Checking the technical performance of stocks against sentiment from analysts and traders is key to identifying contrarian trading opportunities
My articles as of late seem to be very broad-market based, even more so than usual. I've written on how broad market-indexes do in the fourth quarter, before elections, and when it's a very low-volatility environment. This week, I'm going to be more specific and list some sectors and stocks for potential long or short trades.
At Schaeffer's Investment Research, we hunt for stocks using a contrarian philosophy. That means finding stocks that have been moving higher but investors, for whatever reasons, do not believe in. As the stock continues higher, skeptical investors who have made bets against the stock -- either in the options market or by shorting the stock -- will eventually capitulate as their losses mount and unwind their positions. Unwinding these bearish bets will push the stock higher.
The disbelieving investors who have avoided the stock may eventually be enticed to buy into the stock as they see the price move higher and higher. In this case, the pessimism signals a lot of sideline money which could move the stock higher once it is deployed to buy the stock.
Bullish Sectors and Stocks: We group stocks into over 40 sectors, which we get from Investors Intelligence. To find sectors with bullish price action, I simply looked at the percentage of stocks that were above their 80-day moving average. The table below shows the sectors with the highest percentage. I also show the percentage of analysts that have the stocks in the sector ranked as a "buy," and the average Schaeffer's put/call open interest ratio (SOIR). The lower the percentage of analyst "buy" ratings, and the higher the SOIR, the more pessimism being shown toward the sector.
The "Machinery Tools" sector jumps out as a good contrarian setup. It's first on the list in terms of the percentage of stocks above the 80-day moving average, and the average year-to-date return for stocks in this sector is about 36% -- yet only 30% of the analyst recommendations are "buys." Also, the average SOIR of 1.30 means, on average, there is more put open interest on these stocks than call open interest, among options set to expire in the next three months.
So, here are the best performing stocks within the machinery tools sector. These eight stocks have returned at least 25% so far on the year, but only one of these stocks have at least 50% of analysts recommending a "buy." Furthermore, the top three stocks in the table have had their percentage of "buy" ratings decline over the past year. Despite the technical outperformance, analysts have become more bearish toward these stocks. These would therefore be strong contrarian bullish setups.
Bearish Sectors and Stocks: Below is the list of sectors with the fewest percentage of stocks above the 80-day moving average. I'm going down the list some to focus on the "Leisure" sector, which has just 42% of its stocks trading above this trendline. Out of the 10 worst performing sectors by this measure, (leisure is ninth), it is the only one where the more than 50% of analysts hold "buy" ratings. The average stock in the sector is down almost 5% on the year, so why are analysts still on board?
Here are the worst performing stocks within the leisure sector. It's a good list to find bearish contrarian plays. The first two stocks on the list, for example -- Lions Gate Entertainment Corp. (USA) (NYSE:LGF) and Norwegian Cruise Line Holdings Ltd (NASDAQ:NCLH) -- are both down more than 35% so far this year, but analysts seem to love them. Additionally, the SOIR is very low on these stocks, indicating a lot of call open interest relative to put open interest, among near-term options. Admittedly, for LGF, there is substantial short interest -- which means bearish bets. In fact, a lot of these underperforming stocks have a heavy portion of their available float sold short. Still, I would say there is too much optimism in this sector, given the year-to-date price action.
Sign up now for a trial subscription of Schaeffer's Expiration Week Countdown! We'll send you 5 trades for expiration week, each targeting double- or triple-your-money gains in less than 5 days.