The Two Best Performing Stock Groups After A Correction

  • Posted by on February 4th, 2016 at 11:32 am

I don’t know if the current correction is over. What most of us know is that stock indexes hit their momentum lows on January 20th and they have been in an extremely choppy, back-and-forth environment ever since. This is a normal price action after big and fast drops. If past history is a good guidance, we are very likely to see a re-test of the momentum lows at some point. If the test comes with some form of breadth divergence – for example, a smaller number of stocks making new 50-day lows compared to Jan 20 or smaller number of stocks dropping below their 50dma, and we see heavy institutional buying, then we might have a major sign of a bottom. Remember, bottoms are formed by heavy buying, not heavy selling (even though the latter often happens first).

The more interesting question here is, what are the best-performing stocks after a deep market correction?

1. The ones that sold off the most during the correction. Many of them are priced for bankruptcy. The moment the market realizes that it is not likely to happen, we could see some extreme moves in those stocks. And by extreme, I mean 100% to 300% moves in 2-8 weeks. In the current environment, these are oil & gas, steel stocks, emerging markets.

2. Growth stocks that held the best during the correction. Growth stocks are usually high-beta names that get hit pretty hard in times of market panic. If any of them manage to hold above their 50-day moving average, build a new base or even attempt to make a new 52-week high during the correction, they will likely outperform significantly during any bounce attempt. Note that I accentuate Growth. During corrections is normal to see low-beta, high-yield groups like utilities and consumer staples to hold better than the rest of the market, but they are not going to outperform during a market recovery.

Keep in mind that there are different types of corrections. In a garden-variety 5-10% pullback above a rising 200-day moving average, momentum stocks with the highest relative strength during the correction are likely to significantly outperform during a recovery. After a deep >20% correction below a flat or declining 200dma and especially after a long bear market, many of the best performers will come from the most beaten down stocks that were priced for bankruptcy, but managed to survive.

Some corrections turn into bear markets. They are rare, but they happen. Bull markets reward risk-taking, but when the bear puts out honey, he is usually laying a trap. In bear markets, you buy when the fear of losing is very high and you sell when the fear of missing out is very high. As usual, easier said than done.

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