Dog Days Indeed

08/24/2009 2:14 pm EST

Focus: MARKETS

Louis Navellier

Editor, Blue Chip Growth and Emerging Growth

Louis Navellier of Blue-Chip Growth has grown wary of the single-digit stocks and junk bonds at the forefront of this rally. 

Junk stocks have been doing very well this year. Tim Hope, who works for my research firm, ran a survey of all 4,000 stocks in the Navellier universe, rating them by deciles (i.e., 10% segments), sorted by 2009 year-to-date performance over the last seven full months (December 31st to July 31st). The weakest performance was in higher-priced stocks, while lower-priced stocks did best.

The ninth decile (the highest statistically significant segment in this survey) scored 232% gains. That segment includes 400 stocks averaging just $10 per share at the time of purchase.

Turning to the more select universe of the S&P 500, there are now 41 stocks trading below $10, compared with just 23 a year ago, according to Standard & Poor's Capital IQ. Looking back to the start of the last bull market in 2003, there were 42 S&P 500 stocks under $10 a share and they were a good place to invest then, too. Those 42 stocks were up 439% through July 31, 2008.

The low-rated ("high-yield") bonds are also doing well in 2009. Two junk-bond funds (run by T. Rowe Price and Vanguard) are up an average 30% so far this year, while the Vanguard Total Bond Market Index (VBMFX) is up just 4%. It follows that the stocks of those companies that hawk junk bonds are also beating the blue chips, so far. In 2009, the big S&P winners are the 81 companies with weak credit ratings ("BB" or lower), the cutoff point for "junk" bonds.

Stocks in those companies with junk-bond ratings rose by an average 25% from July 10th to August 4th. For instance, Gannett (NYSE: GCI), which publishes USA Today, has debt rated BB, yet its stock climbed 155% from July 10th to August 14th. Ford (NYSE: F), rated "CCC+," gained over 50% in a month, with an assist from "Cash-for-Clunkers," while stocks with investment-grade ratings fared worse.

To be fair, these "junk stocks" had fallen the farthest before March 6th. Companies with the lowest credit ratings were understandably punished the most during the credit collapse of late 2008, but that only means that the latest run to junk stocks says that investors have faith in the credit market recovery now in place. Investors are betting on a return to a healthier credit market in due time.

As Jeff Schacket of Thomson Reuters said, "If investors are willing to put money into companies with shaky finances, that's a good sign—not a bad one." True, but I will be the first to admit that it's a dangerous sport to play with falling knives for too long. Now may be the time to bet on the higher-quality companies catching up.

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