Zacks Investment Research: Equity Market Anomalies for August 18, 2011

CHICAGO, Aug. 18, 2011 /PRNewswire/ -- Zacks Investment Research presents their newest list of stocks featured in their weekly Equity Market Anomalies, which describe how to profit from stock market opportunities.  The stocks in this article focus on the profitable Momentum anomaly. Stocks include: CVR Energy, Inc. (CVI), Select Comfort Corporation (SCSS), W&T Offshore Inc. (WTI), Buckeye Technologies Inc. (BKI) and Stone Energy Corp. (SGY).

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Learn more about equity anomalies at this site: http://hema.zacks.com/

Here are highlights from our most recent Equity Market Anomalies feature:

Profit from Hordes, Swarms, and Flocks

When I think of "hordes," I imagine mass armies of Barbarians pouring in and looting Rome.  "Swarms" remind me of thousands of teeming bees rushing out of a hive.  And on numerous occasions, I've seen "flocks" of crows aggressively attacking lone hawks.  Does this aggressive mob behavior exist in the stock market?  And is there power in a teeming sea of investors?  You betcha!

As it pertains to the stock market, this effect is called Momentum investing.  Momentum investing is the approach of buying stocks that have had price increases over a period of a few months to a year.  Essentially, it is a bandwagon effect.  As investors see a stock going up, they are quick to buy, and more investors follow suit.  It's like following a crowd and there is comfort in numbers when it relates to stock investing.  Would you feel more comfortable buying a stock that's going up or down?  Exactly!

Furthermore, Momentum investing is considered a Market Anomaly because the effect mystifies economists that believe the market is efficient.  Since they think the market fully reflects all information and, therefore, profits above market returns do not exist, it should thus follow that excess returns cannot be made simply by purchasing stocks that have had high recent returns.  Luckily for you and me, the Momentum Anomaly is alive and well.

Here's proof.  Let's use the S&P 500 as the benchmark for the market return and build a portfolio of the ten S&P 500 stocks that have had the best performance over the previous 52 weeks.  From January 2000 until July 15, 2011, the ten stocks that had the best performance prior to portfolio formation had a compounded annual return of 18.7% compared to the S&P 500's 0.8%.  These results indicate that investing hordes, swarms and flocks have a significant amount of power and following trends can actually lead to outperforming the market.

You may be wondering, "Is there a drawback to jumping on the bandwagon?"  Well yes there is.  Sometimes crowds panic and stampede in the opposite direction.  This reversing of direction can lead to high amounts of volatility in a portfolio.  The annualized volatility of the S&P 500 has averaged about 18% over the last 11 years while the portfolio of the ten highest Momentum stocks of the S&P 500 had an average annualized volatility of 34%.  So our sample Momentum portfolio had about twice the volatility of the market, but also about 23 times the return.  Just be aware hordes are going to win over time even if they can be a bit fickle.

Here's a method for finding stocks to take advantage of the Momentum Anomaly:

• First, create a liquid, investible set of the stocks with the largest 3000 market values and average daily trading volume greater than or equal to 100,000 shares (if there's not enough liquidity, it'll be hard for you to trade it).
• Next, due to the uncertainty regarding some foreign issues, keep only U.S. common stocks (There's some bad stuff out there, so let's avoid it.)
• Add another filter by selecting those stocks with a Zacks Rank

1 Year CVR Energy Chart

1 Month CVR Energy Chart