequential gains in both revenues and EPS. This screen yields 193 stocks. The screen further checks to see if the stock is currently on our Trend Leader list which identifies those stocks that are showing strong up-trends according to Aroon, DMI and MACD analysis. This weekend the combined screen yielded only two little know stocks:
  • EMERGENCY MEDICAL SERVICES CORPORATION (EMS)
  • ENDURANCE SPECIALTY HOLDINGS LTD. (ENH)
I'm not saying there's anything wrong with these two companies. What I am pointing out is that investors have thrown the baby out with the bathwater. Whereas a month ago we would routinely see over a thousand stocks on the Trend Leaders list; the most recent list from this weekend has only 52.

It is not unusual for this kind of exaggerated action to be the precursor of a reversal. Sure enough, as Monday's trading played out, stocks ended up putting in a strong rally. As I write this, stocks are rallying in Japan. As long as earnings season doesn't disappoint, we could easily see stocks resume their upward trajectory.

PS: the two stocks mentioned above really are pretty decent with respect to fundamentals. Solidly profitable, P/Es not excessive, little debt, good cash flow. ENH has a 3.3% dividend and a PEG ratio of only 0.48. It almost looks like a value stock but with a rip-roaring chart. Both of these stocks are worth a look.

Disclosure: no positions

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