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A few groups of stocks that have underperformed the market markedly in the past month now look primed to bounce back. It’s a phenomenon known as a “mean reversion” trade.
The Industrial Select Sector SPDR ETF (ticker:
XLI
) is down a bit more than 3% in the past month, while the Materials Select Sector SPDR ETF (
XLB
) has fallen almost 5% and the
Invesco S&P 500 Equal Weight Consumer Discretionary ETF
(RSPD) has slid just over 6%.
All three exchange-traded funds are doing worse than the
S&P 500,
which has retreated roughly 2.8% in that time.
Rising interest rates are behind the losses. While the 5.25 percentage points of rate hikes the Federal Reserve has rolled out since March 2022 are likely to increasingly weigh on the economy, the rise in yields on longer-dated debt over the past month could well cause additional damage.
The stocks in all three funds are vulnerable. Sales for manufacturers of heavy equipment are reliant on broadly strong demand for goods and services. The same goes for producers of metals and other raw materials, which sell those goods to the manufacturers. Sales for companies that sell consumer goods and services also are hit when people feel they have less money to spend.
The point to focus on is that these stocks now look ready to pop. Data from 22V Research show that stocks that have underperformed the S&P 500 over a given month tend to rise for some period thereafter. Their beaten-down prices revert toward the mean, or recent averages.
“Long the worst performers of the prior month and shorting the best has gained more than half the time historically,” wrote 22V Research’s Dennis DeBusschere.
In fact, 22V Research’s “mean reversion portfolio,” which tracks whichever stocks are in a certain percentile of underperformance over the preceding month, has periodically achieved high returns. It gained roughly 15%, for example, in a multiweek stretch at the start of this year.
The reason the losers sometimes suddenly turn into gainers is that as they become cheaper, it can inspire some market participants to swoop in and scoop up shares while they can.
Of course, underperformance means something—recently, it reflects the market’s concerns about earnings at these companies given the economic outlook—but almost nothing in markets is an absolute certainty. There is also some probability that the economy will continue to hold up reasonably well. Given that chance, it makes sense for some investors to buy these beaten-down stocks because their prices already reflect a potential hit to profits.
That buying could send these stocks upward for a bit. Take a look at these funds.
Write to Jacob Sonenshine at [email protected]
Read the full article here
