The Perils of Momentum Investing: 3 Profitable Exceptions

In a recent article “3 High Risk Trades to Avoid,” we warned investors about the perils of momentum investing, a strategy based on hype about an investment theme, a new product or a new industry that captures and captivates the investor mind-- at times when money is cheap. We did remind investors that the momentum crowd hyped with the potential of the telecommunications and networking industry in the late 1990s, falling in love with stocks like Cisco Systems (CSCO), Ciena Corporation (CIEN), JDS Uniphase (JDSU), and Ariba Networks (ARBA), suffered hefty losses once the hype faded.

Here we take a closer look at the fate of another momentum crowd hyped by the potential of sustainability industry in the early 2000, buying up the stock of alternative energy companies.


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2 Ways to Play the Rebound in Financials

Stock leadership rarely carries from one bull market to the next week. Tech stocks were roaring in the mid-nineties, got clobbered when the tech bubble burst in 2000, and did very little in the last decade. Bank stocks were the leading group of the last bull market between 2002 to 2007 with financial institutions reaping large profits from mortgage securitization and financial engineering. During this time period, the Spyder Financial ETF (XLF) outperformed the S&P 500 Index (SPY) by more than 40%.


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When to buy stocks with low P/E ratios

Buying stocks with low P/E ratios is one of the oldest strategies used by professionals and retail investors alike. Perhaps at its core is the idea that stock prices tend to "revert to the mean" in the long-run and companies that are in the dog house today should outperform over a 3 to 5 year time period. Financials and homebuilders stocks with low P/E ratio today fall in this category.

P/E's have certainly gone down in the past two months courtesy of the ongoing market correction. So is it time for investors to go back to the market and start buying stocks with low P/E's?

The answer depends on one's view of the economy and whether one is buying stocks of companies with cyclical earnings versus companies with steady earnings growth. Mechanically, a stock trades at a low P/E because of a disconnect between market price and earnings. Let us consider two very different scenarios:


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The Dollar Rebound and What it Means for the Market

After being in free fall for close to two years, the dollar is turning around, gaining against every major currency, especially against the euro. Is it just noise or a genuine trend?

We do believe that it is the second, for four reasons:

1. Monetary policy shift in the US. In its press conference two days ago, Fed Chairman Ben Bernanke made clear that, unless the economy weakens significantly, there will be no more QE3, so there will be no pressure to further lower long-term rates, which is bullish for the dollar.

2. Fiscal policy shift in the US. In recent speeches, legislators from both parties have expressed determination to address the country’s soaring debt, which is bullish for the dollar.

3. Flight to quality. With sovereign debt issues persisting in Europe, the US treasuries continue to be the safe investment for foreign investors, also bullish for the dollar.

4. Monetary tightening in emerging countries may be over. Monetary tightening has begun to slow down inflation and economic growth in emerging markets, which is bearish for those currencies.

What does an uptrend for the dollar mean for financial markets?


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Time to Go (Bottom) Fishing?

The appeal of the stock market is a function of both time and price. In terms of price, this correction is shallow at best, with no capitulation in sight yet. As far as time is concerned, professional and retail investors alike are getting weary of the lousy market action. Stocks have been declining every week for the past two months with the S&P 500 Index losing about 7% from its 52-week high of 1370 that was reached in late April.

While it does not feel that we hit bottom yet (on Thursday, the S&P 500 made an impressive reversal from the 1260 mark but Friday's action was terrible again with the S&P 500 Index losing 1.2%), two very different catalysts have the propensity to propel the market higher for the second half of the year:

1. The macro catalyst. Economic fundamentals will improve:

• The negative impact of supply disruptions from the Japanese earthquake will diminish with Japanese firms ramping up production.
• The Fed's monetary policy remains accommodative despite the ending of its government bond buying program - the so-called QE2 - and the Fed won't put the breaks on for an extended period of time. It is still watching the economic numbers carefully (especially the unemployment rate and housing numbers) and remains worried about the possibility of Japanese-style deflation.

2. The micro catalyst: Investors go bargain hunting.


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3 Trades for the Post QE2 Period

Every investor who has been around Wall Street long enough knows that there is a time to buy and hold, there is time to sell and stay on the sidelines, and a time to trade. Now is the time to trade.

From late 2001 to the mid of 2007, there was a time to buy and hold stocks, as a string of interest rate cuts by the Fed provided a market "put" that fuelled a positive investor sentiment that turn every news on the economy into good news; stocks climbed one hill after another rewarding investors who bought and held stocks. 

From the late 2007 to early 2009, there was a time to sell and stay on the sidelines, as residential and commercial real estate collapsed, taking Wall Street along for the ride. But then the Fed returned, writing several puts to support the market, launching QE1 and QE2; the positive investor sentiment, the "buy-buy" mentality" returned on Wall Street: The economy gets stronger, stocks go higher; the economy gets weaker, the Fed goes on with QE3, and QEn, and the market goes higher.


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4 Stocks that Beat Wal-Mart

After beating Sears (SHLD) in the 1970s, Wal-Mart became the king of retailing, dominating rural America, and eventually expanding to urban areas and overseas, trashing other retailers on the way. With market dominance came scale, rising market shares, and bargaining power with supplies. That translated into lower costs and lower prices that re-enforced further dominance and rising profitability. Who would dare to challenge Wal-Mart’s dominance?

A few companies did, some successfully. In an article published in Harvard Business Review (“Outsmarting Wal-Mart,” December 2004), Darrell Digby and Dan Haas identify eight retailers that compete effectively with Wal-Mart: Target (TGT), Costco (COST), Walgreens (WAG), Best Buy (BBY), PetSmart (PETM), Dollar Tree (DLTR), Dick's Sporting Goods (DKS).


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3 Sectors to Play the Coming Rebound

Stocks have been lousy for about a couple of months and for good reasons:

• Uncertainty about the survival of the Euro and fear of contagion if (when) the sovereign-debt crisis spreads to Ireland and Spain,
• The Japanese economy slowing down after the earthquake and tsunami,
• Congress' inability to reach a deal to lift the debt ceiling,
• Weak economic numbers in particular for the housing and labor markets.

That being said, echoing the Goldman Sachs' call of 1500 for the S&P500 by 2012, I believe that stocks will keep going higher in the second half of the year for two important reasons:

1. Some shocks that triggered the selling are transitory and thus unlikely to persist. The Japanese earthquake was truly "unforecastable" and the Nippon economy will recover at least in the short-run.The Fed predicts better numbers for the economy for the second half of the year and monetary policy is still very accommodative.

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Why Bondholders Should Share the Burden of a Greek Bailout

Judging from the violent protests in Athens today, Greek citizens are angry. And they aren’t alone. Irish, Portuguese, Spanish, and German citizens are angry, too. They certainly have every right to be angry, as they are called upon to shoulder the entire burden of a bailout that breeds more problems than solutions. Bondholders should have to pay too, as they miscalculated credit risk by lending money to the Greek government at the same rate as they did to French and German governments.

The EU's ongoing policy that bails out member nations with heavy debt burdens is a dangerous game that threatens the economic and political cohesion of the euro zone and EU itself. It prolongs and generalizes the debt crisis; it injects an unhealthy dose of moral hazard into financial markets by transferring risks from bondholders to taxpayers; it pits one European member against another as neither bailout recipients or bailout providers are satisfied, for different reasons though.

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4 Reasons Why Cisco Fell

Of all investment success stories, one stands out: the story of Cisco Systems (CSCO). For more than a decade since the company went public on February 16, 1990, its stock was rising by leaps and bounds, soaring from a few dollars to $630 (when adjusted for nine stock splits). Cisco was in the right business the right time, driving the hype and buzz that propelled other networking and dot.com stocks to the stratosphere. But what set Cisco Systems apart from other companies are its business fundamentals, the ability to deliver innovative products; and its alliances with other major technology players, including IBM Corporation (IBM), EMC Corporation (EMC), Nokia Corporation (NOK), Intel Corporation (INTC), and Oracle Corporation (ORCL) that help the company dominate the Internet gear market. Yet Cisco's stock couldn't define gravity, falling from around $70 (after the last split in 2000), to around $15 today! What caused Cisco's fall?

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3 High Risk Trades to Avoid: China Stocks, Commodities and Momentum Investing

Trading in financial markets is always risky. Investors may lose part or all of the funds committed to a particular trade. But trade in some asset classes that had a big run up in the last two years is more risky than others, as traders are exposed to events that raise the probability of large losses (e.g., the disclosure of accounting irregularities, a change in government regulations, a change in the economic environment, and a shift in momentum). Here we identify three trades that fall into this category:

Buying Chinese stocks listed in the U.S. As we discussed in a previous article, buying Chinese companies traded in U.S. exchanges is a high-risk strategy, as these companies are subject to frequent changes in rules and regulations that undermine their ability to stay in business and maintain profitability. Smaller Chinese companies, especially those listed through ”reverse mergers,” are conducive to accounting fraud and manipulation. This realization prompted some discount brokers to take certain Chinese stocks off the margin list last Wednesday—resulting in hefty losses for popular Chinese companies, like Sina Corporation (SINA), down 11.28 percent; Baidu, Inc. (BIDU), down 3.2 percent; Youku.com, Inc. (YOKU) down 11.35 percent; and Sohu.com Inc. (SOHU), down 5 percent.

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End of May, Beginning of June: A Seasonal or a Cyclical Correction

The beginning of the month is usually positive for Wall Street, as new money from pension funds and automatic savings plans flow into stocks, especially as the world economy recovered from the subprime crisis of 2009. In the last two months, however, this pattern seems to be broken down, as Wall Street sold off both in the beginning of May and in the beginning of June. Is this just a seasonal correction, consistent with the old adage, "sell in May and go away," or a cyclical correction?

Declines in both months were broad, spreading to both, cyclical industries, the likes Caterpillar (CAT), General Electric (GE), and Walter Industries (WLT), and to nocyclical industries, the likes of Pfizer (PFE), Merck (MRK), and Novartis (NVS), which confirms a seasonal correction. Cyclical sectors, however, suffered more than noncyclical sectors. In the first week of June, for instance, the consumer discretionary sector lost 3.2 percent, materials 3.2, and industrials 3.1. Caterpillar and Walter Industries lost close to 10 percent of their value over the last two months, Freeport McMoRan (FCX) 12 percent, Ford (F) and General Motors (GM), Silver ETF (SLV) lost close to 35 percent of its value, and only the gold ETF (GLD) maintained its value, thanks to ongoing geopolitical events. This means that a cyclical correction is underway, accelerating and magnifying the seasonal correction.

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3 Ways to Invest in China

With the Chinese economy growing by leaps and bounds, China has become the new frontier where American investors can harvest higher returns than home. Reaching to the promised land, however, isn’t without risks that depend on the medium of investment. Here we list three different investing strategies:


1. Buy larger Chinese companies listed in US exchanges, such as China Mobile (CHL), China Life (LFC) Petro China (PTR), and China Petroleum (SNP), Bidu Inc. (BIDU), and Sina Corporation (SINA) — a moderate risk strategy. One problem with these companies, however, is that they did have a substantial run up. Petro China has risen seven-fold since listing, while China Petroleum and China Life rose five-fold.

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