With many stocks bottoming in early March, many, included myself, were of the opinion that stocks were significantly oversold and due for a bounce in the second quarter. But I would have never expected to recover a year’s worth of losses in one quarter. That said, that is how the market behaves in periods of extreme crisis and volatility.
Even with a huge rally in stocks, the S&P 500 ended the second quarter with a year-to-date gain of 1.78%. That is a vast improvement compared to the 11% loss at the end of the first quarter, but it’s a minimal return for taking risk in the stock market.
Investors need to do better — and they can.
The aggregate return of my Top 10 Stocks to Avoid in 2009 was a negative 13.48% at the end of the second quarter. With an absolute return approach, investors would be theoretically short these 10 stocks, thus generating positive gains when covered. Obviously, with a loss of 13.48% in the first half of the year, an investor would be well on the way to a fat return at a time when the overall market is flat. I see nothing in the future to suggest a change in this approach. If anything, I think the market is overbought at the moment and is indeed going
through a short-term correction. I look for the aggregate loss of these nine stocks to be greater than 20% at the end of this quarter.
Here are the Top Stocks to Avoid:
Stock to Avoid #1 – Delta Airlines (DAL)
I take my absolute return approach to a deeper level by periodically buy and selling positions during the year. In late February, I suggested that investors cover the short position of Delta Airlines (DAL) at $6.35 per share.
In my last update of the stocks on this list, I suggested that I would still be a seller of Delta. That was wise advice as shares of Delta did indeed lose value over the last three months. This move coincided with a blast in oil prices. Airlines are already struggling (are they not always struggling?) with a weak economy and excess capacity. Rising jet fuel prices make matters worse.
Until airlines can prove profitability on a consistent basis, I would continue to avoid shares. That said, I would not establish a new short position as oil prices appear to have peaked and are now falling.
My advice: sit tight with your current short or stay out of the way during the third quarter and beyond.
Stock to Avoid #2 – Dupont (DD)
Another stock leveraged to the oil market is Dupont (DD). Because many of the company’s products are derived from crude oil, rising oil prices negatively impact profit margins. The only recourse, then, is to raise the price for consumers. But doing so in this environment is unlikely given the weakness in the economy.
As a result, the dynamics of the market are such that profits for DD will be lower in the near term. That puts the company in a bit of a Catch-22. DD needs a strong economy in order to pass along higher prices, but that strong economy keeps oil prices moving higher.
Unless there is a big increase in the supply of crude, Dupont is likely to lag the market. I would stay away from this large chemical maker.
Stock to Avoid #3 – 3M (MMM)
In looking for stocks to avoid, I look for certain triggers or circumstances that would make it difficult for an underlying company to grow its earnings sufficiently to support a higher stock price.
Given the economic crisis and global recession, I hypothesized that multinationals may suffer as a result of a strong dollar. The idea being that investors would flock to the dollar in search for safety. Over the last quarter, though, the reverse has been true.
The dollar weakened significantly as investors bet against the greenback due to inflationary spending in the U.S. As a result, the multinationals have been big winners in the last quarter.
3M (MMM) though was only up slightly in the second quarter as the company’s products failed to capture the imagination of buyers across the globe. When the dollar strengthens in the latter half of 2009, look for MMM to stumble.
Stock to Avoid #4 – Capital One (COF)
One of the smartest trades made within this absolute return portfolio was to cover my suggested sale of Capital One (COF). With a loss of more than 67% earlier this year, I said that enough was enough. And I was dead right.
Since bottoming in March, COF rocketed to $30 by early May. The stock gave back some of those gains, but still trades for approximately more than 100% of the cover price. The reason for the big gain is directly correlated to TARP and a belief that credit card companies will do better than most expect. I’m still skeptical.
While it may be true that a collapse comparable to last fall’s banking crisis is unlikely, the entire credit card industry is still in difficult territory. The world is changing, and consumer spending habits reflect that change. Rather than defaults being the big issue here, I would worry about usage instead.
Credit card shredding parties may become vogue as consumers repair personal balance sheets. And that’s bad news for companies like COF.
I would sell Capital One at these prices.
Stock to Avoid #5 – Boeing (BA)
As difficult as it can be sometimes, the best advice is to stand pat. Take Boeing (BA) for example. I recommended selling this stock on expectations of weakness in the airline industry. The idea being that planes sitting idle in the desert would be competition for new planes from Boeing. Nothing could have been clearer in my mind.
Well, for the first two months of the second quarter Boeing was on fire. BA gained significantly during that time destroying my idea that the company was a stock to sell. Ah, but time was on my side as the company announced a delay in their much-awaited DreamShip — a delay that opened the door for the airlines to cancel orders. Speculation based on that scenario slapped the stock back down to the flat line for the second quarter.
Unfortunately, the news does not get better for Boeing. There is too much capacity in the airline space, and new planes are not needed.
I would be a seller of Boeing today.
Stock to Avoid #6 – Eastman Chemical (EMN)
Similar to Dupont, I selected Eastman Chemical (EMN) as a stock to avoid due to rising input prices and low margins. It is a simple formula that cannot be broken: If a company cannot pass along higher costs, it will make less.
The market has yet to grasp that concept with respect to EMN. The stock has more than doubled since bottoming in March and has skyrocketed during the second quarter. This is in stark contrast to the poor performance at Dupont.
The main difference here with EMN appears to be mostly management-related as the company seems to be better managing expectations. Dupont has suffered due to greater exposure to the housing and auto sectors.
In my opinion, there is no real underlying reason for the big move in EMN. In fact, I would be a seller of this stock given the significant run-up.
Stock to Avoid #7 – United Airlines (UAUA)
To get an idea of how poorly United Airlines (UAUA) has performed, may I suggest viewing this little nugget.
If United is breaking guitars as accused, I would fly another airline. As an avid guitar player myself, such carelessness is unacceptable. The airline industry is struggling, and poor customer service does not help. The above video is now going viral on the Internet — what a PR disaster for the United.
Even though I recommended covering this short position, the stock continued a rapid decline in the second quarter. There is not much more room to fall on the downside. In my last update, I suggested that I would sell this stock and that opinion has not changed.
Unless United is deemed too big to fail, the company will struggle in the duration.
Stock to Avoid #8 – United Technologies (UTX)
Don’t be deceived by the short-term performance of United Technologies (UTX). The weakness of the dollar in the second quarter helped push shares of this multinational manufacturer higher. But these gains merely allowed the company to recover big losses sustained during the first quarter of the year.
The double whammy here for investors is exposure to the aerospace industry. As described previously, the weakness in the airline industry will negatively impact revenue for those companies providing equipment to the space. In addition, reductions in defense spending will also negatively impact UTX.
We are in the early stages of seeing change in how this company operates in the current environment. There is no catalyst for this stock to go higher, and shares are vulnerable to the extent the dollar strengthens.
I would sell UTX.
Stock to Avoid #9 – American Express (AXP)
If there was one mistake made in my management of these Top 10 Stocks to Avoid it would be with respect to American Express (AXP). For the same reasons that I covered my Capital One short, I could have just as easily done the same with American Express.
Shares of AXP bottomed in early March at just over $10 per share. Instead of covering with Capital One, I hedged my bet by keeping the American Express short open. I suppose that is the entire point of absolute return investing, but, boy, was I wrong in doing that.
AXP shot up like a rocket over the last three months and now trades above $23 per share. It has been a big gainer this year returning 25% through the end of the second quarter.
But despite the pain, I’ll stick to my guns. I do not like the fundamentals of the credit card market, and I would still avoid AXP. In fact, the stock may be an aggressive short for some that believe credit will be the next shoe to drop during this economic crisis.