May 2, 20232 min read

HEDGED DEEP VALUE BASKET-PROFIT FROM BOTH SCENARIOS

HEDGED DEEP VALUE BASKET-PROFIT FROM BOTH SCENARIOS

Investors face a predicament that they may not have seen before. Many investments are heavily exposed to the S&P500. As TPA has explained many times, the S&P500 is now inordinately tied to a small number of large TECH stocks. The table below shows that TPA’s BIGTECH index makes up over 28% of the S&P500. TPA’s BIG TECH Index is the top 8 stocks in the Nasdaq 100.

Due to the heavyweight of BIGTECH in the S&P500, investors could face a lose-lose scenario.

The two scenarios are:

1. There is a real economic recovery. If the U.S manages to get Covid-19 under control, businesses can really reopen, and the economy recovers quickly, the stocks that will rally the most will be the non-BIGTECH stocks. Investors have already piled into BIGTECH. When the economy recovers, they will look for beaten-down stocks. BIGTECH will then become an underperformer as investors buy beaten-up areas of the market. However, since BIGTECH is 28.6% of the S&P500, the underperformance of BIGTECH will be a drag on the benchmark index.

2. If Covid-19 cannot be brought under control and the economic situation worsens. Investors may finally decide that BIGTECH is overvalued and may also suffer from a prolonged economic downturn. Some investors may seek safer havens of cash or bonds and sell BIGTECH.

TPA proposes that investors buy a basket of 10 value stocks versus the SPY (the S&P 500 ETF). The 10 value stocks are KSS, CCL, L, PRU AFL, TFC, RGA, AIG, AVT, and GM.

These stocks share the following characteristics:

1. Value – each stock is trading at a discount to their Book Value. The average Price to Book Ratio is 0.67 or 67% of Book Value.

2. Down a lot 2020 year to date – the stocks are down between 27% and 69% YTD while the SPY is up 1.02% YTD. The average YTD performance for the basket is -40.84%.

3. Heavily shorted – the basket stocks have high short positions, with an average short interest ratio (days to cover) of 2.25 days average daily volume. If the economy can recover and the market rallies, shorts may be forced to cover, which will cause an accelerated rally for the basket stocks.

The hedged basket of value stocks may be the solution for both scenarios above.

1. If the economy recovers, these beaten-up stocks should outperform the already well-owned BIGTECH stocks, which already weigh heavily in portfolios, and the S&P500, which is overly exposed to these 8 stocks.

2. If TECH stocks are sold in an overall sell-off, investors who hold these beaten-up value stocks, will be less exposed.

TPA provides charts below for the Value Basket, the Value Basket/SPY ratio, and each of the value basket stocks. All the charts point to technical upside for the Hedged Deep Value trade.