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Mark Hulbert
Aug 28, 2009, 12:01 a.m. EST
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By Mark Hulbert, MarketWatch
ANNANDALE, Va. (MarketWatch) -- It's hardly earth-shattering news that the last six months have been a speculative period for the stock market.
Nor is that a big surprise: The initial thrusts upward of a brand new bull market are always speculative.
Even so, the speculative excesses seen since the market's low on March 9 would appear to be extraordinary. And that's a concern, since one of the distinguishing characteristics of bear-market rallies is their speculative nature.
Consider the blistering performance since early March of those stocks with the lowest financial quality, according to Ford Equity Research, an independent equity research firm. Through Aug. 26, the stocks with the lowest quality rating from the firm (rated C or C-) have produced an average return of 141.8%.
In contrast, the stocks rated A- or higher for quality gained "just" 44.3% -- or less than one-third as much.
(Ford's quality rating, according to the firm, "is based upon a number of factors that indicate a company's overall financial strength and earnings predictability... [such as] size, debt level, earnings history and industry stability.")
A similar story is being told by the contrast between the largest and smallest stocks, since speculative issues are heavily concentrated in the latter category. The 20% of stocks with the smallest market caps produced an average return from early March through Aug. 26 of 121.1%, according to Ford Equity -- versus 52.1% for the largest-cap quintile.
Historical data are hard to come by, but it would certainly appear as though the beginnings of prior bull markets were not nearly this speculative.
Perhaps the most revealing historical dataset in this regard is the one maintained by University of Chicago finance professor Eugene Fama and Dartmouth professor Ken French, which dates back to the mid 1920s. The accompanying table reports the returns of their small-cap growth and large-cap value sectors over the first six months of recent bull markets.
(I chose these two sectors because they are at opposite ends of the quality/size spectrum. The small-cap growth sector consists of those stocks whose size falls within the smallest 50% and for which the ratio of book value to price is in the lowest 30%. The large-cap value sector is at the opposite end.)
To put these historical ratios in context, consider that the corresponding ratio for the recent rally would be 3.2-to-1 if we were to focus on Ford Equity's quality ranking, and 2.32-to-1 if we were to segregate stocks according to market cap.
To be sure, the market's speculative character over the last six months does not guarantee that we're in a bear-market rally, of course. But it is a cause for concern.
And even if you do not think it means the bear market is about to resume, the data would appear to suggest that large-cap value stocks represent better bargains these days than the red-hot small-cap growth stocks.
Mark Hulbert is the founder of Hulbert Financial Digest in Annandale, Va. He has been tracking the advice of more than 160 financial newsletters since 1980.
- JohnMD | 11:23pm 8/27/09
The U.S. economy appears to be growing again, but there hasn't been an "all clear" signal for the U.S. consumer, who remains extremely edgy about the future.
12:14pm Today12:14pm 8/28/09 | Comments: 17
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