What Really Drove Last Thursday’s Rally?

It was great to see the stock market stage such a huge comeback last Thursday. Part of the strength certainly came on the heels of an announcement that the U.S. and China were tapping the brakes on their trade spat.

But underneath the surface, there was something much more interesting driving the rally: low-quality stocks.

In other words, a “mean reversion” crap rally.

This is when investors buy weak stocks with little upside that might pop briefly, rather than stocks with strong momentum and plenty of future upside. So, these low-quality stocks were being propelled higher by buying pressure from index funds and ETFs, as well as some short covering.

In fact, according to Bespoke Investment Group, the worst-performing 50 stocks from the market’s last all-time high are the best-performing stocks recently. Just take a look at Bespoke’s chart below.

Bespoke Chart

Clearly, many investors are viewing the bargain prices in these low-quality stocks as a good buying opportunity. So, it’s no surprise that many of the D- and F-rated stocks in Portfolio Grader rallied, too. You can see in my example below.

F-Rated Stocks

California Resources Corp. (CRC), Renewable Energy Group, Inc. (REGI) and Whiting Petroleum Corporation (WLL) were up 10%, 7.8% and 8.5%, respectively, on Thursday. However, prior to that, the stocks had fallen by double digits. Since the close on January 2, 2019 to last Thursday’s close, CRC dropped 45%, REGI dropped 48.2% and WLL has tanked 67.5%.

In comparison, the S&P 500 is up 18.6%, the Dow is up 14.5% and the NASDAQ is up 21.8%. Clearly, even with Thursday’s pop higher, these stocks are significantly underperforming the stock market.

The weak performance of these three stocks isn’t surprising, as they all receive F-ratings for their Quantitative and Fundamental Grades, making them strong sells.

And while they might be experiencing a little fun right now, come October, I expect that party to come to an abrupt end. “Crap” stocks cannot float very long. Fundamentals simply cannot be ignored forever.

In my system, an “F” stock is still an “F” and a strong sell no matter how the market rallies over any particular time period.

I expect third-quarter earnings season, which will kick off in October, to right the ship. The “smart money” will go back to investing in high-quality stocks. This is great news for my Breakthrough Stocks, as they are all fundamentally superior, with strong earnings and sales momentum and see excellent buying pressure to keep them moving higher over time.

My Breakthrough Stocks are characterized by 26.6% average forecasted sales growth and 27% average forecasted earnings growth. So, I expect many of my Breakthrough Stocks to break out once earnings season returns.

This makes it all the more important to invest now. The next best buying window is on September 16. After that, a buying window won’t open until the third-quarter earnings season. So, if you want to get into position for any post-earnings rallies, now is the time to do it. I just released a new buy and my Top 5 Stocks for September in last week’s September Breakthrough Stocks Monthly Issue, which will give you plenty investment ideas to get started with. Click here for all the details.

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