Generating absolute returns is all about insurance and minimizing risk. In doing so, investors may sacrifice a bit of upside, but they will in all probability miss out on any significant downside, thus the attraction.
At the start of this year with all heck breaking loose, the only rational approach for investors was to mitigate risk. Only a crazy person would look at the landscape and throw caution to the wind by following a long-only approach to the market.
Sure, in hindsight, selling stocks short or hedging a portfolio looks like a bad idea, but that’s not necessarily true. Even though stocks have generally increased in value this year, there is a segment of the market that has lagged.
More importantly, with stocks down significantly during the first two months of the year, an actively-managed absolute return portfolio, whereby stocks sold short at the beginning of the year and then later covered, would help boost returns.
Why Hedging Our Bets Has Worked
That is exactly how I have managed my 2009 Top Stocks to Sell. With big gains at the start of the year, I covered three of the 10 positions. In doing so, I was able to secure positive returns while maintaining the insurance policy for the remainder of the year.
This was particularly important, as the stocks recommended to sell increased in value significantly since bottoming in early March. In the aggregate, the 2009 Top Stocks to Sell have generated a net loss of 6%. Not bad, considering how far stocks have run. For example, the S&P 500 was up more than 17% at the end of the third quarter. Put our Top Stocks to Sell in tandem with our Top Stocks to Buy in 2009, and the total return for the period is 24%. So much for absolute return strategies lagging the market. In this case, our long/short portfolio is generating significant outperformance. The trick, of course, is to keep the momentum going for the remainder of the year.
Since the end of the third quarter, stocks have continued to rally and are likely to keep rallying through the end of 2009. Be that as it may, I will make no changes to the list of stocks to sell portion of my absolute return portfolio. I like the idea of an insurance policy here in case of a late correction triggered by institutions looking to lock in profits.
Here is a quick update on six of my top stocks to sell.
Stock to Sell #1 – Dupont (DD)
Dupont (DD) lagged the market for the first half of the year, but that changed during the third quarter. DD exploded during the period and finished the first nine months up more than 27%. From market deadbeat to market star all in one quarter. Not bad, considering oil prices, a key component in most Dupont products, increased at the same time. Of course, the improvement in the economy helped this cyclical company greatly. At four times book value and more than 40 times trailing earnings, the stock is a bit rich at current levels. Even if the company meets expectations in 2010, the valuation is still rich given growth is likely to be in the low double digits at best. There are better opportunities out there.
Stock to Sell #2 – 3M (MMM)
Giant multinational manufacturer 3M (MMM) has been on a straight path higher since bottoming in March. Shares have nearly doubled in value during that time. As of the end of the 3rd quarter, the stock was up more than 28% for the year, greatly exceeding market averages. Helping propel the stock higher during the summer has been the collapse in the dollar. The weakness in the domestic currency greatly enhances the value of sales overseas. MMM has been increasing such foreign sales for nearly two decades. Will that trend continue in 2010? It is likely, but much of the trend is already priced into the stock. I’m biased to small cap stocks going forward. I would avoid this behemoth.
Stock to Sell #3 – Boeing (BA)
There is a reason many investors remain skeptical of stocks during this most impressive market run. When a market pushes all stocks higher no matter the underlying fundamentals, investors cannot help but to question the validity of the rally. For example, aircraft maker Boeing (BA) has seen a number of setbacks, including delays in the much anticipated Dreamliner. No matter to investors, as BA has appreciated by nearly 27% in 2009. At current levels, BA is priced for perfection. But given the delays we have already seen, is it reasonable to assume 2010 will go off without a hitch? I would not bet on it.
Stock to Sell #4 – Eastman Chemical (EMN)
I could not have blown it more by including Eastman Chemical (EMN) on the list of 2009’s stocks to avoid. The chemical company has tripled in value since bottoming in March. That move puts EMN up almost 70% at the end of nine months. The company is firing on all cylinders and recently stated that it expected to beat the average estimate for 2009 earnings. Such performance is
what investors hope for from any stock. It is a disaster if you are short the stock. That said, it is expected that any portfolio will have its missteps, and that has been the case here. With so little time remaining in the year, there is not much to do but sit back and take your medicine. Thankfully the performance of the rest of the portfolio minimizes the damage.
Stock to Sell #5 – United Technologies (UTX)
Like 3M, United Technologies (UTX) has been on a straight shot higher since shares bottomed in March. The difference is in the velocity of the move. Despite the strong rebound, UTX was up a modest 13% as of the end of the third quarter. Analysts do not expect much growth in 2010, even though the economy has improved. One would expect UTX to benefit greatly from a weaker dollar, but that is not the case based on earnings estimates. Certainly between now and the end of the year, UTX is likely to tread water. If stocks take a step back, UTX can be expected to follow suit and possibly then some. I would stay short this stock through the end of 2009. And I would avoid it in 2010 as well, though I would not be short.
Stock to Sell #6 – American Express (AXP)
I feel so sorry for those big financial companies like American Express (AXP).
Cry wolf during a crisis and in a blink of an eye, the landscape becomes incredibly favorable for profits. Pay back the government, and all is forgiven. For good measure, we’ll keep the easy money flowing. Credit card makers are making a mint in this environment. As a result, stocks of these financial giants are some of the best performers this year. AXP is up more than 80% so far in 2009. Not bad, considering shares were down some 50% at the start of the year. That is one giant recovery and then some. With analysts expecting significant earnings improvement going forward, AXP is not necessarily expensive. As such, this is a stock that will be covered at the end of the year. Keeping the short in place until that time allows for a market correction that may still come before the year ends. The environment for 2010 should be very positive for AXP.