Is the new, old trend: Buy commodities, sell retail?

139 stocks went up 50% or more during the month of May. To create this list, I used a liquidity filter of average number of shares traded per day >100k and a quality ratio of minimum price of $2.00.

Distribution by sector

may 09 50% moves

The move in the Basic material sector has been impressive during the last 4 weeks. The 10 year treasury yield has been steadily climbing since end of March. Higher yield is usually caused by selloff in the bond market and it is often an indicator of expectations for higher inflation 6 months ahead. As a result of that, all commodities groups were dramatically boosted and I expect this trend to continue during the summer.

The changes in the accounting methods and the steep yield curve were more than welcome by the financial sector, which again performed well despite multiple secondary offerings. The difference between the short-term Fed’s rate and the 10 year T-note rate is practically risk free money for the banks. In longer-term perspective, the higher yield means higher mortgage and consumer credits rates and I believe that will be devastating for the banks from 2010 forward. In the meantime, they might continue to offer “earnings surprises”. Let the banks worry about that and concentrate on the opportunities that the market provides now.

Earlier this week, the Consumer Confidence Index jumped unexpectedly – a first sizable jump since 2003. I believe this is a consequence of higher savings. People feel more confident as they have gradually built a cushion by saving more, paying off their debt, trying to live within their means. An increasing savings rate, higher yield, higher commodity prices, rising unemployment will rob the consumer purchasing power and I have no doubt that this will affect negatively the retail sales and the real GDP growth. When is going to happen. I don’t know. Probably the consequences will be felt in the fall or early 2010. Let the retail and the government worries about that and concentrate on the opportunities that the market provides now. And currently, they are in the commodities.

Price matters


People, suffering from cold, were asked to buy medicine with different price range. When surveyed, those who tried the more expensive medicine, reported that they recovered faster. The reason wasn’t in the price. It was their expectations. When you pay more, you expect that you’re getting the best possible decision to a problem. Your expectations become a self-fulfilling prophecy. This is why placebos work so often and this is why the effectiveness of new medicines is always compared to the effectiveness of placebos.

Another experiment was performed. People, suffering from headache, were asked to try 2 pills. One was sold at the market for 1 cents, the other for 99 cents a pill. The surveyed didn’t know which pill is which and in the end of the day the results from the two pills were very close. A week later, the same experiment was conducted. This time all participants were told that one of the pills is state of the art, miracle of the medicine and very expensive. The other was an ordinary aspirin sold for a 1 cent per pill. The difference in the results was stunning. The people who used the expensive pills got better, faster.

Relying on price is the most often taken shortcut in our world. It is natural for a human being not to be proficient in everything. After all, the available information doubles every month. There is no physical possibility to keep up with everything and be an expert in everything. This is why, we often choose to rely on price. Expensive is often regarded as high quality; cheap is often thought to be inferior. That doesn’t mean that we are always right. On the contrary. Such simple minded approach guarantees that we will be wrong in many cases. But in a world that gets more complicated by the second, relying on price as a measure of quality is a safe bet. Safer than anything else. 

The same approach could be applied to equity selection. It is true that high priced stocks don’t double as often as let say $1 prices stock, but they are also more liquid and less volatile. In my position sizing approach, I always take into account the individual stock’s volatility and its price.  Higher priced stocks provide the opportunity to use tighter stop in percentage terms, which means much better trading opportunities in term of risk to reward.

I will be glad to hear what is your take on the subject.

S&P 500 vs U$D

s&P 500 vs U$DIf you take into account the recent weakness in the Dollar, S&P 500 is actually flat for the last 6 months. I have mentioned before that for the FED to be able to sell enough treasuries, they have to scare the money out of the stock market into the bond market by igniting deflationary concerns. If that happens, we should see the Dollar higher and S&P 500 lower in the following year or two. So far, the FED have been choosing the other alternative – printing, which will ultimatelly lead to higher prices, initial commodities boom, followed by retail slump. I am not sure which one will be less evil for the peope – an inflation and assets run ala Island or a long-term deflation ala Japan. I would choose the latter, but that’s me.

pe ratio

You can see how the current plunge in earnings has affected the current P/E ratio of S&P 500. I am not a believer in P/E as an equity selection tool, but by any means the chart clearly shows that stocks are not cheap based on current earnings. Certainly the market is a discounting mechanism that always look 6 months ahead and this is not taken into account in the chart.