Notes on a Worst-of-Breed Rally

I have to tell you it is almost uncanny how every recent correction has played out almost identically. We've been talking about this for the past month - first goes the weak sisters of retail, financials, and homebuilders (the "early cycle recovery" stocks), then come the non-early cycle but non-commodity (tech is a great example), and everyone runs into commodities as a "safe haven" while the rest of the market crumbles. At which point, the bears come to the safe havens and maul the last group hiding. (that stage has happened over the past week)

Then we move to the next stage where the hedge funds, flush with the governments 'easy print' cash need to find someplace to run up, so they go back to the early cycle names (along with short covering). Aside from Monday, which appears to be a situation that was specific to Fannie Mae and Freddie Mac, we seem to have been entering that phase the past week - these sectors, if not rallying, stopped going down. Only homebuilders were lagging. And most joined the party yesterday.

The only thing missing this time around has been that truly "watershed" selloff where all parties are indited. Maybe it happens, or maybe the 6 weeks straight of selling was the watershed, just in a rotational pattern. I don't know. But in weeks like this (where as I wrote the indexes would hold up, or even rise) and our global growth portfolio would get smashed, while our Ultrashorts in Retail, Commercial Real Estate, and Finance would blow up in our face (at the tail end of the corrective process) we'd have performance like this -- index +1%, Rising Tide Growth -6%. And I'd kick the proverbial dog.

To allay this to some degree, I've tried to add a small barbell approach (owning some "junk" sectors) while as discussed, and you can see in our holdings, completely slashed short exposure to the bad sectors in the past week. In fact, we've gone so far as to go long the Financials (for a trade). Well we're still getting our head handed to us, but it's not quite as bad as the previous iterations. I am simply amazed that the pattern is playing out so identical - usually on Wall Street, once a pattern is detected it's exploited and becomes useless very quickly. You can see the short covering in the Crocs (CROX), Under Armour (UA) etc - all the most beaten-down merchandise flying. This makes for treacherous shorting, since it is very difficult to short what has been working for weeks on end, and even the index shorts are working against you.

With that said, I want to see the S&P over 1275 to feel more frisky (1270 seems to be the new resistance) BUT I am going to add some long exposure in areas that usually hover closer to the bottom of the portfolio - i.e. non-commodity type of stuff. First, we're adding to homebuilder DR Horton (DHI) position - while Lennar (LEN) was up 11% today, DHI has been up around 4%ish. So simply as a 'catch up' buy.The next 2 buys are simply Chinese names that have shown some great relative strength of late - WuXi PharmaTech (WX) and Perfect World (PWRD). The former is a "healthcare" stock which the Street has been running to (along with tech) of late, although it's treated as a "Chinese" stock instead of a healthcare, and the former we've simply been waiting for it to break its head over resistance. These latter two I've had as 0.1-0.3%ish type of exposure so I'm simply making them into 0.8% type of holdings each.If "the pattern" continues - commodity stocks will act listless for a week or two, everyone will call the death of commodities - all the hot money chasers will get bored since "these stocks suck - they don't go up 8% everyday" - and in about 10-15 days they'll take off. Again, it cannot be that easy, but I am just outlining how it has worked in the past. So I'm buying merchandise that is not in that wheel house. With the market holding in here well to close the day, I am sure the Invisible Hand will work its magic in premarket tomorrow and get us north of S&P 1275. We'll see on Wednesday.

Disclosure: Long all names mentioned except Crocs, Under Armour in fund; long DR Horton in personal account

Comments

[AtlanticAve]

Mark, what are your thoughts on natural gas stocks? (CHK, HK, XTO, etc.).

I took some profits on these a few weeks back, but then got back in and have since taken a beating. I'm not down as bad as I could be because I loaded up on DUG a while back...but it's still not a great feeling.

I would agree with your thesis that the "this is the death of commodities" crowd has once more rushed into the streets, forgetting that the last time they crowded the boulevard they were found shortly to be hiding beneath the dustbins...

So...is XTO a buy? It's gotten hammered.

Oh yeah...and don't even get me started on coal stocks...

[AtlanticAve]

...to continue, I would agree that we shall shortly see the commodities start rallying forward again (especially Natural Gas stocks). There's no amnesia quite like the Wall Street brand of forgetting. Still, it's pretty rough out there right now...