When a stock price makes a new 52-week high or low it is usually a sign of a strong trend. Going against the flow at these times is fraught with danger for investors betting for a sudden change in direction.

That is because share prices tend to overshoot. Behavioural scientists have shown that investors overreact to bad news and underreact to good news.

When bad news comes investors often sell for emotional reasons rather than rationally looking at how the fundamentals of the business (profit, cash flow, market position etc.) have been impacted by the news.

This is particularly the case when a stock holding is making a loss. In fact, studies have shown that the mental pain associated with paper losses is indistinguishable from physical pain.

Investors who have the fortitude and patience to see through negative news flow and focus on the fundamentals can unearth long-term buying opportunities among stocks trading at 52-week lows.

Although just because a stock is trading at a new 12-month price low does not automatically mean it is trading below what it might be worth. In other words, creating a 52-week low screen is just the starting point for further fundamental research.

But be mentally prepared because buying stocks with weak price momentum is tough and as mentioned at the start of the article, there is nothing to stop further price weakness. Timing the absolute bottom is nigh on impossible, but one thing to watch for is when a stock price rallies on bad news. This may indicate most the bad news has been discounted.

WHAT ABOUT 52-WEEK HIGHS?

Just as investor’s emotions can get in the way of rational thinking when bad news appears they can also impair judgment when the opposite happens. Behavioural biases are again at work. Academic research has shown that stocks making new 52-week highs tend to outperform.

The reason is because investors perceive the new high as an ‘anchor’ and become reluctant to buy, waiting instead for a cheaper entry point. This hesitation occurs even after positive news hit the wires, which in a rational world should encourage a buying mindset. Savvy investors can therefore use 52-week high screens to identify potential stocks to purchase (assuming the fundamentals stack up).

Combining 52-week highs lows can be useful in gauging overall investor sentiment. For example, it is one of seven indicators which goes into CNN’s ‘Fear and Greed’ index.

The index is designed to capture extreme sentiment and has a decent track record of pinpointing good buying and selling opportunities. It is a contrarian indicator which highlights when to bet against the crowd.

The 52-week sub-index takes a running total of new 52-week highs and compares it to new 52-week lows on the New York stock exchange. When there are many more highs than lows, it flashes greed, and it flashes fear when lows outnumber highs.

The latest reading on 20 October was flashing fear and the overall index is in fear territory suggesting a respite rally for risk assets could be on the cards. A free resource providing 52 week high/low data can be found at Investing.com. Paid for software services such as Stockopedia and Sharepad allows users to screen for shares trading close to 52-week highs/lows.

SCREENING FOR NEW HIGHS/LOWS

Each day a different list of names may occupy the new highs and lows list, so it is more practical to isolate stocks which are trading close to their lows/highs instead.

Shares has used Stockopedia software to screen for stocks trading near 52-week lows and highs. As referenced earlier when discussing the Greed and Fear Index, current market sentiment is poor with far more stocks trading near their lows than the number trading near to 12-month highs.

All the stocks in the 52-week lows table trade on a single digit one-year forward PE (price to earnings) ratio which may not be a surprise. Less intuitively eight of the stocks on the highs list also trade on a single digit PE which shows you do not always have to pay through the nose for stocks doing well.

One thing which jumps out is that HSBC (HSBA) makes the highs list while Lloyds (LLOY) and NatWest (NWG) are on the lows list. Lloyds is the UK’s largest mortgage lender and both companies are exposed to the UK economy while HSBC is more influenced by Asia as it is globally diversified.

That said, it does look anomalous given the same macro factors are affecting all banks. Asian and emerging markets peer Standard Chartered (STAN) was also trading close to 12-month highs before being clobbered after missing third quarter earnings estimates on 26 October.

While banks benefit from rising interest rates thanks to a gap between what they charge to lend money compared with what they pay out on deposits, competitive and regulatory pressures can narrow this gap and, at some point, investors start to focus on credit risk and rising bad loans.

There are other financials on the lows list including Jupiter Fund Management (JUP) which is trading not only near 12-month lows but all-time lows. Although the overall asset management industry benefits from structural tailwinds driven by increasing demand for investment services, the way those services are delivered is changing rapidly.

Increased competition from passive investing is pressuring fee income which means only the largest and truly differentiated managers are thriving. It would be reasonable to expect more consolidation across the sector in coming months.

It is not a surprise to see oil and gas companies on the highs list given the strong oil price and geopolitical uncertainties. But there are other reasons why the sector could enjoy an extended period of outperformance.

Many investors have eschewed investing in traditional energy companies in favour of companies driving the green energy transition. These are typically long duration infrastructure assets trading on high PE multiples. Their shares have suffered as interest rates have increased.

By contrast BP (BP.) and Shell (SHEL) trade on low PEs which means they are less sensitive to interest rates. Both firms are scaling back investment plans to develop new oil and gas projects. Not only will these actions reduce future supply and potentially increase oil and gas prices, but it also leaves more cash to be distributed to shareholders.

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