NEW YORK (Real Money) -- When basketball players are out of position they get taken to the cleaners. When football defensive backs cover the wrong man they get toasted. When baseball players play the ball wrong, they can cost you the whole game.
On Thursday, you saw what happened when portfolio managers got stuck with the wrong stocks and had to adjust or rotate, lest they fall behind the averages.
For much of the last month I have been focused on the giant sea change that I said portfolio managers do not yet see coming -- the sea change out of the shares of companies that benefit from a strong dollar and into ones that thrive when other currencies get stronger. This is that broad rotation out of domestic safe havens like retailers and restaurants and rails into the big international companies that are headquartered here, but have a huge amount of sales overseas.
I feared that when the portfolio managers realized that they, like pro defenders that are radically out of position, their moves to correct would be vicious and punitive to the domestics and heavenly for the internationals. That's just what's happening.
Why is it occurring and how do we profit from it? First, understand that it is occurring because the rest of the world's become stronger while we have stayed the same or become weaker. Europe, in particular, has turned quickly after its central bank changed the rules and took interest rates down so low that money had to either go into the stock market or into projects that good give you a much better return.
Both are bullish for the real economy, either through the wealth effect or because of stepped up lending. We saw that in this country when our central bank executed a similar game plan.
In the last month we have seen so much good news out of France and Italy and Spain, that you have to acknowledge the turn. That's why the European stock markets have double and triple the return of our averages.
Strong economies act like magnets. You want their stocks and you want their currencies.
So few portfolio managers saw this coming, though, that they totally ignored the move. They overlooked the bottom in the euro as witnessed by the ETF that goes by the CurrencyShares Euro ETF (FXE). That was the bottom that occurred when the euro didn't take out its low back in April 13.
At the same time they ignored that the data showed our own economy slowing, largely because our own goods became too expensive for the world because of that strong dollar.
Expectations got lofty for the domestic stocks during this whole period, and they got reduced for the internationals in part because so few people thought the bounce in the euro could last. It made sense. We just got through an earnings period where the companies that sell overseas had their numbers cut and cut radically while the safe haven domestics shot the lights out. It all made sense.
Now, it is all reversed. Analysts cut estimates so low for the international companies, in part because of a stronger dollar forecast and in part because of economic weakness overseas. But with the dollar reversing and with those overseas markets getting better, now those lowered estimates could get trounced.
So portfolio managers need to buy the international companies and they need to buy them ahead of others in order to beat the averages. If they have fresh capital they can just buy the internationals. Most don't though. They have to sell the stocks of the domestic safe havens that they loved so much to raise the capital.
There initially didn't seem to be a lot of urgency to the rotation. In fact, many of the stocks of the pure-American companies either flat lined or meandered a bit lower.
Until this week when we started to get some really poor numbers, first in the aggregate, like weaker retail sales, and then in the specifics, like weak rail numbers -- pure domestics of course-and now in actual shortfalls from the very companies that had been so rewarding for so long like Macy's (M) Wednesday and Kohl's (KSS) Thursday.
Macy's certainly missed but I thought it had a fairly good justification for it, namely weather, a port strike, fewer tourists mainly to its important flagship store and some execution issues. Kohl's? This stock has been a remarkable performer, and the third largest retailer shocked us when it said that business was "modestly below" expectations.
The Street thought they were going to crush the numbers, which is how you get a nine dollar decline from a lofty $74 level. Is that an overreaction? Of course. Rotations almost always overshoot, however, and they take out even companies that are doing well, like Costco and Jack in the Box.
Who knows how, for example, Ross Stores (ROST) and Target (TGT), an Action Alerts PLUS holding, are doing as they haven't spoken of late. Let's just say we are now in a shoot first ask questions later phase of retail and restaurants.
Do you have to throw these stocks out along with the rotators? I don't think so. That's shortsighted. You have to be able to take some pain if you own these stocks, though and the pain tends to last more than a day or two.
How stark is this move? Consider the stocks of UnderArmour (UA) and Nike (NKE). The former put up tremendous numbers but is largely domestic. The latter put up very good numbers, I could argue not as good as UnderArmour. The stocks, though? UnderArmour can't get out of its way while Nike's been red-hot. That's just how it is.
Or look at how the stock of internationally oriented Domino's Pizza (DPZ) has done against the stock of Jack in the Box (JACK), which reported tremendous numbers but is constrained by its domestic focus.
Now I think that we are still early in the move to the internationals. So many companies, especially in technology, but also in drugs and goods, generate a huge amount of profit overseas and yet are well below where they could go.
Consider IBM (IBM) which had an okay quarter that was totally trashed by the strong dollar. It is well off its highs. Or Eaton (ETN), PPG (PPG) and Dow Chemical (DOW), all of which have been penalized severely by their lack of competition because they were stuck with selling goods that became too pricey because of that darned greenback. The stocks of these companies could soar. Same with Boeing (BA), which has to go against Airbus, which has planes priced in undervalued euros. A leveled playing field could get Boeing, which is at $147 back to $158, its all-time high.
In the soft goods and health care segments Merck (MRK), Johnson & Johnson (JNJ), Pfizer (PFE), Gilead (GILD) and Celgene (CELG) have been hurt by an overvalued dollar. Same with Pepsico (PEP) and Hain Celestial (HAIN). Their stocks have more room to run.
In the hard goods category, consider Deere (DE), Caterpillar (CAT) and Cummins (CMI). They could all break out. Or may I suggest the defense stocks, Northrop Grumman (NOC), Lockheed Martin (LMT) and General Dynamics (GD) as others see the United States withdrawing from the market policeman role, and these companies are beginning to get big orders.
The most logical place to go, though? Technology. The three that come to mind that could be radically revalued: Apple (AAPL), Google (GOOGL) and Facebook (FB), three names for Action Alerts PLUS.com. These have all been stalled out even as I could argue they all had excellent quarters. The currency headwinds, however, blunted sales pretty dramatically. Now, I think the estimates will be way too low. All three I believe could romp here, along with Cisco (CSCO), which shouldn't even be down after last night's excellent quarter except it had already run into the number.
Again, remember, rotations are vicious. We don't know when they will end. We don't even know if the dollar will stay weak or that Europe will continue to be strong. Nevertheless, I believe in the sea change and I think these moves are still ongoing.
It's still not too late to take action on the winners, even as I admit that I am loath to sell the losers if only because many have become too cheap already!
Editor's Note: This article was originally published at 4:04 p.m. EDT on Real Money Pro on May 14.