Lower-Risk Stocks Could Be Ready to Run after the Recent Pullback

By TradeSmith Editorial Staff

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It has been a lousy start of the year for the stock market, no two ways about it. The S&P 500 is down about 6.6% from its all-time high in early January. And the blue-chip index was down more than 12% at its low point two weeks ago.

But last week, stocks staged a strong reversal to the upside. The S&P 500 jumped 1.5%, posting its best weekly gain so far in 2022.

The catalyst: strong earnings reports from several blue chips, including Amazon (AMZN), Alphabet (GOOGL), and UPS (UPS). S&P 500 fourth-quarter earnings reports have been solid so far. And that’s helping to counter investor concerns about rising interest rates and inflation.

We are just past the halfway point in this earnings reporting season, with 56% of S&P 500 companies having already posted their results as of last Friday. And even though the numbers look good so far, investors aren’t giving the results much credit.

Even the best of results are not being rewarded.

The good news is that so far, 76% of S&P 500 companies have beaten Wall Street earnings estimates on the bottom line. And 77% of them have beaten top-line revenue estimates as well.

The bad news, as you can see in the chart above, is that investors aren’t rewarding the companies reporting upside surprises.

Typically, when companies beat both their sales and earnings estimates, their stocks see an average gain of 2.36%, according to Bespoke Investment Group data going back over the past 10 years.

But so far this year, stocks posting a double surprise are up only 0.15%. In other words, these stocks are barely moving despite surprisingly strong sales AND profit results. I chalk that up to investor skittishness after the recent market pullback.

Many of the hardest-hit stocks over the past month are growth companies that typically have strong financial results. But with the threat of higher interest rates just around the corner, investors are simply not willing to reward growth stocks with higher valuations.

Overall earnings estimates for the S&P 500 are still trending higher for 2022. But the rate of change in the sales and profit estimates is slowing. And that is making investors very cautious.

So, what’s a good antidote to rising market volatility and a cautious climate?

TradeSmith subscribers can use our exclusive screening tools to find stocks that offer lower-risk entry points, specifically our Low Risk Runners strategy.

When a stock triggers a new Entry Signal by entering the Green Zone, we know that this is the best time to get into a stock. But our research also shows that when a stock moves from the Yellow Zone into the Green Zone, it is likewise a great potential buy signal. The reason is less risk.

Stocks that make the grade as Low Risk Runners have already started solid uptrends. They have then pulled back in price just enough to still be interesting, but not so much as to be in the danger zone.

A stock in the Yellow Zone is still within its normal range of volatility, but it has only half the downside risk compared to a stock that has just entered the Green Zone for the first time. To illustrate, here’s an example from a few years back.

Coincidentally, the Federal Reserve was also hiking interest rates back in 2017. And investors were getting nervous about higher rates, same as they are now.

In the chart above, you can see that semiconductor giant Intel Corp. (INTC) was a terrific example of a Low Risk Runner. The stock triggered a new Entry Signal in August 2016. After that, INTC re-entered the Yellow Zone three times and each time bounced back into the Green Zone.

By entering the INTC trade when it showed up on our Low Risk Runners screen, there was only a 9% risk of being stopped out (in the Red Zone), rather than the full 17.4% risk based on INTC’s Volatility Quotient (VQ).

And because INTC was within its normal range of volatility, it was no surprise to see it move higher in a short period of time. From July 2017 to May 2018, the stock was up almost 60%, compared with a gain of just 12% for the S&P 500 index.

Here are a few of the things we look for to identify a Low Risk Runner:

  1. The stock has recently moved from the Yellow Zone back into the Green Zone.
  2. The stock has an average VQ less than or equal to 40%, meaning it’s a lower-volatility stock.
  3. The stock must be trending up, or at least moving sideways. No down-trending stocks make the cut.
At the start of this week, I used our screening tools to search for large-cap stocks that met our Low Risk Runners strategy. The screener alerted me to 23 stocks that fit the bill as potential buy candidates right now.

The majority of these stocks are well-recognized blue-chip stocks, including Johnson & Johnson (JNJ), JPMorgan Chase (JPM), and Pfizer (PFE).

An added plus is that all these stocks pay generous dividends, ranging from 2.44% for JNJ up to 2.96% for PFE. And low-risk stocks that pay current cash dividends are a great way to help protect yourself in turbulent markets.