Market Insider

The strategy that has found winners when the market bounces back

Key Points
  • It's been a market-beating strategy to buy the three S&P industry sectors and the 12 sub-industry sectors that did the worst in the sell-off, CFRA's Sam Stovall notes.
  • Energy, health care and materials saw the biggest losses in the recent correction that drove the S&P 500 down 10.2 percent.
  • Stovall said there's no guarantee the correction has ended, and while it's in a tradeable bounce, the market could retest Friday's lows.
Stocks bounce back from worst week in two years

Energy, health care and materials stocks were the biggest losers in the sell-off, and they have the most to gain in a stock market bounce.

It's been a market-beating strategy to buy the three S&P industry sectors and the 12 sub-industry sectors that did the worst in a market drop, according to CFRA's chief investment strategist, Sam Stovall.

Stocks have ripped higher since the tested and held the 200-day moving average Friday afternoon. The S&P 500 was up 0.6 percent Monday, trading at about 2,635, just below its 100-day moving average.

The market fell through "correction" levels of 10 percent after just 13 days from its high, well below the 64-day average of other corrections, according to Stovall. This was the quickest correction or eventual bear market in the past 73 years, he noted.

Maxim Malinovsky | Getty Images

"I think it's a tradeable bounce right now because we did test the 200-day moving average," said Stovall. "When you think about it. Fundamentally things haven't really changed that much. With so many people still on the sidelines and worried, my feeling is that if everyone is expecting this type of correction, it will be shallower than most people were looking for."

If the bottom is in, the market could have a more rapid recovery than normal based on the swift decline.

"My feeling is to know whether this is the real bottom, we probably will have to go through a retest of the cash lows," he said.

Stovall said history shows that six months after a correction, the S&P has been up an average of 22 percent, and the bottom three sectors outperform, with a 24 percent average gain. In corrections since 1990, there was even bigger outperformance when looking at the 12 sub-industry sectors that performed the worst. They gained more than the S&P 500 63 percent of the time six months after a correction, with an average 55 percent gain.

During the recent sell-off among the sectors, energy was down 14 percent, health care 11.7 percent and materials 10.6 percent.

Of the sub-industry sectors, semiconductor equipment, down 18.8 percent, did the worst, followed by life and health insurance, off 15.9 percent. Health-care supplies and oil and gas exploration and production were both down 15 percent.

Air freight and logistics also did poorly, losing 13.9 percent.

The S&P had a nearly 12 percent intraday decline before Friday's bounce, and was off 10.2 percent on a closing basis as of Thursday.

If the market continues to correct, the S&P has averaged corrections of 14 percent that took 98 days to go from peak on average.

Stocks that would benefit from infrastructure spending were also battered more than the broader market. Construction materials names fell 13.6 percent and construction machinery and heavy trucks stocks were down 13.3 percent.

Stovall picked stocks for each industry subsector that CFRA analysts rate the highest. For example, he chose Caterpillar in construction materials; Lam Research in semiconductor equipment; Walgreens Boost Alliance in drug retail; MetLife for life and health insurers; United Parcel Service for air freight and logistics; and Exxon Mobil for integrated oil and gas. Exxon, for instance, was down 12.8 percent since the beginning of the month, and it was up about a half percent Monday.