The broader markets are at an all-time high. The Dow Jones Industrial Average finally cleared 20,000 and just kept on rising. Stocks even shrugged off commentary from the Fed on Tuesday that suggests an interest rate hike is imminent. We’ve now gone nearly eight years without a bear market in U.S. equities.
In short, the bulls are in charge … and that should make investors nervous.
For one, there are plenty of potential catalysts for a correction or even a new bear market. There’s tepid growth in the U.S. and overseas, potential political conflict, and a bull market that’s a bit long in the tooth. And it’s usually when investors gets complacent and/or overconfident that the market reverses.
The bulls might be winning for now — but that usually means the bears are only hibernating.
What’s notable about the post-election optimism is that it has led to big gains in a number of high-risk, high-reward stocks. Should caution return to the market, those stocks that had the biggest moves in the bull market usually are first in line to reverse along with broad market sentiment.
As such, here are seven stocks to sell or short into the ground for profits should the bears attack.
Stocks to Sell or Short Before the Bears Strike: Tesla Inc (TSLA)
One of the market’s most divisive stocks is electric car manufacturer Tesla Inc (NASDAQ:TSLA).
The bulls see founder and CEO Elon Musk as a visionary, and his automobiles as the perfect combination of performance and environmental responsibility. The bears see a nice idea turned into a company now worth more than $45 billion despite negative cash flow, negative earnings and a series of missed production targets.
The long-term argument won’t be settled for some time. But in the near-term, Tesla stock looks potentially risky.
TSLA is within a few hairs of all-time highs thanks to a 55% gain since just the beginning of December. Put another way, Tesla has added roughly $16 billion in market valuation in about 11 weeks.
That puts a lot of pressure on the company to hit production targets, which were moved up last year. It raises the possibility of another equity offering, which could quickly end the rally. And, of course, it leaves TSLA stock seemingly unprotected if broader market sentiment changes — at all.
Stocks to Sell or Short Before the Bears Strike: Arconic (ARNC)
In other words, AA became ARNC — and then gave investors shares of a different “AA.”
That might sound confusing, but investors seem to understand the story just fine. Both AA and ARNC shares have risen 70% since the spinoff. Post-election optimism and higher aluminum prices are boosting both stocks.
Arconic, in particular, has benefited of late from a position taken by activist Elliott Management. Elliott has said ARNC is worth anywhere from $33 to $46 per share, against current levels just under $30. And investors might be wise to follow Elliott, who has engineered sales of Qlik Technologies, Riverbed, Informatica and Compuware, among others.
So why place ARNC on your list of stocks to sell right now?
For one, there’s a key point to note about that list: It’s largely tech-dominated. And ARNC shares already are just about 10% below the bottom end of Elliott’s valuation range.
The activist is gearing up for a tough proxy fight, and calling for the removal of CEO Klaus Kleinfeld. This situation likely will take time to play out — perhaps long enough for investor patience to wane, or optimism to wither.
Stocks to Sell or Short Before the Bears Strike: Tronox (TROX)
Chemical company Tronox Ltd (NYSE:TROX) has been one of the best-performing stocks over the past year. Shares are up 381% from 52-week (and all-time) lows of $3 reached last February.
There’s some reason for optimism, but a $1.7 billion market cap seems aggressive for Tronox.
This is a company that was flirting with bankruptcy just a year ago. It is saddled with $3 billion in debt. Interest expense through the first nine months of 2016 was almost 9% of revenue.
Pricing for the company’s key product, titanium dioxide, admittedly has firmed. But a nearly 400% gain for an unprofitable, indebted company seems to suggest far more improvement. It’s not as if TROX shares simply rebounded out of last year’s bear market, either. The stock has almost doubled just since Election Day.
Tronox should be among the first stocks to sell for profit-taking purposes if risk returns to the equity markets. Because when investors look more closely at fundamentals, TROX stock could give back those gains in a hurry.
Stocks to Sell or Short Before the Bears Strike: Scientific Games (SGMS)
Scientific Games Corp (NASDAQ:SGMS) is a roll-up of several gaming companies. The original SciGames was the nation’s largest provider of lottery systems and scratch-off tickets. But in quick succession, the company bought slot machine manufacturer WMS Industries, and then WMS peer Bally Technologies, which itself had just acquired gaming equipment manufacturer SHFL Entertainment (formerly known as Shuffle Master).
The combinations created what was supposed to be a “one-stop shop” for casino customers. It also created a massive debt load. SciGames still has over $8 billion in debt, supported by barely $1 billion a year in Adjusted EBITDA.
Meanwhile, the logic behind the SciGames roll-up hasn’t played out. Online gambling legalization in the U.S. has stalled. The numbers of casinos opening has plummeted. Existing operators — particularly U.S. regionals like Boyd Gaming Corporation (NYSE:BYD) and Pinnacle Entertainment Inc (NASDAQ:PNK) — have chosen cost-cutting and margin expansion over investing in new slot machines. As a result, SciGames’ sales growth has been below expectations: just 6% through the first nine months of 2016. And profit growth has come largely from merger synergies.
Yet SGMS sits at its highest levels since the financial crisis, with shares exceeding $20.
Debt refinancing, which eliminated near-term maturities, has helped the stock, as has optimism toward increased consumer spending going forward. But a ~150% gain in the stock just since September seems excessive, and SciGames still has a reasonable chance of wiping out if its results don’t improve — or if even a modest recession impacts profits at the wrong time.
In a bull market, the high level of debt allows investors to model more upside for the leverage. In a bear market, however, those same investors focus more on the risk. Given that, at current cash flow levels, SciGames would take something like 30 years to pay off its debt, a reversal in sentiment could mean a reversal in the stock.
Stocks to Sell or Short Before the Bears Strike: BofI Holding (BOFI)
BofI Holding, Inc. (NASDAQ:BOFI) is another battleground equity on our list of stocks to sell — and another issue where the bulls are currently winning, and winning big.
At the moment, BOFI looks like a classic short squeeze. Some 36% of the float is sold short at the moment — but that figure is actually down from about 40% around the time of the U.S. presidential election.
To be sure, the bull case for BOFI benefited from Donald Trump’s surprise win. Investors are betting that both lower regulation and higher interest rates will help earnings, and thus the stock. That optimism, likely helped by short-covering, has moved shares up about 60% since Election Day.
Short squeeze potential aside, however, investors do need to be careful.
BofI still is dealing with lawsuits, including one from a former auditor who claimed the company violated regulations and falsified financial statements. The bank’s client base has been riskier than most, and BOFI isn’t cheap. As the Wall Street Journal pointed out on Tuesday, shares trade at 2.5x book value — a hefty multiple for any financial and above the peer average of 1.8x.
With the stock at its highest levels since the disclosure of the first lawsuit in 2015, it might be time for BOFI longs to take profits and step away from the battlefield for a moment.
Stocks to Sell or Short Before the Bears Strike: Platform Specialty Products (PAH)
What’s interesting about both SGMS and Platform Specialty Products Corp (NYSE:PAH) is that they represent an apparent change in the market’s opinion toward roll-up stories. The implosion of Valeant Pharmaceuticals Intl Inc (NYSE:VRX) cast a shadow on the strategy of using debt-fueled acquisitions for growth.
But Valeant isn’t the only roll-up stock to suffer. Sequential Brands Group Inc (NASDAQ:SQBG), an apparel company, has fallen from $18 to $4 in less than two years. Performance Sports Group Ltd (OTCMKTS:PSGLQ) is in bankruptcy. And ClubCorp Holdings Inc (NYSE:MYCC) remains below its IPO price despite recent rumors of a takeover.
But sentiment toward PAH stock has turned. Shares are up roughly 75% since the election, their highest levels in over a year. But the risk is far from gone. A $350 million equity offering tanked the stock in September, though it did firm up the company’s balance sheet. Still, Platform Specialty has over $5 billion in debt, almost 7x its 2016 adjusted EBITDA guidance. Free cash flow through the first nine months of 2016 was negative.
PAH’s presence in both agricultural and oil and gas end markets certainly has been a factor of late. But it’s far from guaranteed that either industry will pick up soon. Like SGMS, if overall economic sentiment weakens at all, the company’s leverage will be looked at very differently, as will its stock.
Stocks to Sell or Short Before the Bears Strike: Supreme Industries (STS)
The stock chart for Supreme Industries, Inc. (NYSEMKT:STS) is something to behold.
Shares of the truck body and specialty vehicle manufacturer were under $6 in February 2016; they neared $20 just seven months later.
Then, the bottom fell out. A huge decline in backlog disclosed in the Q3 earnings report sent STS stock down 38% in just two sessions.
And yet Supreme Industries has taken back all of those losses … and then some. Perhaps more incredibly, the stock’s move has come solely on investor sentiment. Q4 earnings impacted by the lower Q3 backlog haven’t even been reported yet. It seems likely that STS will post a decline in earnings year-over-year; yet the stock certainly isn’t priced like it. In fact, Supreme trades at almost 17 times the sole 2016 analyst EPS estimate. It trades over 3 times book value. Both are rather high figures for a cyclical company facing a potential glut in the used truck market.
Again, the run since November (about 70%) is coming solely off those multiples expanding. The last time Supreme Industries reported earnings, investors fled the stock. Fundamentally, nothing has changed since then — other than STS’s stock price, and substantially so. That seems to set up a dangerous Q4 — even if the broad market stays positive.
If earnings disappoint and sentiment changes, STS could be a great short, because it’ll have a long way to drop. If you hold, this should be on your list of stocks to short.
As of this writing, Vince Martin had a bearish options position in SGMS.