It’s ugly out there. The major indices aren’t in bear market territory — at least not yet — but the average stock most certainly is.
Bespoke Investment Group ran the numbers a few days ago and found that the average large-cap stock was already down 22.5%. For mid- stocks and small-cap stocks, it gets a lot worse. Mid-caps were down 26.5% and small caps were actually down more than 30% … and this was before Wednesday’s selloff.
That’s not just a garden-variety correction. That’s a deep bear market.
As for the “why,” you can lay the blame on three things: sagging crude oil prices, a weakening China and high market valuations.
Where do stocks go from here? Frankly, if I knew the answer to that with any certainty, I wouldn’t be spending my time writing this article. It’s entirely possible that stocks could find a bottom today or tomorrow, and that this whole episode will be forgotten a few months from now.
But then, it is also entirely possible that it gets really nasty from here. If you recall, the S&P 500 lost half its value in both the 2000-02 bear market and the 2008-09 meltdown. And given that the market is still very expensive, we could easily be in for that kind of tumble.
So with no more ado, let’s jump into 10 stocks to sell before things get even worse.
Stocks to Sell: Volkswagen (VLKAY)
YTD Return: -15%
There will come a time to buy scandal-ridden Volkswagen (VLKAY). I just don’t believe that time is now.
Volkswagen shocked investors last year when it revealed that it had been cheating on emissions tests. The scandal — which has resulted in both criminal investigation and threats of civil lawsuits in multiple countries around the world — sent the stock into a tailspin. The shares had already been drifting lower for months, and the emission scandal pushed the stock price to less than half of VW’s 52-week high.
With shares still in the gutter, Volkswagen might seem like a low-risk buy, right?
The government investigations have barely even started, and this promises to be drag through the courts for years. Consider how long it took oil major BP (BP) to shake off the 2010 oil spill — and that was an accident.
Furthermore, we have no idea to what extent buyers will punish the brand in light of the company’s betrayal. Sales dropped 5% last year, and this in a record year for many other automakers.
Again, there will be a time to back up the truck and buy shares of Volkswagen. I just don’t believe that time is today.
Stock to Sell: Chipotle (CMG)
YTD Return: -4%
I love Chipotle (CMG). Even typing out the word makes me long for one of their burritos. And no, not even an E. coli outbreak can keep me away.
But we’re not talking burritos here. We’re talking stocks. And Chipotle stock is a falling knife that I wouldn’t want to catch right now. As I’m writing this, CMG shares trade for about $460, down enormously from its 52-week high of $758. But even after that tumble, shares trade for 33 times expected earnings.
Same-store sales growth had started to fall before the health scare, and the company’s ability to plug this gap by raising prices seems a little doubtful given that Chipotle already recently raised prices. And it doesn’t help that the costs of Chipotle’s ingredients have risen at a time when American wage growth is stagnant.
Buy Chipotle burritos. But take your losses on the stock.
Stocks to Sell: Yum Brands (YUM)
YTD Return: -8%
I’m a little embarrassed to admit this, but I’ve also been known to sneak the occasional soft taco from Yum Brands’ (YUM) Taco Bell. What can I say? It’s close to my house, and it’s convenient when I need a quick late-night snack.
Americans are eating less fast food, it seems. But that has nothing to do with why I’m cautious on YUM stock. My fear has everything to do with Yum’s exposure to China. Yum currently gets more than half of its revenues from China, which is by far its largest market.
Last year, Yum outlined a plan to spin off its China business as a standalone company by the end of 2016. The non-China half of the company will then complete its transition to a pure-play franchiser. That’s actually a really bullish investment story. I’m just concerned that a hard landing in China will bring a lot of pain in the meantime.
So if you own YUM stock, dump it and move on.
Stocks to Sell: Twitter (TWTR)
YTD Return: -24%
Poor Twitter (TWTR) just can’t seem to get it right.
While social media rival Facebook (FB) has become a darling story stock, Twitter has continually left its investors disappointed. At $17.64 as of this writing, TWTR shares have now dropped to a third of their 52-week high of $53.49.
Yet even after the stock price collapse, shares are far from cheap, trading at more than 6 times sales and at 31times forward earnings. And the company has yet to earn a consistent profit.
Making it worse, new user growth appears to be stalling out, even though TWTR has barely a fifth of Facebook’s user base. I love Twitter and use it daily. But I also estimate that at least a fifth of my followers appear to be some sort of spam bot. It’s hard to see advertisers paying much to spam other spammers.
But perhaps the biggest sign the company is facing trouble is that it is apparently considering lifting its 140-character limit to 10,000 characters. While all companies grow and adapt, a radical shift like this shows a lack of direction. Twitter’s entire identity revolves around the 140-character minimum. That they would even consider changing this at this time is a sign of desperation.
Dump Twitter and move on.
Stocks to Sell: IBM (IBM)
YTD Return: -6%
IBM (IBM) has been the proverbial red-headed stepchild of the tech industry for years. IBM was late to embrace the cloud and thus lost serious ground to cloud pioneers Amazon (AMZN), Alphabet (GOOGL) and Microsoft (MSFT). Revenues have been in decline for 14 consecutive quarters.
Eventually, IBM will break this horrendous chain, but it will only be because the comps are so bad it’s impossible not to beat them.
Perhaps the biggest sign yet of how truly desperate IBM’s situation is came from an offhand comment made my Oracle’s (ORCL) Larry Ellison. Last year, Ellison commented that he “never sees IBM anymore” when he competes for enterprise business. This wasn’t chest-thumping bravado. It was something closer to pity.
You can feel sorry for IBM all you want. Just don’t own it.
Stocks to Sell: Harley-Davidson (HOG)
YTD Return: -13%
There are few stocks out there with a bleaker macro picture than Harley-Davidson (HOG). Its riders are almost exclusively baby boomer white men, and this is a demographic that is now mostly too old to ride. Management knows this and has been reaching out to younger riders, non-Caucasian riders and women.
But the stereotype of the grey-bearded rider remains for a reason.
HOG is not “expensive,” per se, trading at about 10 times forward earnings estimates. But this is also a highly cyclical industry, and it’s hard to imagine a large surge of new Americans dropping tens of thousands of dollars on something as frivolous as a motorcycle with the economy looking wobbly.
Harley is not a stock I would want to carry into a bear market. If you own it, consider dumping it.
Stocks to Sell: Facebook: (FB)
YTD Return: -10%
I know, I know. Facebook (FB) is one of the few real growth stories left out there. So why on earth would I recommend dumping it?
One word: valuation.
Facebook has really managed to succeed where rivals like Twitter have failed in monetizing its users. FB continues to wring more dollars out of each user even while continuing to grow its user base at an amazing clip.
But the stock trades for nearly 100 times earnings and 18 times sales. At that valuation, you’re assuming that the growth will continue at the current pace indefinitely.
The problem is, Facebook’s North American users are responsible for an outsize percentage of its revenues, and the North American market is growing much slower than overseas markets.
Yes, I know. Facebook has yet to really scratch the surface in monetizing Instagram and Oculus. I get that. But with investor sentiment souring toward the stock market, even the highfliers are likely to be taken down a notch.
Stocks to Sell: Amazon (AMZN)
YTD Return: -16%
Amazon (AMZN), perhaps more than any other major company in the world, really has some impressive momentum behind it right now. Christmas 2015 cast aside any doubt about Amazon’s emergence as the go-to retailer for virtually everything under the sun.
And it’s not just retail. Amazon competes with Netflix (NFLX) in streaming video and with Microsoft and Alphabet in enterprise cloud computing. Amazon really is taking over the world.
The problem is that investors have bid up the shares beyond any price that could be considered reasonable. AMZN trades for more than 800 times trailing earnings and 100 times projected forward earnings.
Now, the conventional wisdom here is that Amazon’s nosebleed valuation is more of a “denominator effect.” It’s not that the price is exceptionally high, but that the earnings are exceptionally low due to Amazon’s insistence on growth at the expense of profits.
There’s definitely some truth to that. But the investor euphoria that sent this stock to the moon can vanish in a hurry in a real bear market. I’d exit this today and consider re-entering at a later date.
Stocks to Sell: Tesla Motors (TSLA)
YTD Return: -17%
I’d love to own a Tesla Motors (TSLA) car. They’re stylish, have monster performance and alleviate any guilt about polluting the planet.
Alas, I have two young children, so I won’t be buying a $70,000 car any time soon.
But while I like Tesla’s cars, I can’t say I like its stock. As I’m writing this, TSLA shares trade hands at $200 per share, down from nearly $300 at one point last year. But even at this reduced price, the stock trades for 110 times this year’s expected earnings and at 7 times trailing sales. To put that in perspective, General Motors (GM) trades for 5 times next year’s expected earnings and at 0.3 times trailing sales.
Hey, I get it. Tesla is the future, GM is the past. But at some point, the pricing gets downright nuts. These are both auto stocks, for crying out loud.
Plus, with the price of crude oil in the gutter, an electric car — even a high-performance one like Tesla — loses a lot of its appeal.
Should we have a real bear market, I’d expect Tesla to get creamed.
Stocks to Sell: JCPenney (JCP)
YTD Return: +4%
And finally, we get to JCPenney (JCP).
Hedge fund superstar Bill Ackman was nearly the death of this struggling retailer. His attempts to change its stodgy image nearly led to its bankruptcy.
Well, guess what? If this spate of volatility in the stock market turns out to be a prelude to a recession, I think it will be that final nail in the coffin.
Yes, JCP is up 4% in a very, very down market … but that’s still part of a 30% downswing since late October. A retailer that is struggling to stay relevant in a relatively benign economy is going have a hard time surviving a real recession.
Will we get a recession? Maybe, maybe not. But in the event that things get really bad, JCP is not a stock I’d want to own.
Charles Lewis Sizemore, CFA, is the chief investment officer of investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. As of this writing, he was long MSFT.