Look for the 'Fat Pitches'

By Enrique Abeyta

Tuesday, May 4, 2021

► In yesterday’s Empire Financial Daily, I explained how the efficient-market hypothesis is far from true in the short term…

For folks unfamiliar with the hypothesis, this is an academic theory stating that, at any particular point in time, every stock is “perfectly” priced, taking into account all the information available.

Any experienced market participant who has seen dramatic moves in stock prices in the short term knows this is far from true. Over a shorter time frame, it’s always about the balance of buyers versus sellers.

The recent price action in the stock of video-game company GameStop (GME) is a great example of why that theory doesn’t work in the short run.

As a trader or investor, it becomes important to understand what is moving share prices, as it’s often misunderstood…

Sometimes, “seasonality” can play a role. This happens when fund managers, who are compensated based on their performance, scramble to do whatever they can at the end of the year to create positive performance.

Other times – as was the case with GameStop – an epic “short squeeze” can play a role. As Berna explained at the time…

A short squeeze happens when everyone runs for the exits at the same time – similar to a run on the bank.

A rapid and unexpected increase in the price of a highly shorted security is usually the catalyst for a squeeze. As traders rush to close their shorts in great numbers after the initial move up, it creates even more upward pressure on the stock due to the rush of buyers. The further sharp rise in price sends more shorts scrambling to cover… and the squeeze gains force.

Another concept that can move stocks around is ‘rotation’…

As I explained yesterday, while individual institutional money managers generate a smaller portion of market action than they did a decade ago (today, the markets are full of algorithms), they’re still a major driver in the markets.

Many – if not most – of these investors are tied to benchmarks, which are typically a particular stock index. They get rewarded (big bonuses and keeping their jobs) by outperforming those benchmarks.

As a result, benchmark indexes and what comprises them are highly important to these managers.

Many benchmarks hold hundreds of stocks, so one quick way to start a portfolio indexed to them is simply to replicate the index. Then, to drive potential outperformance, institutions can “overweight” or “underweight” individual stocks or sectors.

For instance, the S&P 500 Index has a weighting to “financials” – banks, brokerages, etc. – of slightly more than 10%. The largest of those is legendary investor Warren Buffett’s Berkshire Hathaway (BRK-B), which makes up about 1.5% of the index.

With such a large weighting, it becomes important for institutional managers to have an opinion on Berkshire. Then they can choose to own more or less of the stock.

This is how most of these investors manage their portfolios… and thus, overweighting and underweighting decisions can be big drivers of stock market movements between sectors – these are called “rotations.”

While much of this activity focuses on a particular stock or industry, it’s often driven by a theme…

For example, 2020 was a great year for this kind of trading. Professional investors chose to rotate out of companies that were hit hard by COVID-19 (casinos, airlines, cruise ships, etc.) – becoming underweight in those names.

At the same time, they chose to become overweight in COVID-19 beneficiaries. While many of these were high-flying technology companies – such as video-conferencing company Zoom Video Communications (ZM) – some were traditional consumer businesses.

Stuck at home, people used more consumer products, such as groceries and household goods. This benefited the companies that make these products… as well as those that sell them.

It also led investors to become overweight in businesses that have little or no exposure to economic movements or COVID-19, like telecommunications or utilities companies.

If an institutional manager owned these in size, he had a good performance last year…

However, starting in late 2020 and picking up big steam in 2021, this trend has been unwinding

The first part of this is fairly straightforward… The institutions are rushing back into “recovery” names that were hit hard by COVID-19. A great example is casino titan Las Vegas Sands (LVS), which we traded in my Empire Elite Trader service for a 15% gain in less than three weeks.

The less obvious side of this rotation is the selling of previous winners. For the most part, this isn’t happening because of any real change in stock fundamentals, but rather due to the idea of relative positioning.

As a result, the rotation doesn’t happen quickly… but the selling is consistent and has begun to affect a large number of companies.

These are big, liquid stocks of companies with long track records of outperformance…

Many – perhaps most – of them will continue to meet investor expectations for growth, even as the world returns to normal.

What we have seen, though, is that many of these names are reaching historic oversold levels based on the relative strength index (“RSI”).

In Empire Elite Trader, we’ve taken advantage of these rotations by successfully trading stodgy blue-chip stocks like spice maker McCormick (MKC) for a 6% gain in 30 days… consumer-products giant Procter & Gamble (PG) for a 7% gain in two months… and logistics and shipping behemoth FedEx (FDX) for an 11% gain in about seven weeks.

Of course, many of these are larger and less volatile companies… so they may not produce the high double-digit returns that we’re seeing in the craziest areas of the market.

That’s the goal of Empire Elite Trader: hitting “singles” and “doubles” again and again, which really adds up over time.

But in my other service, Empire Elite Growth, we’re swinging for the fences…

Here, we won’t even consider a stock if it doesn’t have 300%, 500%, or even 1,000% upside potential.

There’s a saying in baseball that you should “hit the ball where it’s pitched” – take what the pitcher is giving you as a good pitch to hit instead of forcing a swing.

And in Empire Elite Growth, we’ve found a group of seven stocks positioned to benefit the most from the “grand reopening.”

For the past year, millions of people have missed out on traveling, concerts, and sporting events. With all the economic uncertainty at the height of the lockdowns in 2020, these folks socked away massive amounts of money.

But now, as restrictions are beginning to lift, all that pent-up demand will come flooding back… and it will lead certain stocks to massive gains in the months ahead.

This is exactly the type of setup we look for in Empire Elite Growth. And right now, I’m pounding the table on seven stocks in particular that are primed to ride the wave higher. Learn more right here.

In the mailbag, readers react to last week’s essay on the hot housing market…

What are your post-pandemic plans? Have you booked any vacations, bought tickets to see concerts or sporting events, or even gone to the movies? Let us know in an e-mail to [email protected].

“We sold a house – a rental we have had for 36 years, to a flipper, so we didn’t have to drive from San Diego to Phoenix to fix it up. Renters paid the mortgage, we sold for 3.5 times the original price, on a $10,000 investment. 73% a year return, not counting repairs.

“We also bought one – 2 weeks ago in the red-hot Reno market for 9% over asking, all cash, 2 week close.

“We did not set foot on either property, did both transactions by email and phone. There were hiccups, but not worse due to the pandemic.” – Allison F.

Berna comment: Congratulations on your great return on the Phoenix house, Allison. I hope Reno works out just as well for you.

“We bought a home in Steamboat last August, and we helped our daughter buy a condo in Bozeman last month.

This funny video just about sums it up :)” – Jean F.

Berna comment: Jean, that video is hilarious!

“In January, I listed my 83-year-old house I lived in for 37 years. Sold it in 10 days to a lady who grew up here in New Mexico and is moving back from Los Angeles. Brought in almost $50k more than I thought it would.” – Jimmy A.

“I was downsizing for the second time and had purchased a replacement home in November 2019. I needed to do some updating to the house before I put it on the market. I put the house on the market and 3 days later, on March 6th, I accepted a contract for the sale of my home with an April 9, 2020 closing date.

“By mid-March, real estate contracts all over the Oklahoma City, OK area were being canceled by buyers who had lost their jobs. My realtor had 3 contracts fall through in late March. I got lucky, my buyers were teachers and still had jobs. With the pandemic accelerating, I was very nervous up until the day we closed.” – Vicki A.


Enrique Abeyta
with Berna Barshay
May 4, 2021

Whitney Tilson
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About Whitney Tilson

Prior to creating Empire Financial Research, Whitney Tilson founded and ran Kase Capital Management, which managed three value-oriented hedge funds and two mutual funds. Starting out of his bedroom with only $1 million, Tilson grew assets under management to more than $200 million.

Tilson graduated magna cum laude from Harvard College with a bachelor’s degree in government in 1989. After college, he helped Wendy Kopp launch Teach for America and then spent two years as a consultant at the Boston Consulting Group. He earned his MBA from Harvard Business School in 1994, where he graduated in the top 5% of his class and was named a Baker Scholar.

Click here for the full bio.