May 24, 2022

In a ‘baby with the bathwater’ market, here are a dozen unfairly punished stocks, ripe for a bounce

By Barbara Kollmeyer

Critical information for the U.S. trading day

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Another equity selloff is brewing as a warning from Snapchat’s parent has triggered broader panic, with fears Snap is the next canary in the coal mine for tech.

Or it just may be another excuse to sell Monday’s rip, a strategy Bank of America recently advised as it believes full capitulation is some ways off.

Getting knocked down along with tech stocks this year have been the smaller companies, which are pricing in a “nasty recession and decline worse than many bear markets,” notes a team of Jefferies strategists led by Steven G. DeSanctis.

The Russell 2000 (RUT) is down 20% year-to date, not too far off a 26% drop for the Nasdaq Composite (COMP). Much like the Nasdaq, the Russell is in the grips of a technical bear market, down 26% from a November 2021 all-time high.

“It just keeps getting worse for small-caps with performance from the peak worse than the average recession and even worse than the average pullback. This has pushed our absolute valuation model back to fair value when just 15 months ago it was in the 100th percentile,” DeSantis tells clients in a note.

Jefferies notes its relative valuation model is now at levels not seen since 2003. While it has been waiting for another shoe to drop — in the form of earnings estimates following gloom from retailers — that has yet to happen. DeSanctis said the team is seeing as many upward as downward revisions in the sector, and it was probably “too aggressive” in cutting its 2022 Russell year-end target to 2080 and earnings growth to 13%.

In our call of the day, the Jefferies team argues that this hard-hit group of stocks has been unduly punished by a “baby with the bathwater” reaction by investors. And the team offers a dozen or more stocks it thinks could be poised for a bounce.

That isn’t all sectors of course, and Jefferies is steering clear of secular growth, as estimates keep falling. Cyclicals are a different story. Exiting a bear market, “these stocks hang with growth, they continue to see better revision trends, and ’22’s estimated growth now stands at over 18%,” said DeSanctis.

Neither is the team leaning toward bond proxies such as defense stocks. “Valuations are well above their long-term averages, driven by big inflows into these sectors, and of course, the group tends to lag when the bear goes back into its cave,” the team says.

And don’t bail on stocks with overseas exposures, as the team thinks China is closer to ending lockdowns (even though Beijing had some gloomy COVID-19 news this week), with plenty of resources to stimulate their economy. “We think this could be like the second half of 2016 when higher overseas exposed names beat the index by over 6% in the back half of the year,” said DeSanctis.

As for the buy-rated names, the team has 14 that have “fallen harder than the index, but did not miss numbers nor see a cut in their estimates.” At the top are Sonos, DraftKings, Aptiv, Floor & Decor and Coty.

Here’s the full list:

FactSet, Jefferies

Opinion:
‘I feel like I am reliving the summer of 2008.’ Strategist David Rosenberg sees bear market sinking the S&P 500 to 3,300.

The buzz

Snap (SNAP) is slumping 30%, after the social-media group said it would likely miss quarterly estimates due to a “further and faster than anticipated” deterioration of the economy. It is also hitting the rest of the internet sector — Facebook
parent Meta Platforms (FB), Pinterest (PINS), Alphabet (GOOGL) and Twitter (TWTR).

Fed Chair Jerome Powell later is due to give remarks at a Native American development conference at 12:20 p.m. Eastern Time, with new home sales due at 10 a.m. Eastern.

Meeting with big financial institutions, the People’s Bank of China and China’s banking regulator urged lenders to “go all out to stabilize the fundamentals of the economy.” JPMorgan and UBS have both downgraded China’s economy recently.

Best Buy (BBY) and Nordstrom (JWN) will report ahead of the open, followed by Intuit (INTU) and Agilent Technologies (A) after the close.

The markets

FactSet/MarketWatch

Stock futures (ES00)(YM00)(NQ00) are pushing lower, with bond yields (TY00)(BX:TMUBMUSD02Y) also drifting south, oil prices under pressure and the dollar (DXY) getting some bids, along with gold (GC00).

The chart

The latest in the hunt for stock-bottom rationale comes from Stifel’s chief equity strategist and veteran market watcher Barry Bannister, who says he is watching for deteriorating corporate credit to signal further stock downside.

“Tighter financial conditions have unwound the froth, but corporate credit is the downside risk, and upside needs a Fed pause,” he tells clients in a note.

Bloomberg/Stifel