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Pro Analysis

These investments look poised for a comeback

Xinhua | Wang Ying via Getty Images | Xinhua News Agency

It's the time of year to survey the markets' losers in hopes of finding some worst-to-first candidates – investments that have been so bad that they have great comeback potential.

Unlike in sports, the cellar dwellers in financial markets aren't granted top draft picks to help them better compete in coming seasons. But assets that have lost a great deal of value, or have declined for a few years in a row, tend to benefit from the pattern of "mean reversion" – the effect where extreme moves tend to reverse themselves over time.

This might seem out of tune with the current U.S. stock market action, which features broad participation in the rally to new highs and leadership by economically-sensitive sectors. The "average stock" – as measured by the equal-weighted version of the S&P 500 index – is up some three percentage points more than the market-capitalization weighted benchmark itself.

Why not just "go with what's working," then?

Well, it's perfectly fine to do both - to play the momentum of the current trend while looking for battered and discarded outlying investments as a proxy for value. Decades of academic research in finance tells us that momentum and value are the two investment factors that most winning strategies are made of, after all.

Mebane Faber, co-founder of Cambria Investment Management and an author of several investing books, says buying assets that have undergone deep drawdowns (losses of, say, more than 60 percent from their high) or that have declined three or more years straight places the odds in the buyer's favor for outsized returns in subsequent years. He points out that these screens are mostly just a stand-in for buying things very cheap, often with washed-out investor sentiment as a bonus.

One of Faber's picks from a year ago using this approach was coal stocks. The group had lost 80 percent of its value over the prior four years and was down each calendar year. So far in 2016, the Van Eck Vectors Coal ETF (KOL) has surged by 115 percent.

This example shows that the news and available fundamental evidence might be of little help for those looking for spring-loaded comeback plays. Coal prices and the value of the miners had just become too low.

This strategy works best with whole sectors or countries' equity markets than individual stocks. One company can go bankrupt, of course. And you've likely heard the old Wall Street joke, "What do you call a stock that's down 90 percent?" Answer: "A stock that was down 80 percent and then was cut in half."

With those disclaimers in mind, here are a few areas that have taken extreme punishment in the past year or more, and could be spring-loaded for a violent rebound.