Indicator of the Week: The Best Stocks to Own After a Big Pullback

The stocks that drop the most during big pullbacks tend to rally the most going forward

Senior Quantitative Analyst
Jan 20, 2016 at 7:30 AM
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2016 has started with a pretty harsh pullback. The S&P 500 Index (SPX) was down over 12% from last November's high to last week's low. By my count, it's the fifth 10% pullback for the index since the 2008 crash. The question everyone wants answered is whether the pullback is over or if we have further to fall. Well, I'm not sure I can answer that question. Instead, I'm going to make the bold assumption that we have hit a bottom, and if that's the case, which stocks might we focus on going forward.

After a Pullback: The tables below make it very clear which stocks are best to own after a sharp pullback in the S&P 500 Index. The stocks that pulled back the most tend to rally the strongest when it's over. To get the data below, I looked at how the current S&P 500 stocks performed after each of the four prior pullbacks. For each pullback, I tracked how the best 50 stocks during the pullback did over the next month and compared it to how the worst 50 stocks during the pullback did. I also show the data for the other stocks. 

The worst performers during the pullback averaged a gain of about 12.5% in the subsequent month after a bottom, with 84% positive. The best performers during the pullback returned an average of 5.23% over the next month -- also with 84% being positive. The most telling stat in the table shows that 69% of the worst performers during the pullback outperformed the S&P 500 over the next month. Of the best performers, only 34% of those stocks did better than the S&P 500 during the rebound.

The second table below is similar to the first but it looks at a longer time frame. It shows data for the six-month returns after the pullback. This table has one less pullback considered, because the last big pullback ended in late August, so those stocks have not had six months of data yet. Similar to the first table, it shows the stocks to own are the ones that did the worst during the pullback. In fact, 71% of those stocks go on to beat the S&P 500 over the next six months, compared to just 37% of the stocks that did the best during pullback.  

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Another Breakdown: This time, I took those worst-performing stocks and broke them down even further. I summarized their returns over the next month and six months depending on whether their year-over-year (YOY) returns were positive or negative after the pullback. The stocks that were positive even after the pullback show better returns going forward. Looking at six-month returns, the stocks that were positive YOY average a 47% gain after the market bottoms. The stocks that were negative YOY after the pullback returned 31.8%.  

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Stocks to Own: So, let's say we are at the bottom now of this pullback (a big assumption). Which stocks are best to own right now? I looked at the 50 worst S&P 500 stocks since the November high and only two of them had a YOY return (or 52 weeks) that was positive: Newfield Exploration Co. (NYSE:NFX) and Under Armour Inc (NYSE:UA).

To get a bigger list of stocks, I looked at all stocks that met some liquidity criteria and found ones that pulled back at least 15% since the November highs and were positive over the past 52 weeks. If we bottom right now, then most stocks will be good stocks to own. However, the following stocks -- according to the analysis above -- should be some of the best stocks to own going forward.

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