Published May 11, 2009

Investors win big on bombed-out stocks

Stocks with poorest fundamentals have risen by around 56%

By NEIL BEHRMANN
IN LONDON

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IN A stark reminder that a crisis also presents opportunities, shares of struggling companies whose stock prices were bombed out two months ago have been among the best performers in the extraordinary global stock market surge on Wall Street and European exchanges.

'The rally has been particularly pronounced in very low quality stocks,' said James Montier, market strategist of Societe Generale. Stocks with the poorest fundamentals have risen on average by around 56 per cent in the past two months, while shares of companies with the best prospects and balance sheets have risen by around 15-30 per cent over the same period, he said.

'This dash to trash stands in contrast to longer-term evidence showing it is generally value stocks with strong fundamentals that generate the best returns over time.'

Mr Montier, carrying out research on the behaviour of Wall Street, London and European bourses, has found that banks, insurance companies, hedge fund firms, mining companies and commercial property shares with huge losses and large debts have outperformed other shares by a wide margin. Many of these stocks had been dumped and were at extreme oversold levels.

But the bounce from the market low of March 9 to May 8 was sometimes in tandem with awful results and in many cases, extensive debt - 474 per cent for AIG, 358 per cent for Barclays Bank, 283 per cent for Citigroup, 278 per cent for the Bank of America, 148 per cent for the Royal Bank of Scotland, and 439 per cent for the heavily indebted casino gaming and property company MGM-Mirage.

However, even after these heady increases, all these shares are still substantially below their highs of the 2007 market peak.

Hedge funds had sold short many of these and other vulnerable shares, expecting to buy them back at a profit at lower prices. The bears were caught out by the rally and had to buy shares back at a loss at much higher prices.

Mr Montier thus found that the stocks in the S&P500 with the largest short, or bear positions, soared by an average of 70 per cent during the past two months. Those which hedge fund bears avoided because their businesses were sound, rose on average by 20 per cent or less.

Ironically, stocks of hedge fund businesses were also targets of the bears because of the implosion in the industry, extensive withdrawals and losses. The disclosure of the Bernard Madoff fraud in December also caused a rush out of hedge funds and hedge fund shares.

Shares of Fortress, a large hedge fund and private equity firm that manages around US$27 billion, plunged from US$37 in 2007 to only 77 US cents in December 2008, but since then have soared by 740 per cent to US$6.40. Blackstone, another hedge and private equity firm which manages US$91 billion, crashed from a peak of US$38 to US$3.87 on Feb 26 but thereafter rallied by 258 per cent to US$13.84 at the close of trading on May 8.

The danger for latecomer jittery money managers and investors is that they could rush in and be whipsawed by an unexpected swift correction, warned Mr Montier and other market strategists.