February 8, 2021
BARRON’S
M3
are outperforming the broader market.Small-cap stocks have roared ahead of largerones in the past few weeks....Low-pricedstocks, many of which got that way for verygood reasons, have been jumping for monthsnow.” We could have pasted that into justabout any Trader column in recent weeks.
The comparisons don’t stop there. Re-
cent headlines highlighting losses at MelvinCapital and other short-selling hedge fundsalso echo ones in 2003. Just one of 17 shortfunds finished with a positive return thatyear, with Rocker Partners, a prominentshort fund, finishing the year down 36%.The fund’s David Rocker said it left him feel-ing like “Alice at the Mad Hatter’s Ball.” Thatquote could come from any short seller now.
What the shorts forget is that when a
recession ends, crappy companies, particu-larly those that appear to have no future,rally. In 2003, the list included Lucent, theformer Bell Labs; Yahoo!; and Research InMotion, known today as
BlackBerry
(BB).
Today, it’s names like GameStop,
AMC En-
tertainment Holdings
(AMC), and, well,
BlackBerry. That actually makes sense:When the U.S. falls into a recession, theweakest companies file for bankruptcy pro-tection, while the rest buy themselves sometime. “We’re at the stage [in the businesscycle] when you expect lower-quality com-panies to do better,” says Barry Knapp, man-aging partner at Ironsides Macro Economics.
In the 12 months from the October 2002
bottom, the S&P 500 Quality–Lowest Quin-tile Index rose 38%, doubling the S&P 500’s19% rise. Low-quality stocks also outper-formed coming out of the recession in 2009,with their index gaining 69% to the S&P500’s 47% gain over the 12 months begin-ning in March of that year. (High-qualitycompanies have high returns on equity andless financial leverage, among other factors,according to S&P. Low-quality ones don’t.)
We’ve yet to see that kind of performance
since the March 2020 bottom—low qualityhas gained 40%, lagging the S&P 500’s 44%rise—but it might simply be early in the pro-cess. The bear market, after all, lasted amere 19 days. The low-quality rally, if it doesshow up, should have legs. It certainly didfollowing the bear-market bottoms in 2002and 2009, when the outperformance inthose stocks continued for a second year.That could mean opportunities still exist insome low-quality areas of the stock market.
Still, once the bounces are finished, lon-
ger-term games can be hard to come by.Some companies disappear, others go on todominate their industries, and still more justfight to exist, with their stocks going no-where for a decade or more.
That was the case with utility
AES
(AES). It got hit hard, as did many utilities,following Enron’s collapse, and traded forunder a buck in October 2002. A shortsqueeze drove it as high as $8.35 by June—an astounding 781% rise—and then as highas $25.52 in June 2007. Since then, it hasnever closed higher than those 2007 highs.
Until now. AES, which has a large renew-
able-energy business, finally broke out ofthat range when the Democrats won controlof the Senate in January. That, combinedwith a subsequent
pullb
ack, ca
used Ever-
core ISI technical analyst Rich Ross to call ita “high conviction long” offering a “table-pounding 14-year base breakout.”
But it isn’t just the technicals that make
AES, which now trades at $26.86, look at-tractive. Its profits took a hit from the Covidlockdown, but not as big a hit as expected.And it should get a boost from President JoeBiden’s climate plans and the push to reduceemissions. The company has also—finally—gotten past all its problems from nearly 20years ago by earning an investment-graderating from S&P in
Novem
ber.
After more than a decade in the wilder-
ness, AES may be ready to run again.
BIndustry ActionPerformance of the Dow Jones U.S. Industrials, ranked by weekly percent change.*
Oil & Gas
8.14%
Financials
6.08
Technology
5.94
Industrials
5.72
Consumer Services
5.39
Consumer Goods
4.82
Basic Materials
4.38
Utilities
2.38
Health Care
1.18
Telecommunications
0.81
Source: S&P Dow Jones Indices* For breakdown see page M36.Don’t settlefor average.Upgrade your financial advisor atbarrons.com/directory
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