When the phoenix flies, it really flies.
You may recall the phoenix investing strategy from blog posts earlier this year. In essence, it entails buying stocks that are priced for failure (as in, bankruptcy). For every stock that actually does blow up, a bunch survive the turmoil and rally like you wouldn't believe. Dangerous? Yes. Interesting? You bet.
The strategy was brought to our attention by Cam Hui, who writes the Humble Student of the Markets blog and regularly updates a stock screen that searches for stocks that meet his criteria. Most important, these stocks must have fallen 70 to 90 per cent from their 52-week highs but still have a market capitalization of at least $100-million (U.S.), signalling they were once decent-sized companies.
In February, this list included Citigroup Inc., Bank of America Corp., Fifth Third Bancorp, Liz Claiborne Inc. and Wyndham Worldwide Corp.
Turns out, the strategy did what it was supposed to do: It creamed the broader market when stocks began to recover in early March. Mr. Hui looked at the returns in two different ways.
The first is the conservative approach: You bought a basket of phoenix stocks in February, when he wrote about the strategy, and sold them on June 22, when the S&P 500 fell below its 22-day moving average. The gain: 118 per cent.
The second approach gives you the theoretical return if you had timed things perfectly: You bought the basket of phoenix stocks on March 9, when the S&P 500 hit a 12-year low, and you sold the basket on May 8, when junk stocks hit their peak. The gain: 236 per cent.
"In short, a trader buying a phoenix portfolio would have seen somewhere between a double and triple in his capital in roughly three months," Mr. Hui said.
So have you missed your opportunity? Perhaps not. Mr. Hui is bearish about the near-term future for the stock market, primarily because of the China story. He believes that many of the expectations for a global economic recovery rest on the idea that China's economy is growing.
However, he believes that fears of a slowing China will soon circulate among trading desks now that commodity prices have corrected over concerns that China is accumulating commodities but not consuming them.
"This would knock the last underpinnings of the current market rally and a decline in the equity indices," he said. "It would also mean that the U.S.-dollar and bond market would tactically catch a bid. The S&P 500 could well test the old lows, either made last November or last March. That will be the time to buy phoenix. Be patient."