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Oversold 'Free Money' Companies Could Jump 12%

By Sean Michael Cummings, analyst, True Wealth

Investors fled one of the world's best business models last month...

Legendary investor Warren Buffett credits this type of business as "the engine that has propelled [Berkshire Hathaway's] expansion since 1967."

Buffett explained the magic of these businesses in a 2011 letter to shareholders. Here's what he said...

[This] model leaves us holding large sums – money we call "float" – that will eventually go to others.

Meanwhile, we get to invest this float for Berkshire's benefit...

When such a profit occurs, we enjoy the use of free money – and, better yet, get paid for holding it.

This industry isn't just a pillar of Buffett's investing strategy, though. It's a huge part of the U.S. economy. In fact, it generated $1.36 trillion in annual premiums in 2021.

If you haven't guessed yet... the industry I'm talking about is insurance.

In March, droves of investors bailed on insurance companies, pushing the entire industry into "oversold" status. But history tells us that flight could be setting up a year of big gains.

Let me explain...

The Nasdaq Insurance Index gives us a good idea of the insurance sector's performance. This index contains a basket of insurance companies. And it has a long history, going back to 1971.

March's banking turmoil caused a sell-off. The index plunged almost 11% between the start of February and mid-March. And that drop sent it into "oversold" territory, based on the relative strength index ("RSI")...

The RSI is a simple but useful tool for investors. It tells us if an asset's or index's price has moved too far, too fast in either direction.

Overly bullish investors piling into an asset can push the RSI above 70 – to "overbought" levels. Once an overbought setup happens, a price drop often follows.

On the other hand, an overly bearish move can drive the RSI below 30 – to "oversold" levels. And when that happens, a snapback rally is likely. These signals are especially strong once the RSI rises back above oversold levels.

On March 15, the index hit an RSI of 26 before bouncing back. Take a look...

It's easy to look at the decline in insurance stocks and want nothing to do with them. But that's not the right decision according to history.

Instead, setups like today's can lead to outperformance. To see it, I examined this index's performance after similar oversold bounces since 1971. Check it out...

Insurance stocks have been "steady Eddies" for the past 52 years. On average, they have returned 3% a year.

But buying after an oversold bounce can quadruple that gain... Similar instances have led to 4% gains over three months, 7% gains over six months, and 12% gains over the following year.

Investors have great odds of making a profit, too. Since this index's creation, its RSI has bounced from oversold levels 162 times. And insurance stocks were positive a year later 73% of the time.

Investors are fleeing insurance stocks today. But as contrarians, we see their mistake. History shows we can expect a fantastic year for these companies after the March sell-off.

Insurance companies have a well-earned reputation among the world's best businesses. Combine that with this signal, and the outcome is clear... This is a group of stocks you should consider right now.

Good investing,

Sean Michael Cummings

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