Finding Buyable Stocks In A Market That Has Already Rallied

As we know, the stock market has charted something of a “V” pattern since early December, with the bottom point having occurred around Christmas. And right now, the S&P 500 is within a whisker of the early December high, the point from which the market started to draw the downward portion of the “V.” So it’s easy for casual observers to assume that the market’s rally is finished. Maybe that’s so. Maybe it’s not. In either case, there are ways to look for buyable stocks.

(c) CamStock Photo, dolgachov

Screening for Strong But “Oversold” Stocks

Oversold is a word that’s well known in technical analysis circles but which those who are familiar with my work may find a bit misplaced in an article written by me. After all, I’ve been a committed fundamental practitioner since I got started way back in 19-you-don’t-need-details. Like many similarly situated novices, I was and in many ways still am all in on Graham and Dodd and other fundamental gurus of the day, and I kept it going over the years including in the mid 1990s (while I was at Value Line), having been the first analyst to launch regular coverage of Berkshire Hathaway (BRK-B), which included the opportunity to get starstruck as I spoke to Mr. B himself regarding my quarterly updates.

But rather than seeing fundamentals as being opposed to technicals, I see them as working hand in hand. Fundamental analysis tells you about the company. Technical analysis tells you about the collective thought process of market participants who are reacting to company characteristics, events, etc. Think of it as reading the “invisible hand,” not the traditional invisible hand that we’ve all been taught operates to balance supply and demand in the market for goods or services, but the invisible hand that brings supply and demand for shares together. Studying this invisible hand can do much to alert you to ides that it hadn’t previously occurred to you to look for, provide feedback confirming your ideas are likely sound or suggesting you might have missed something and may need to revisit your thesis, and for one like me who works primarily with data, cueing me into the role being played by qualitative factors.

Putting both technical and fundamental analysis to work, I used the Chaikin Analytics screener to search within a universe built to resemble the Russell 3000 constituent list to find good stocks that have become oversold. If the market rally persists, these stocks can be expected to strengthen again once the factors that led to the oversold condition pass, as they usually do. If, on the other hand, the market does tire out, I’d rather start a decline holding oversold stocks as opposed to those that have been driven up to a point where they are ripe for “mean reversion” (i.e., overbought). Either way, it’s important to have other reasons to be bullish, as are built into the screen:

  • Bullish Chaikin Power Gauge rating: This one factor covers a lot of core analytic territory including basic fundamental, valuation and earnings trends. Starting here completely removes the screen from the realms of tea-leaf reading or other pejorative notions that might be associated with technical analysis. 
  • Stock price above Rising Long-Term Trend: All rating systems are the result of statistical analysis, and in statistics, favorable and unfavorable outcomes coexist. That’s fine when we examine output in the aggregate, as long as favorable outcomes predominate over unfavorable ones. But when looking at an individual stock, it helps to have some independent reason to assume the probabilities favor this particular stock being in the favorable-outcome camp. When the long-term trend (defined in Chaikin Analytics as the 200 day Double (extra smoothing) exponential moving average (a version that gives more weight to recent price movements) is rising for a favorably ranked stock, it means Mr. Market has thus far been acting toward the stock the way the rating assumed he would. And when the current price is above this trend, this signifies that thus far, the scenario remains valid.
  • Stock is Oversold: I would not be bullish on badly-ranked declining-trend oversold stocks. But when an oversold reading is combined with the two above-mentioned tests, that suggests a good entry point into a generally strong stock. Think of it as boarding a train, but not by jumping on while it’s still moving (as is often done in the movies) but by waiting for it to come to a full stop in the station. (Continuing the analogy, buying an oversold but poorly-ranked stock that’s in a downtrend is like boarding a different train that’s stopped in the station, but instead of quickly resuming the trip, that train is being taken out of service and will most likely crawl toward a repair yard.)
  • Stock is Mid-Cap or Large-Cap: By eliminating small caps, I’m playing a bit of defense in case the market decides not to extend the upper leg of the “V” pattern. I see size as part and parcel of the Quality factor, with smaller size implying lower quality and greater potential future volatility.
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