Investors picked up some important clues in Monday's surge. Stocks that rose even higher than the broader averages are the ones that investors will flock to in any future rallies, especially if we get a bout of profit-taking as many expect.
Strengthening equity markets might also push up interest rates for several reasons: money flows out of bond funds and into equity funds would reduce fixed income demand, and some fixed income investors may perceive that a firming market is a harbinger of eventually strengthening economic activity. We have ample room for rates to move up and still see equities as relatively undervalued, so this is not an imminent threat to any further rallies but could pose bigger headwinds later in the year.
We now know which stocks might post the biggest moves on any future sharp rallies. So if we get further weakness, and these stocks pull back, you may want to revisit them ahead of the next move. To be sure, some of the big Monday movers noted below were simply beneficiaries of a short squeeze. Yet others can be seen as prime beneficiaries of a potential economic recovery. The most obvious beneficiaries of the strong market were the banks -- both large and small. A consensus is emerging that the remedies put in place will indeed strengthen the entire financial framework of our country. Yet it's important to remember that we're still in an economic slump and economic activity beyond the stimulus could settle back into longer-term low-growth mode. At least the banks can count on a fairly broad spread between their borrowing and lending costs, so margins may rebound nicely, even if revenue trends remain weak. Some other big gainers are simply seen as generating higher sales and profits when the economy rebounds: Charles Schwab ( SCHW) was up 14% on Monday, Joy Global ( JOYG) was up 9% and Broadcom ( BRCM) was up 10%. A number of natural gas stocks also got a sharp boost, especially those that are heavily leveraged such as Chesapeake Energy ( CHK). The group is also benefiting from a perception that the falling rig count may also help the supply/demand equation. But investors should be prepared for continuing difficult news on the gas storage front as we go into the summer. It may not be a great time to let your winners ride too long.
Other stocks got a lift from short-covering: Retailers such as Charming Shoppes ( CHRS) (up 33%) were boosted as shorts were squeezed, and any changes to the uptick rule could extend those gains further. ATP Oil & Gas ( ATPG), which rose more than 20% on Monday, also had more than 20% of its shares sold short according to the most recent data.
Shares of rental car giant Hertz ( HTZ) rose 18%, perhaps on a rising sense that the companies' debt maturities in 2010 would more easily be refinanced in a better market environment. Hertz may prove to be a big beneficiary of even deeper financial distress at some of its rivals. Shares of steelmakers U.S. Steel ( X) and Nucor ( NUE) also posted nice gains, but it's important to remember that Nucor's CEO recently said that business is absolutely terrible. Shares of Nucor have rebounded nicely since those bleak comments, but it very unlikely that management's tone will quickly reverse. Nucor is a great company with solid long-term profit prospects, but expectations of sharply improving business later in 2009 seem ill-founded. In a similar vein, you should be cautious about chasing the home builders after many of them such as Pulte Homes ( PHM) and KB Homes ( KBH) moved up double digits yesterday. Housing sales activity could rebound starting in 2010, but new homebuilding activity probably will not. It will likely be some time before they are doing brisk business again as there are still so many existing homes that haven't even hit the market yet in the face of lousy demand. Lastly, solar stocks took off yesterday -- LDK Solar ( LDK) shot up 23%. This is the speculative end of the market and if investors keep embracing these types of high-beta stocks, it is probably a very good sign for small cap stocks in general, which tend to perform very well in the latter stages of economic downturns.