The rising tide of the great bull market has lifted most boats, but some strategies that trounced the index last year are also ready for what might happen next. Here are three possible scenarios...
1) Q3 rally powers on, taking the S&P 500 to 2,000 and higher on strong earnings
2) Volatile, sideways action in a range between S&P 2,000 and 1,850 into autumn
3) 10-12% correction that tests the Feb. lows, and possibly lower with bad news
I'm going to tell you about a strategy that did very well in the past year - more than doubling the 32% return of the S&P 500 in 2013 - and that could still outperform in 2014.
Scenario #1: More Gains Ahead
If scenario #1 is the most likely outcome, it is because it's supported by the economic backdrop. Fundamentally, the economy is growing sufficiently to keep recession at bay and the Fed is still "on our side" with a commitment to very low interest rates for another 6-12 months. These are two of the biggest factors which attract money into stocks, in addition to corporate earnings power.
Speaking of earnings, the S&P is on its way to another record year, tracking toward aggregate EPS of $117. And the Q2 earnings season is confirming this trend with over 60% of companies beating revenue estimates.
But we also know that typically in Q3, portfolio managers begin to shift their attention to next year's estimates. 2015 EPS projections are between $125 and $130, representing 7-11% earnings growth.
And in a strong bull market, the multiple investors are willing to pay for that growth can expand to 17 or 18X. At a minimum, that puts the S&P 500 north of 2,100 in six months.
So with big macro worries once again on the sidelines - from Europe and China to Russia and the Middle East - my favorite line from last year is still true: money managers are heads down, picking stocks.
So I am sticking with the strategy that got me here, where I "follow the money" of institutional portfolio managers - those running $100 million or more - as they pile into growth stocks. By matching the earnings momentum of Zacks Rank #1 and #2 stocks against a database of SEC 13D and 13G institutional filings, I can screen for stocks that are under accumulation by the investors who move markets.
While I can't buy every stock I find that meets these two criteria, what I get is a solid list of names to do some homework on. I pour over the analyst reports to find out why they are raising estimates and I try to see what the institutional buyer saw that made him or her plunk down enough cash to amass a 5% stake in the company. More on this strategy and some of the successful picks in moment.
More . . .
Big in-the-know funds and pension plans try hard to keep others from spotting their key moves too soon. They need time to go all in, drive up the prices, and make big profits.
Before now, you could only catch their moves early if you had the time and expertise to comb through obscure SEC filings. Today, a Zacks strategy brings the best of them to you at "first sniff" so you can enjoy the full profit ride. During 2013, this approach was Zacks' best performer, more than doubling the S&P 500 with a stellar overall gain of +66.4%.
Scenario #2: Home on the Range
Markets are all about investing under uncertainty. And few markets are more uncertain than the ones gyrating back and forth in a volatile range, as bulls find that "buying the dips" has become more challenging and bears believe that finally they have the BIG correction they've been predicting.
But do you know what professional money managers like Steve Mandel of Lone Pine Capital, or the many funds of BlackRock, or even Carl Icahn do? First, they check to make sure the fundamentals are still in place that warrant a bull market vs. a bear market.
Then, they keep focused on picking exceptional stocks that others are irrationally selling because these investors look out past the volatility to what they see as the true and fair value for their investments that will be realized over time.
Now this is where my screening gets a little trickier because I am using the Zacks Rank, a short-term earnings momentum model, against the longer holding periods of the "whales" of the stock market, my name for the institutional investors. For this, I simply try to make sure I am buying in the lower end of a value range by some combination of technical or timing opportunity.
Often the timing opportunity is simply being very quick as soon as I see the "whale" announce his or her position. Other times it means waiting until the stock comes back a bit. In either case, it has led to many 20%+ winners for the portfolio. Two of my best sector/industry plays of the past year have been Technology and Biopharma. As you probably know, these areas also strongly outperformed the broad market.
With solid gains in names like Valeant Pharmaceuticals (VRX), Pharmacyclics (PCYC), Synaptics (SYNA) and Ubiquiti Networks (UBNT), I have tried to capitalize on the long-term trends in medicine and communications that are definitely on the radars of the whales. In a sense, I am using their superior research teams and their capital to make outsized gains for my customers.
Other sectors and industries where this has worked terrifically are Retail and Energy. Remember, in the era of QE, money rarely leaves the market and goes to cash. It simply rotates to the next hot area.
Scenario #3: The BIG Correction
This is the scenario that every investor fears the most, and none of us can predict. All we can do is play the odds. What I do is assign probabilities to potential outcomes. And right now, the correction scenario is gaining some traction but it is still the least likely.
Among our 3 scenarios, I am currently at a 60% chance of #1 (Bull Charge Continues), a 25% chance of #2 (Big Sideways Range) and a 15% chance of #3 (BIG Correction). Even the largest asset manager on the planet, BlackRock, recently said that the market is "fairly valued." But does this mean they are selling all of their stocks and advising their clients of the same?
Of course not. Their ranks are also filled with portfolio managers who are stock-pickers. They know they can outperform a frothy or fairly-valued market by selecting the best growth opportunities.
But if a big correction does become more likely, it doesn't mean you run for the hills either. The whales certainly aren't doing that. After they sell some of their big winners, they are buying new stocks on the way down. And if you've ever experienced a several month correction or a bear market before, you know that they are full of violent 2-3% rallies where individual stocks can move 5-15%.
Bottom line: you want to be positioned for those rallies by getting into great stocks that the whales love - when they are on sale. All this requires is having a formula and the discipline to follow it.
My edge is not that I am the greatest stock picker in the world. But I know how to follow some of the best and overlay my own "margin of opportunity" parameters.
Beating the Market by More Than 100%
Of course, you too can follow those whale investors from their earliest filings, if you have the time and resources. If not, just turn to our Zacks Follow the Money Trader.
This strategy monitors a vast, ever-changing database to detect the best trades before funds and plans fully build their positions and before other institutions join in and drive up the prices. Then we filter down those moves even further through our proprietary indicators. Right now, only 8 stocks make the grade as FTM recommendations.
That is how we more than doubled the robust S&P 500 for an overall 2013 gain of +66.4% and more than tripled the quieter market during Q1 2014. Now the whales are continuing to bite and I am about to add 2 more positions to the portfolio. So I have an interesting invitation for you: Come see our real-time buys and sells, along with those of all other Zacks services, for the total sum of only $1.
Kevin, a Senior Stock Strategist at Zacks, is a recognized authority in global markets and noted for predicting and tracking the movement of smart money. He provides commentary and recommendations for the Zacks Follow the Money Trader.
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