Hungry For A Free Lunch

Steve Strazza
December 30, 2021

From the desk of Steve Strazza @Sstrazza

"There's no such thing as a free lunch."

Many of you are already familiar with this popular market adage as it is a commonly used quip in our industry.

All it really means is that you can't get something for nothing from the market.

Have you ever bought a high-yielding stock for the dividend and rode it into a big drawdown just for them to announce they're cutting the payout?

Did you listen to a friend about a biotech stock that was supposed to rip higher on positive FDA results... but it actually gapped lower?

How about following the analyst community into a stock that was a consensus buy... until it turned out not to be?

In all of these scenarios, the investor is simply looking for a free lunch. And 9 times out of 10, these situations don't work out. There are no easy investments or get-rich-quick tricks on wall street. At least not sustainable ones. You have to put in the work.

One rule that I live by for my own investing is this: "If it seems too good to be true, it probably is."

I've learned first-hand to run from investment opportunities that don't pass the "smell test" and I believe I sleep better at night for it.

But there are definitely strategies that we can employ and proven processes we can follow to increase our win percentages and profitability. Our friends over at Stock Trader's Almanac have found a strategy they believe is so good that they even call it "Wall Street's only free lunch."

In this post, we'll discuss the strategy and have some fun by putting our own little spin on it.

The fundamental theory behind the free lunch strategy is simple. Based on historic data, NYSE stocks selling at 52-week lows on the last triple-witching session before Christmas tend to outperform the market for the subsequent two-month period.

The strategy takes advantage of the tax-loss harvesting that tends to occur in the last few weeks of the year. Ultimately, they're buying the most beat-up stocks in December and betting on a tactical mean-reversion bounce into the new year.

Many of these stocks are secular laggards and not names we want to hold for the long run. As such, the strategy looks to book gains quickly. These are trades, not investments.

Before we dive into the list, just a few quick things:

This scan identifies the weakest stocks in the market. This is in direct opposition to our traditional top-down approach, whereby we focus on buying the strongest stocks from the strongest groups.

The timeframe of this strategy is also shorter than our traditional timeframe. We're trying to make money this quarter and most of our trade ideas reflect that. The free lunch strategy is looking for dead-cat bounces in stocks that sold off aggressively into year-end so the timeframe is just a few weeks to two months. The shorter the better.

Now let's add our own flavor to the scan.

Even though we're looking at stocks making new lows, we can add additional parameters to identify the strongest names. Here are some filters we added:

  • Price is above the 2018 highs
  • One-month relative change is positive

Because tax-loss harvesting starts long before year-end, we expanded the new 52-week low filter to include any stocks that made a new low in the month of December. Basically, we're highlighting stocks that made new lows earlier in the month but recovered quickly enough to outperform the market over the past several weeks.

When we run this scan on all the US-listed equities over $1B in market cap, this is what we get:

As expected, there are a lot of tech and biotech names on the list. Some well-known large-cap names are Disney $DIS, Newmont Mining $NEM, T-Mobile $TMUS, and Uber $UBER.

The two largest credit card companies, Visa $V and Mastercard $MA also made the cut. They were some of the strongest names, and offer an excellent example of the kind of momentum characteristics we look for in long-term leaders.

We really like the fact that momentum failed to get oversold on both of these charts with the recent lows. In fact, it's been over a year since either has registered an oversold reading.

When we look at MA, there is also a bullish momentum divergence in play as the RSI-14 has made higher lows despite the lower price lows since September.

As for V, there's no divergence but it is impressive that momentum remained in a bullish regime despite a nearly 25% drawdown in the back half of the year.

Not getting oversold is a characteristic of uptrends... not downtrends. And when we zoom out on V and MA, it becomes clear that the structural trends are very much intact for these two names.

It's not often that these stocks make new 52-week lows but both did just that on December 1st. They've rebounded nicely in the time since and have reclaimed their pre-COVID highs. These levels are now offering a well-tested polarity zone to define our risk against.

We want to give these secular leaders the benefit of the doubt and buy this weakness. We can be long MA above 347 with a target of 437 over the next 1-3 months. As for V, we're long above 214 with a target of 264 over the next 1-3 months.

Let's look at one more name that stands out on the scan. Here's the mid-cap consumer electronics stock, Dolby Laboratories $DLB:

Unlike V and MA, momentum hit oversold this fall. But also unlike those two charts, DLB just hit overbought following a swift rally off its 52-week low. There was also a bullish momentum divergence in place and RSI did not hit oversold at the December lows.

When we add a failed breakdown and whipsaw at the January lows to the mix, there's a lot to like in this chart right now. While there is still overhead supply at the May highs, we have a favorable risk/reward and a clearly defined level to trade against.

We're long DLB above 88 with a target of 116 over the next 1-3 months.

These are the best setups that fit within our framework of identifying strong stocks with favorable risk/rewards, but we encourage you to look into the rest of the names on the list.

We'll also be following up this post with another scan where we'll highlight stocks with short-term pullbacks within the context of strong uptrends, so be sure to look out for that.

Notice how all three of these setups have a few things in common. First and foremost, the structural trends are all intact. These are all secular leaders and the new lows appear to be nothing more than shakeouts within strong primary uptrends when we zoom out on the charts. The other bullish characteristic is that momentum did not get oversold at the December lows. This tells us that sellers are getting tired, and these corrections are likely coming to an end.

Just to recap, while a strategy might have a great track record, there is still no "free lunch" on wall street. The only thing we can do is use the tools at our disposal to increase our odds of winning. And that's exactly what we've done here. We took a list of beat-up stocks based on a well-tested strategy and employed extra filters to find some of the strongest names that we believe are still in primary uptrends.

We can even find leaders when we're scanning for new lows! What do you think about that?

Allstarcharts Team

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