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Why Are Investors Piling Into These 4 Stocks Today?

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At a time when the energy markets are still on edge after OPEC’s December 4 decision to keep oil lower for longer, and with the S&P 500 barely in the green today, shares of Dow Chemical Co (NYSE:DOW), E I Du Pont De Nemours And Co (NYSE:DD), Kinder Morgan Inc (NYSE:KMI), and Freeport-McMoRan Inc (NYSE:FCX) are surging. Let’s find out why investors are piling into these four stocks this morning. In addition, let’s also examine what hedge fund sentiment has to say about each of them and their long-term prospects.

Why do we track hedge fund activity? From one point of view we can argue that hedge funds are consistently underperforming when it comes to net returns over the last three years, when compared to the S&P 500. But that doesn’t mean that we should completely neglect their activity. There are various reasons behind the low hedge fund returns. Our research indicated that hedge funds’ long positions actually beat the market. In our back-tests covering the 1999-2012 period hedge funds’ top small-cap stocks edged the S&P 500 index by double digits annually. The 15 most popular small-cap stock picks among hedge funds also bested passive index funds by around 53 percentage points over the 38-month period beginning from September 2012 (see the details here).

First on our list are two global chemical companies, Dow Chemical Co (NYSE:DOW) and E I Du Pont De Nemours And Co (NYSE:DD), whose shares are up  by 11% and 10.9% respectively, on the news that the two will announce a merger tomorrow. If regulators approve the deal, the merger of equals will create a $90 billion-a-year Goliath in the chemicals industry, with a market capitalization easily in excess of $100 billion. According to the Wall Street Journal, Dow Chemical CEO Andrew Liveris will be Chairman of the new company, while E I Du Pont De Nemours And Co (NYSE:DD) CEO Edward Breen will be the CEO. Although the terms of the deal haven’t been released, investors are buying the two stocks because there is plenty of overlap between the two companies. The overlap and additional pricing power to be gained should unlock synergies that will make the combined company substantially more profitable. Because of today’s rally, shares of Dupont are now well in the green year-to-date, while shares of Dow Chemical are up by over 20% since January 1.

Among the big winners of the deal is Dan Loeb‘s Third Point, which owned 23.5 million shares of Dow Chemical as of September 30. In 2014, Loeb wrote that Dow Chemical was under-earning its potential by $2.5 billion in EBITDA annually because the global chemicals producer was too focused on making downstream products rather than maximizing profits. Loeb called for Dow management to cut costs and divest its lower-margin divisions, which Dow management has subsequently done. If Dow merges with Dupont, the combined company will have even more cost cutting opportunities that will increase EBITDA further.

On the next page, we examine the latest news concerning Freeport-McMoRan Inc and Kinder Morgan.

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