Hold your nose and "rent" the junk

The stock rally in 2012 has been characterized by a low-quality rally, or "dash for trash". I wrote here that investors were under-invested in equities and have been rushing for the entrance. They have been chasing the low-quality high-beta names as a way to quickly increase their equity exposure.

If I am right in my thesis that we are in the midst of a buying panic, then the low-quality theme makes sense as a trade. The way to participate is through the use of the Phoenix strategy.


The Phoenix rises again?
I gave a buy list of Phoenix stocks on February 24, 2009, shortly before the ultimate bottom in the stock market in March 2009. The idea behind the strategy is to find beaten down stocks that barely survived the bear market and have the financial or operational leverage to benefit from the coming upturn.

The February 24, 2009 list produced many winners. Notable among them were household names such as the Bank of America (BAC):

Liz Claiborne (LIZ):

...and Saks (SKS):

Different macro backdrop, but still dashing for trash
This time, the macro backdrop is different. We were not in a recession, though arguably it has been a period of anemic economic growth, so the situation for many companies isn't as dire as it was in late 2008 and early 2009. Nevertheless, Phoenix does make sense as a way to participate in the "dash for trash" theme.

With that in mind, I screen the members of the Russell 3000 for the following characteristics:

• Stock price below $8 (lower quality, high beta names)
• One year return of -50% or less (beaten down stocks)
• Market capitalization of $100 million or more (must be "real" companies)
• Net positive insider buying (number insider buys - number of insider sells > 0, which should provide some downside support should our thesis turn out to be wrong)

I came up with the following 39 names:

American Superconductor Corp (AMSC), ATP Oil & Gas Corp/United States (ATPG), Aviat Networks Inc (AVNW), Broadwind Energy Inc (BWEN), Central European Distribution Corp (CEDC), Clearwire Corp (CLWR), Cleveland Biolabs Inc (CBLI), Coldwater Creek Inc (CWTR), Demand Media Inc (DMD), EXCO Resources Inc (XCO), Fairpoint Communications Inc (FRP), Frontier Communications Corp (FTR), Gentiva Health Services Inc (GTIV), Geron Corp (GERN), Globalstar Inc (GSAT), Hampton Roads Bankshares Inc (HMPR), IntraLinks Holdings Inc (IL), Kratos Defense & Security Solutions Inc (KTOS), K-Swiss Inc (KSWS), MEMC Electronic Materials Inc (WFR), Meritor Inc (MTOR), MGIC Investment Corp (MTG), Monster Worldwide Inc (MWW), Office Depot Inc (ODP), OfficeMax Inc (OMX), Opnext Inc (OPXT), Overstock.com Inc (OSTK), Pacific Biosciences of California Inc (PACB), Popular Inc (BPOP), Quepasa Corp (QPSA), Radian Group Inc (RDN), RAIT Financial Trust (RAS), Savient Pharmaceuticals Inc (SVNT), SIGA Technologies Inc (SIGA), Sigma Designs Inc (SIGM), Skilled Healthcare Group Inc (SKH), Sun Healthcare Group Inc (SUNH), TriQuint Semiconductor Inc (TQNT) and Willbros Group Inc (WG).

Important caveats and disclaimers
I know nothing about your investment objectives and risk tolerance so don't construe this as investment advice as this may not be a suitable strategy for you.

This is obviously a high risk approach and I would take the following steps to control risk. First of all, determine how much of your portfolio you want to put into this strategy as 100% commitment is not suitable for pretty much everyone. Second, diversification is critical. I have received feedback when I last issued the call to buy into the Phoenix strategy about this stock or that stock not working out. If you do employ this strategy, you should buy a basket of these stocks and not focus on just one or two names.

Do your own due diligence on the stocks on the list. For some investors, this list could serve as a starting point to do some investigation of their own. As well, define your risk tolerance carefully, either on an individual stock basis and/or on a portfolio basis.

Lastly, this is a momentum dependent strategy that should be rented and not owned. As soon as momentum wanes, that will be the exit signal.

You're on your own.


A shorter list
If 39 names is too much for you to think about, then I winnowed the list down to eight names by requiring that there are no insider sells (instead of just positive net insider buying) and heavy insider buying, defined as more than five insider buys within the last six months:

ATP Oil & Gas Corp/United States (ATPG), Coldwater Creek Inc (CWTR), Gentiva Health Services Inc (GTIV), MEMC Electronic Materials Inc (WFR), Savient Pharmaceuticals Inc (SVNT), SIGA Technologies Inc (SIGA), Sun Healthcare Group Inc (SUNH) and Willbros Group Inc (WG).

Since the market rally has been going on for several months, buying into a Phoenix strategy now is being late in the game. However, as equity underweight investors rush to get into the stocks, this strategy should yield some decent returns if my investment thesis is correct. One important component of this approach is to watch momentum indicators carefully. When they start to turn down, then it's time to get out.

Be bold. This is the time to hold your nose and "rent" the junk.


Full disclosure: I am personally long ATPG and SVNT and may seek to get long the other names mentioned in the days to come.


Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.