Investing strategies for 3 future market scenarios

Will stocks head higher, hit a lull or move into a correction? Here are some ways to handle any outcome.

By Zacks.com Oct 25, 2013 4:13PM

Dice on stock listings © Kate Kunz/CorbisBy Kevin Cook

 

The rising tide of the 2013 bull market has lifted most boats, but some strategies that trounced the index are also ready for what might happen next. Here are three possible scenarios:

 

1) Big year-end rally that takes the S&P 500 to 1,800 and higher into Q1 2014


2) Volatile, sideways action in a range between S&P 1750 and 1600


3) Big correction that takes out the June lows at S&P 1560


I'm going to tell you about a strategy that did very well in the first three quarters of the year -- more than doubling the 20% return of the S&P 500 -- and that could very well continue to outperform for the next year.

 

More gains ahead

If scenario #1 is the most likely outcome, the reason is that it's supported by both the fundamental and technical backdrops. Fundamentally, the economy is growing sufficiently to keep recession at bay and the Fed is "on our side." These are two of the biggest factors that attract money into stocks, along with corporate earnings.


Speaking of earnings, the S&P is on its way to another record year. And with big macro worries about Europe, China and Washington once again on the sidelines, my favorite line from January is still true: money managers are heads down picking stocks.


So I am sticking with the strategy that got me here, where I "follow the money" of institutional portfolio managers -- those running $100 million or more -- as they pile into growth stocks. By matching the earnings momentum of Zacks Rank #1 (Strong Buy) and Zacks Rank #2 (Buy) stocks against a database of SEC 13D-G institutional filings, I can screen for stocks that are about to move big.


While I can't buy every stock I find that meets these two criteria, what I get is a solid list of names to do some homework on. I pour over the analyst reports to find out why they are raising estimates and I try to see what the institutional buyer saw that made him or her plunk down enough cash to amass a 5% stake in the company. More on this strategy and some of the successful picks in moment.

 

Home on the range scenario

Markets are all about investing under uncertainty. And few markets are more uncertain that the ones gyrating back and forth in a volatile range, as bulls find that "buying the dips" has become more challenging and bears believe that finally they have the BIG correction they've been predicting.


But do you know what professional money managers like Steve Mandel of Lone Pine Capital, or the many funds of BlackRock, or even Carl Icahn do? First, they check to make sure the fundamentals are still in place that warrant a bull market vs. a bear market.


Then, they keep focused on picking exceptional stocks that others are irrationally selling because these investors look out past the volatility to what they see as the true and fair value for their investments that will be realized over time.


Now this is where my screening gets a little trickier because I am using the Zacks Rank, a short-term earnings momentum model, against the longer holding periods of the "whales" of the stock market, my name for the institutional investors. For this, I simply try to make sure I am buying in the lower end of a value range by some combination of technical opportunity or timing opportunity.


Often the timing opportunity is simply being very quick as soon as I see the "whale" announce his or her position. Other times it means waiting until the stock comes back a bit. In either case, it has led to many 20%+ winners for the portfolio. One of my best sector/industry plays this year has been biopharma and biotech. As you probably know, this area also outperformed the broad market by more than double.


With solid gains in names like Alnylam Pharmaceuticals, Medivation and Jazz Pharmaceuticals, I have tried to capitalize on the long-term trends in healthcare and medicine that are definitely on the radars of the whales. In a sense, I am using their superior research teams and their capital to make outsized gains for my customers.


Other sectors and industries where this has worked terrifically are Retail, Energy and Technology. Remember, in the era of QE, money rarely leaves the market and goes to cash. It simply rotates to the next hot area.

 

What if the big correction comes?

This is the scenario that every investor fears the most, and none of us can predict. All we can do is play the odds. What I do is assign probabilities to potential outcomes. And right now, this is the least likely scenario.


Among our 3 scenarios, I am currently at a 60% chance of #1 (Bull Charge Continues), a 25% chance of #2 (Big Sideways Range) and a 15% chance of #3 (BIG Correction). Even the largest asset manager on the planet, BlackRock, recently said that the market is "fairly valued." But does this mean they are selling all of their stocks and advising their clients of the same?


Of course not. They are stock-pickers. They know they can outperform a frothy or fairly-valued market by picking the best growth opportunities.


But if a big correction does become more likely, it doesn't mean you run for the hills either. The whales certainly aren't doing that. After they sell some of their big winners, they are buying new stocks on the way down. And if you've ever experienced a several month correction or a bear market before, you know that they are full of violent 2-3% rallies where individual stocks can move 5% to 15%.


Bottom line: You want to be positioned for those rallies by getting into great stocks that the whales love -- when they are on sale. All this requires is having a formula and the discipline to follow it.


My edge is not that I am the greatest stock picker in the world. But I know how to follow some of the best and overlay my own "margin of safety" parameters.

 

Kevin Cook, a Senior Stock Strategist at Zacks, is a recognized authority in global markets and noted for predicting and tracking the movement of smart money.
 
To read this article on Zacks.com click here.
 

6Comments
Oct 26, 2013 12:14PM
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If the Fed holds, most likely,  then the market can go up with rotation as year end tax selling and windows dressing takes place. Apple's earnings on Monday coupled with Fed mid week will set the stage for November. January could be really tricky with another budget and debt battle looming.
Oct 25, 2013 8:15PM
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Didn't really see much mentioned about Politics in the article, little blurb about Fed?

 

But somewhat true Jeffishere, Markets fair better historically under Democrats than Republicans.

Oct 25, 2013 6:15PM
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The more certain Folks complain about Obama, the More Record Highs the Markets have made. Here's the Reality, The Makeup up of Congress has little to nothing to do with if the Markets will Rise or Fall. The same can be stated for the White House. The Government is an Bought and Paid for Entity that serves the interest of Mega Global Corporations. Ditto for the FEDS. If and when the Markets do fall, and they will, it will because the always fall at some point. We here in the Real World call them Cycles. Just as Economies move in and out of Boom and Bust Cycles.

Stocks don't offer protection for anything, they offer Profit Potential. Unless you are some expert in Options, you won't get any protection just by buying stocks.

The next important economic question is whether Corporations will begin paying Workers a Living wage as opposed to only Rewarding the Barking Dogs. If they keep the status quo, expect near Zero Growth or a depression. The 1% can't continually leech off the 99% and expect the economy to Recover.

Oct 25, 2013 5:08PM
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That depends on the future makeup of Congress...  If the Democrats win, sell everything and convert it to foreign currency and gold.   Before the socialist confiscate it.   

The next most important economic  question is Obozocare.  If it stays, expect near zero growth or a depression.

After that the economy  will recover in 3 years when the imbecile '57 states' is gone.

Stocks offer protection  against the Fed's money printing.  Especially foreign investments.
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