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John Heinzl (Kevin Van Paassen)
John Heinzl (Kevin Van Paassen)

Stock Picks

Market rally has made leaders out of losers Add to ...

Forget the good. This stock market rally is all about the bad and the ugly.

Since markets bottomed in March, the S&P/TSX composite index has surged 35 per cent - including another triple-digit point gain yesterday - making it one of the biggest rallies in decades.

The S&P 500 has rebounded 34 per cent, as investors seize on signs that the economy is improving, or at least getting less bad.

But it's not blue-chip stocks that are leading the charge. It's the lowest-priced, highest-risk, least-profitable companies.

"Stocks that are more volatile ... or are the most threatened fundamentally are the same stocks that are outperforming in the current rally," Myles Zyblock, chief institutional strategist at RBC Dominion Securities, said in a note to clients yesterday.

It's typical in the early stages of a broad-based stock market rally for lower-quality stocks to post the biggest returns. But Mr. Zyblock warned that "these are also the same stocks facing the risk of an outsized correction if/when the market begins to hand back some of its recent gains."

RBC found that lower-priced stocks, which are often speculative in nature, have vastly outperformed higher-priced stocks since the market bottomed, reflecting investors' increased appetite for risk.

RBC divided both the S&P 500 and S&P/TSX into 10 equal groups, from lowest to highest price. For the S&P 500, the lowest-priced stocks returned a hefty 172.5 per cent, while the highest-priced group rose just 23.6 per cent. For the S&P/TSX, the returns were 139.9 per cent and 31.5 per cent, respectively.

In another sign of investors' willingness to gamble on lower-quality stocks, many of which were beaten down to extreme levels, the least-profitable U.S. companies have posted the largest gains. On the S&P 500, the bottom one-tenth of stocks ranked by return on equity have surged 115.2 per cent, compared with 34.5 per cent for stocks with the highest return on equity.

"These are the stocks that got absolutely pounded during the selloff," said David Cockfield, portfolio manager with Leon Frazer Associates. "You had a lot of people ... really entertaining the view that we were going into a depression. The financial markets were going to collapse and we were going to lose a whole bunch of banks and it was going to be a disaster."

As a result, investors dumped companies they worried would fail in a deep downturn, driving their stocks into the ground.

One example is Teck Resources , which plunged to $3.35 during the financial panic last November, down from more than $50 a year ago. But as worries about Teck's survival have faded, the stock has gained 326 per cent since March 9, the largest advance on the S&P/TSX.

Other big gainers include Thompson Creek Metals , up 184 per cent; Sherritt International , ahead 165 per cent and Manulife Financial , up 144 per cent.

"Part of the rebound in those stocks was really that they got probably grossly oversold," Mr. Cockfield said. "What happens to them from here on in is something else again."

Follow on Twitter: @johnheinzl

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