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AS SUMMER IN NEW YORK comes to a close, equity-trading volume has dried up. Many traders and investors are out of town, soaking up the last rays of the season and trying to avoid sneaking peaks at their BlackBerries. At half-staffed trading desks and in the media, in the absence of real action, there's lots of chatter about esoteric technical market indicators.
Crossing our desk—and no doubt, yours—have been stories and research reports citing the appearance of such creepy-sounding market signs as the Hindenburg Omen, the Kindleberger Cycle and the Black Cross, or Death Cross, as it is sometimes known. (Barron's covered the Hindenburg Omen in our Aug. 18 issue; see "Taking Stock of a Scary Market Signal.") One research outfit, First Global, calls its own bearish view the Lusitania Omen. Suffice it to say, these indictors are Teutonic in grimness, if not all in name.
Regardless of their predictive ability—and the Hindenburg in particular is pretty poor on that score—that they gain any traction is due as much to investors' uncertainty as the vacuum in other information at this time of year.
Stock markets that are uncertain tend to move down. September is around the bend, and even more than October, it historically has been the stock market's bete noire. The fall might not be fun.
Still, important data—not invented omens—lead a rational investor to posit that the market probably is oversold at least in the short term, and that a rebound could be ahead.
The huge rally in the bond market and a drop in Treasury yields, now 2.65%, not that much above the S&P 500 dividend yield, suggest another recession is coming, and soon.
But going back to 1977, after the previous 14 bond-market rises of 10% or more over four months, stock-market rallies ensued, according to a recent Bespoke Investment Group report. In the following one, three, six and 12 months, the Standard & Poor's 500 rose in more than 75% of the rallies. "If bond-market rallies were indicative of future weakness, it wasn't evident in the stock market," BIG wrote.
In the past three years, investors have moved unprecedented amounts of money from stocks to bonds, according to the Investment Company Institute. Bull markets typically end after individual investors move massive amounts of money to stocks.
It won't take much of a drop in bond prices to send lots of investors back to stocks. And the number of people who can sell stocks is diminishing. The number who might have to buy if the bond market reverses is rising.
NORMALLY, MY RESPONSE TO THE HOARY Street saying "it's a stockpicker's market" is a barely restrained yawn. When isn't it? Well, maybe now.
This summer, investors are battling like equally matched football linemen: a lot of pushing, a lot of shoving, but very little ground gained or lost. Poor housing or labor data drive the market down, sprouting fears of a double dip, while better numbers—less frequent, admittedly—push prices back up by about the same amount. Since mid-May, the S&P 500 index effectively has round-tripped between 1,025 and 1,125—twice.
"When stock picking is difficult, it's a great environment for pair trades," says Cort Gwon, director of trading strategies and Research at FBN Securities. By putting an equal amount of dollars in the stocks of two companies in the same industry, one stock purchased and the other sold short, the investor is less exposed to the mood swings and macro worries that drive the broad market.
Gwon screens for unusual divergences between market leaders whose stocks have been highly correlated historically. When one underperforms the other significantly enough for about three months, he recommends buying the underperformer and selling short the outperformer. "Something has broken down in the relationship between the two stocks and you don't know what it is, but you are betting it's not a significant factor and that the spread between them will return to normal," he says.
If both stocks go up or down by the same percentage, the return is zero. But if, as expected, the long position rises more than the short, or the shorted stock falls more than the purchased one, a positive return is generated. Gwon refreshes his portfolio of about 21 pair trades regularly. The average monthly total return of each pair is 1.4%, but he recommends investing in a portfolio of trades rather than single pairs.
Lately he has recommended buying grocer Safeway (ticker: SWY) and shorting Kroger (KR). Though the two stocks usually are more than 90% correlated, Safeway is down about 11% since late May and Kroger is up 3%. Other buy/short pair trades include CVS (CVS)/ Walgreen (WAG) and Norfolk Southern (NSC)/ Union Pacific (UNP).
In a market where company fundamentals seem less urgent, this is a short-term trade, not a long-term investment. But it's not a stockpicker's market, is it?
E-mail: editors@barrons.com
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