Home Business As ‘Low Quality’ Stages a Comeback, This Utility Stock Looks Set to Break Out

As ‘Low Quality’ Stages a Comeback, This Utility Stock Looks Set to Break Out

As ‘Low Quality’ Stages a Comeback, This Utility Stock Looks Set to Break Out

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Bearish equity strategists are calling the GameStop saga a sign of a market bubble.


Marangifoto/Dreamstime

It was a crazy time. Left-for-dead stocks were soaring. Short sellers were taking a beating. And everyone wondered whether too much “liquidity” was inflating bubbles.

It was 2003.

The GameStop saga, as a market event, appeared to come to an end this past week.

GameStop’s

stock (ticker: GME) fell 80%, to $63.77, and while that was still more than three times higher than it had been at the end of 2020, its ability to captivate had seriously waned.

Yes, politicians are still calling for investigations and planning regulations. Reddit traders continue to rally around the beleaguered videogame retailer. And talk of “rigged markets” and the “democratization of trading” and the “revolt” of the little guy continues to ring through the electronic halls of Wall Street and beyond. Even bearish equity strategists have gotten into the game, calling GameStop’s rip a sign of a market bubble that will surely pop any day.

If only it didn’t sound so familiar. Here’s how the Trader column described the situation in May 2003, when the dot-com bust had finally come to an end: “There are emerging hints of the kind of speculative pique and latent selling pressure that can undermine strong markets. Riskier sectors are outperforming the broader market. Small-cap stocks have roared ahead of larger ones in the past few weeks….Low-priced stocks, many of which got that way for very good reasons, have been jumping for months now.” We could have pasted that into just about any Trader column in recent weeks.

The comparisons don’t stop there. Recent headlines highlighting losses at Melvin Capital and other short-selling hedge funds also echo ones in 2003. Just one of 17 short funds finished with a positive return that year, with Rocker Partners, a prominent short fund, finishing the year down 36%. The fund’s David Rocker said it left him feeling like “Alice at the Mad Hatter’s Ball.” That quote could come from any short seller now.

What the shorts forget is that when a recession ends, crappy companies, particularly those that appear to have no future, rally. In 2003, the list included Lucent, the former Bell Labs; Yahoo!; and

Research In Motion,

known today as

BlackBerry

(BB). Today, it’s names like GameStop,

AMC Entertainment Holdings

(AMC), and, well, BlackBerry. That actually makes sense: When the U.S. falls into a recession, the weakest companies file for bankruptcy protection, while the rest buy themselves some time. “We’re at the stage [in the business cycle] when you expect lower-quality companies to do better,” says Barry Knapp, managing partner at Ironsides Macro Economics.

In the 12 months from the October 2002 bottom, the S&P 500 Quality–Lowest Quintile Index rose 38%, doubling the

S&P 500’s

19% rise. Low-quality stocks also outperformed coming out of the recession in 2009, with their index gaining 69% to the S&P 500’s 47% gain over the 12 months beginning in March of that year. (High-quality companies have high returns on equity and less financial leverage, among other factors, according to S&P. Low-quality ones don’t.)

We’ve yet to see that kind of performance since the March 2020 bottom—low quality has gained 40%, lagging the S&P 500’s 44% rise—but it might simply be early in the process. The bear market, after all, lasted a mere 19 days. The low-quality rally, if it does show up, should have legs. It certainly did following the bear-market bottoms in 2002 and 2009, when the outperformance in those stocks continued for a second year. That could mean opportunities still exist in some low-quality areas of the stock market.

Still, once the bounces are finished, longer-term games can be hard to come by. Some companies disappear, others go on to dominate their industries, and still more just fight to exist, with their stocks going nowhere for a decade or more.

That was the case with utility

AES

(AES). It got hit hard, as did many utilities, following Enron’s collapse, and traded for under a buck in October 2002. A short squeeze drove it as high as $8.35 by June—an astounding 781% rise—and then as high as $25.52 in June 2007. Since then, it has never closed higher than those 2007 highs.

Until now. AES, which has a large renewable-energy business, finally broke out of that range when the Democrats won control of the Senate in January. That, combined with a subsequent pullback, caused Evercore ISI technical analyst Rich Ross to call it a “high conviction long” offering a “table-pounding 14-year base breakout.”

But it isn’t just the technicals that make AES, which now trades at $26.86, look attractive. Its profits took a hit from the Covid lockdown, but not as big a hit as expected. And it should get a boost from President Joe Biden’s climate plans and the push to reduce emissions. The company has also—finally—gotten past all its problems from nearly 20 years ago by earning an investment-grade rating from S&P in November.

After more than a decade in the wilderness, AES may be ready to run again.

Read the rest of The Trader:The Stock Market Is Bouncing Back for the Right Reasons—but the Yield Curve Could Spell Trouble

Write to Ben Levisohn at [email protected]

This article is auto-generated by Algorithm Source: www.barrons.com

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