Sweet and Lowdown

In a column posted nearly three weeks before the Nov. 20 market low, I wrote the following:

We're at a particularly dangerous juncture in the market. We're about to split and go our separate ways. Recent homogenous performance (uniformly ugly) will go to the wayside, to be replaced by unusually wide performance spreads.

Then, about one week before the market low, I followed up with:

The bounce in the next cycle will produce disparate gains in stocks -- gains that range from modest to mind-boggling.

The evidence since Nov. 20 unequivocally points to a massive performance disparity among stocks. There's an underlying symmetry here that's beautiful to behold: The stocks that were ravaged the most in the mega-bear market are also the stocks that have bounced the most.

The stocks that I panned as "wet-noodle" stocks, destined to underperform, have barely budged during the recent bounce, with General Mills (GIS - commentary - Cramer's Take), Johnson & Johnson (JNJ - commentary - Cramer's Take) and Kellogg (K - commentary - Cramer's Take) up by only 4% to 6%. On the other hand, the 13 stocks I suggested as buys in past columns, which included Expedia (EXPE - commentary - Cramer's Take), Overstock.com (OSTK - commentary - Cramer's Take), CarMax (KMX - commentary - Cramer's Take) and Brunswick (BC - commentary - Cramer's Take), have bounced by 13% to 147% since Nov. 20, with an average bounce of 50%.

Let's walk through the strategy involved, because I expect it will generate exceptional performance over the next couple of years. Start with this historical fact: Bear markets are followed by rebounds that retrace 50% to 100% of the decline within two years of the low.

There are three important implications here:

1. Since the market does not retrace 100% of a bear market decline instantly (or even within a matter of months), we can safely conclude that the stock market was right; stocks, in fact, merited a discount.
2. Even though the market was correct in applying a discount, it invariably overdoes it. If the market did not overplay its hand, stocks would go down and stay down, but, without exception, the market always bounces.
3. It's important to recognize the symmetry pre- and post-bear market -- namely, baby bear markets beget baby bounces, and big bear markets beget big bounces.

Applied to the individual stock level, the above truisms hold up. Stocks deserved to be discounted in the face of a particularly difficult economy, but the decline was excessive. Remember, the value of a business equals the net present value of its cash flows over the long-term, not its cash flows over the next quarter or two.

Most important, the symmetrical relationship that the rebound shares with the decline facilitates finding the big winners in the next cycle. Kellogg barely got nicked in the mega-bear market just past. A 50% retracement of its itsy-bitsy decline will get you an itsy-bitsy profit. On the other hand, Office Depot (ODP - commentary - Cramer's Take) shares fell from $20 to $2. A 50% retracement of the decline, to $11 per share, amounts to a 450% return.

---

At time of publication, Alsin and/or ACM was long Expedia, Overstock.com, CarMax, Brunswick and Office Depot, although holdings can change at any time.

Arne Alsin is the founder and principal of Alsin Capital Management, a California-based investment adviser. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Alsin appreciates your feedback; click here to send him an email.