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Why Leaders Emerge Out of Bear Markets First

·4 min read

“When the time comes to buy, you won’t want to.” – Walter Deemer

While bear markets can be painful, they are a necessary part of the economic cycle that pave the way for the bull markets that will inevitably follow. Right about the time the market is nearing a bottom, most investors have experienced substantial declines in their portfolios. These losses instill a degree of fear that renders them unlikely to buy after the market has been steadily declining.

At market bottoms, we tend to see consumer sentiment at historic lows. We also normally see a very low percentage of stocks trading above their 200-day moving averages. And as we can see below, the percentage of S&P 500 constituents trading above their respective 200-day moving averages is nearing lows that have coincided with previous market bottoms:

StockCharts
StockCharts


Image Source: StockCharts

Market leaders typically emerge first out of a bear market. Most investors find it difficult to pull the trigger as these leaders appear to be trading too high or too expensive. So they wait, only to become frustrated over time that they didn’t buy sooner. While we aren’t quite there yet, now is the time to do your homework and identify which stocks are beginning to build bases. These stocks will start to make higher highs and possibly even find new ground on the way back up – much earlier than the major indices will.

Bear Markets Create Opportunity

The top-performing stocks will be ahead of the broader market averages at significant turning points, such as the shift from a bear to bull market. Leaders emerge out of a bear market by hitting their lows first, before the indices put in their major low. The stocks that hold up best throughout the down move and start to gain momentum (even as the indices continue to fall) are the companies we want to target for bullish positions.

Another confirmation sign we can look to is if a stock is hitting a new 52-week high as it outperforms the market. Few investors have the fortitude to buy stocks near new highs, when in reality these are the stocks that are most likely to continue to outperform. Most of the stocks that have been hitting 52-week highs this year are energy-related stocks, but it appears many of those companies are extended and have been taking a breather recently. Let’s look elsewhere to see what may lead as we head into the second half of the year.

The Zacks Retail – Jewelry industry group is currently ranked in the top 21% out of approximately 250 industries. Because it is ranked in the top half of all Zacks Ranked Industries, we expect this group to outperform over the next 3 to 6 months. Also note the favorable valuation for this group:

Zacks Investment Research
Zacks Investment Research


Image Source: Zacks Investment Research

Historical studies have shown that roughly half of a stock’s price movement can be attributed to its industry grouping. By focusing on stocks within the top industries, we can dramatically improve our odds of success.

Envela Corporation (ELA)

Envela Corporation (ELA) is a leading stock within this industry. Envela buys and sells jewelry products to individual customers, dealers, municipalities, and other domestic organizations. Its products include fine watches, bridal and fashion jewelry, diamonds, and gemstones. ELA also buys various forms of precious metals. Envela Corp. was incorporated in 1965 and is based in Irving, TX.

ELA has surpassed earnings estimates in each of the past four quarters. The company most recently posted Q1 EPS last month of $0.10, a 100% surprise over the $0.05 consensus estimate. ELA has delivered a trailing four-quarter average earnings surprise of 45.83%.

Zacks Investment Research
Zacks Investment Research


Image Source: Zacks Investment Research

Notice how ELA has been making a series of 52-week highs. The stock is up 51.8% this year while the major indices are in a bear market. Growth looks set to continue for this jewelry company as estimates call for a 13.51% increase in EPS ($0.42) relative to last year. Make sure to keep an eye on ELA as the stock continues to outperform.


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