Zero Hedge

Today's curious equity market performance would lead many to believe that the market may truly have hit a bottom. Bad news gallored when stripped of their media spin, yet the market was up a solid 1.5%. While there are many bottom up and top down analyses available (and applicable) that would indicate wholesale buying now is still premature (especially when it comes to overall market growth expectations), it would be a folly to try to explain that to hedge fund managers (the ones who are still around) that still have redemption-locked cash lying in the backoffice, which of course has to be put to action. And with HY bonds having returned over 12% in the past two months, many managers are afraid of jumping on that bandwagon for fears it may have run out of steam, so the only logical place to dump money is equities.

Whereas we don't advocate going long here without a good reason, it makes sense to present some data for those who are brave enough and are looking for good opportunities, as well as identifying undervalued sectors (a common theme seems to be that equities are trading as a whole asset class, with little distinction between different industry groups). With the help of some recent charts from GS (which incidentally is most overwight on Financial, Staples and Telecom, and most underweight on Info Tech, Energy and Healthcare) we present the facts and leave it up to investors to draw their own conclusions.

In terms of finding an appropriate group of companies or industries, one has to start with an underlying premise for a risk/return target, with the easiest distinction being Value or Growth stocks, or something GARPy i.e. inbetween. Empirically, GARP has outperformed the S&P over the past 59 months by 148 bps, Growth outperformed by 191 bps and Value underperformed by 460 bps. Maybe in this still very uncertain environment (we still have no clarity if the government will adopt an aggregator bank or asset guarantee financial rescue plan: the two would have profound and quite opposite impacts on the market) GARP is the proper equity way to go (if any).

How has the market fared so far to-date based on sectors, styles and strategies? Here is the data through January 31:

Curiously the only "styles" working are core commodities and hedge funds (although the CSFB number seems a little suspect), with the balance of all major strategies generating negative returns to date.

As one screens for opportunistic investment ideas, as we mentioned, the best combination seems to be at the intersection of growth and value.

What are the screenable Growth metrics:

Core Growth: i) forward sales ii) near-forward EPS and iii) far-forward EPS
Momentum: EPS revisions in the last 4 weeks
Profitability: i) forward operating margin, ii) forward profit margin, iii) forward change in profit margin and iv) ROE

What are screenable Value metrics:

Sales: forward EV/Sales
Earnings: i) P/E (next year); and ii) P/E (long-term) i.e. PEG
Cash flow: i) CF Yielf and ii) EV/EBITDA
Book Value: P/Book
Dividends: i) Relative Div. Yield and ii) Relative Implied Growth

Results of a screen thus posited indicate that resulting Growth companies are the ones with >70% of Growth score; Value: >70% of Value score, GARP: >50% of Growth and >50% of Value, and the "discarded" unattractive companies have <40%>

The resulting matrix is presented below, with a 10,000 foot industry break out based on the above categories.

A much more defined, sub-sector screened matrix indicates a variety of interesting industry opportunities in any given space.

This type of screening can be continued with specific companies being the end result, however it makes sense for investors to do their own homework in approaching this screen, and come up with proprietary results.

Incidentally, we have spoken before about the rather optimistic earnings growth assumptions embedded in the current "fair value" of the S&P. It is curious to see the dichotomy on a sales and earnings growth from a consensus standpoint for 2009 and 2010, implying the bulk of equity value creation has to come from cost and SG&A streamlining, meaning companies have many more layoffs still ahead of them .

How is investor capital actually allocated , and what kind of risk tolerance do the different classes have?

Not surprisingly the mutual fund family (60 largest mutual funds presented) has performed on par with the market YTD.

Incremental capital will need to come from outside sources to restoke a rally in light of the last month's drubbing.

As for investors who look at out of favor industries and sector, the below graph showing historical S&P 500 sector capitalization, might present some interesting opportunities:

Lastly going back to basics, in terms of the different sectors' relative earnings multiples and growth, the sector that seems to still be the most precariously positioned is consumer discretionary, while energy may be poised for a pick up once the nearly 50% projected slump in 2009 earnings is absorbed.

And again with some more sub-sector resolution.

So what is the conclusion? We have no idea... But every radioactive cloud has a silver lining. Perhaps days like today are indicative of the investing public finally trying to sift thru the debris and pick out relatively mispriced babies that had been previously thrown out with much of the bathwater, or alternatively sectors and sub-sectors. Amusingly, most sectoral rallies end up in a general lifting of the overall market as many people on the sidelines will follow any rally, whether it is up or down, thus drowning out relative value opportunities (or make them even more pronounced some may argue).

Our caveat: purchase with caution, and not follow every heart beat of the market (which is on bypass anyway), but opportunities do exist.

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