Hated Stocks Unlock Market as Analysts Prove No Guide to Gains

Photographer: Scott Eells/Bloomberg
Traders prepare for Twitter Inc.'s initial public offering (IPO) on the floor of the New York Stock Exchange (NYSE) in New York, U.S., on Thursday, Nov. 7, 2013.

Nobody saw it coming.

To pick a winning stock at the start of March, you had to find a company that was hated by analysts, adored by short sellers, avoided by institutional buyers and averse to doing just about anything but pay dividends. Shares with those characteristics have generated returns of as much as 5.8 percent even as the Standard & Poor’s 500 Index (SPX) stood still, data compiled by Bespoke Investment Group LLC and Bloomberg show.

The unlikelihood of arriving at such a blueprint after a five-year bull market is taking a toll on asset managers, with more than 80 percent of growth and value funds trailing benchmarks in 2014. For investors coming back to the market just as losses in Internet shares approach 20 percent, it’s a lesson on how little past performance says about the future.

“When you are fighting a market trend, you have to choose whether you have to ride it, or you get out of the way,” Jerry Braakman, chief investment officer of First American Trust in Santa Ana, California, said by phone on May 8. His firm, which manages $1.1 billion, trailed the S&P 500 in the first quarter and has cut holdings in financial and consumer-discretionary shares while adding to stakes in energy and utilities. “It’s just been a difficult market.”

Photographer: David Paul Morris/Bloomberg

Stocks that were snapped up last year because of the promise of future earnings growth became losers in March, April and May. Los Gatos, California-based Netflix Inc., which rallied 298 percent in 2013, is down 26 percent. Amazon.com Inc. in since March. Close

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Photographer: David Paul Morris/Bloomberg

Stocks that were snapped up last year because of the promise of future earnings growth became losers in March, April and May. Los Gatos, California-based Netflix Inc., which rallied 298 percent in 2013, is down 26 percent. Amazon.com Inc. in since March.

U.S. stocks fell last week, giving the Nasdaq Composite Index (CCMP) its worst decline in a month, as a technology and small-cap selloff overshadowed optimism the Federal Reserve will continue to support the economy.

Equities advanced today, sending the Dow Jones Industrial Average to an all-time high, as deals activity boosted confidence in the economy. The S&P 500 rose 1 percent to 1,896.65 at 4 p.m. in New York, topping a record close from April.

New Leadership

Stocks that were snapped up last year because of the promise of future earnings growth became losers in March, April and May. Los Gatos, California-based Netflix Inc., which rallied 298 percent in 2013, is down 26 percent. Amazon.com (AMZN) Inc. in Seattle, up 59 percent last year and 383 percent since March 2009, has fallen 19 percent.

In their place are companies that trade at the smallest multiples to profits, get the lowest ratings from Wall Street firms, attract the fewest mutual fund owners and have the highest short interest. Energy companies in the S&P 500, with an average price-earnings multiple of less than 15 at the start of March, have jumped 7.4 percent since then, beating all other industries except for phone stocks.

Telecommunications companies offering dividends averaging 4.9 percent two months ago are up 8.3 percent. Utilities that were paying out 3.8 percent and were most hated by money managers in a March survey by Citigroup Inc., added 4.9 percent.

Fund Returns

The shift caught some professional investors off guard. Among mutual funds that invest in large-cap growth companies, about eight out of 10 trailed their benchmark index this year, the second-highest proportion since at least 2004, data compiled by Chicago-based Morningstar Inc. show. About 82 percent of value funds lagged behind, compared with 63 percent in 2013. Of all the funds, 77 percent underperformed the market.

The HFRX Equity Hedge Index fell for a second month in April, the longest stretch in two years. The Global X Guru Index exchange-traded fund, which tries to replicate hedge fund holdings, is down 3.7 percent in 2014. Paul Tudor Jones, founder of the $13.6 billion Tudor Investment Corp., said on May 5 at the 19th annual Sohn Investment Conference in New York that macroeconomic investing is as difficult as he’s ever seen.

Momentum Reversion

The reduction in monetary stimulus by the Fed has made it difficult to predict both the economy and the market, according to Dan Morris, a global investment strategist at TIAA-CREF Asset Management in New York.

“That momentum reversion made it very tricky from a stock selector’s point of view,” Morris said by phone. The firm oversees $569 billion. “There is still enough uncertainty around the Fed. We’re going to have these bouts of volatility that are going to continue to make it challenging.”

While the fund performance may be a wakeup call for individuals about market volatility, deposits to mutual funds and ETFs that buy American equity haven’t stopped. After withdrawing $260 billion from equities during the four years through 2012, investors added $140 billion in 2013 and about $20 billion this year, data compiled by Investment Company Institute and Bloomberg show.

As investors regain confidence in the economy and equity inflows continue, funds that offer stable returns during market turmoil will stand out, according to Frank James, founder of Alpha, Ohio-based James Investment Research Inc.

Defensive Mode

“What really helps is if you don’t lose money in bad down markets, they’ll never forget and they stay with you,” James said in a phone interview. “We were in golden years before when we were trying to make money in an aggressive way and now we’re in a defensive mode.”

His $3.1 billion James Balanced: Golden Rainbow Fund (GLRBX) is up 2.8 percent this year, beating 73 percent of its peers, data compiled by Bloomberg show.

Technology, the most loved industry among funds in the survey by Citigroup, suffered some of the biggest losses. The Nasdaq Internet Index, which rallied 494 percent over the five years through March, has since dropped 19 percent as concerns grew that valuations as high as 822 times estimated earnings for stocks such as Amazon and Twitter Inc. aren’t justified.

The 30 S&P 500 stocks most favored by analysts two months ago have fallen 0.4 percent while those with the lowest ratings have climbed 5.3 percent, data compiled by Bloomberg show. AGL Resources Inc., a natural gas distributor based in Atlanta that was ranked the lowest, has advanced 11 percent.

Most Shorted

Shares targeted by bears are rising. Mining equipment maker Joy Global Inc. and phone service provider Frontier Communications Corp. were among eight companies that had short interest exceeding 20 percent of their shares available for trading at the end of February. Their stocks have since increased an average 2.9 percent.

The 50 companies least favored by institutional investors, such as Exxon Mobil Corp. and Windstream Holdings Inc., have gained 4.9 percent since March. The most loved, such as GameStop Corp. and VeriSign Inc., are down 0.2 percent.

“Once it’s a crowded trade and everyone is in the same consensus, that’s kind of group thinking that there is nowhere to go but down,” Craig Hodges, the Dallas-based manager of the $1.2 billion Hodges Small Cap Fund, said by phone. The fund has beaten 99 percent of its peers over the past three years. “We try to look at contrarian areas.”

To contact the reporter on this story: Lu Wang in New York at lwang8@bloomberg.net

To contact the editors responsible for this story: Lynn Thomasson at lthomasson@bloomberg.net Jeremy Herron

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