All seems well in the U.S. stock markets at the moment. The Dow Jones Industrial Average and the S&P 500 Index both sit at all-time highs. Large-cap tech stocks have soared. Cyclicals are gaining. With macro indicators like consumer confidence and the unemployment rate both strong, there are few reasons to expect an imminent market correction.
At the same time, however, some observers feel that U.S. stocks have become overheated. Record-low volatility has led to fears that the market has become too complacent. Earnings multiples in some sectors have reached historical highs, and even unprofitable software stocks are being valued at eight to nine times revenue, if not more.
A market correction may not be on the way in the near term — but it wouldn’t be a complete shock, either. There are reasons to think that U.S. stocks are due for some sort of a pullback, given a basically uninterrupted bull run since last February.
If that market correction indeed is coming before year-end, here are 10 stocks that likely will show the first signs of broad market weakness — and are likely to be among the biggest losers when that weakness arises.
10 Stocks to Sell in the Next Market Correction: Tesla (TSLA)
Obviously, the long-term story at Tesla Inc (NASDAQ:TSLA) has yet to play out. As dug-in as both TSLA bulls and bears appear, both sides should remember that few stocks in the market offer more uncertainty than TSLA.
But in the near term, any shaking of investor confidence seems likely to be reflected in Tesla stock before almost any other issue in the market. This is a stock that’s gained 67% year-to-date — adding $22 billion-plus in market value in the process. Its valuation — no matter who is calculating it — is based on profits coming toward the end of the next decade, and beyond.
And those profits will only come if Tesla succeeds in dramatically changing the worldwide automotive and transportation markets. But that’s a hugely audacious goal.
TSLA, in other words, is a stock whose value is based almost entirely on confidence. And if investor confidence wanes, Tesla should be one of the stocks to feel it.
10 Stocks to Sell in the Next Market Correction: Santander Consumer USA Holdings (SC)
Credit markets usually tighten when a market correction hits. And that could potentially imply trouble for auto lender Santander Consumer USA Holdings Inc (NYSE:SC).
Santander’s portfolio skews heavily toward subprime, with 86% of its loans in that category. Default rates already are rising, and Bloomberg reported that the company only verifies income on about 8% of its loans.
Fellow lenders like Ally Financial Inc (NYSE:ALLY) and Credit Acceptance Corp. (NASDAQ:CACC) would struggle as well. CACC actually is one of the most-shorted stocks in the market, with nearly 36% of its float sold short at the moment.
But SC’s extra subprime exposure and questions about “peak auto” make it the likely canary in the credit coal mine. And it means SC has significant room to the downside if investors start to see broader risk in the market.
10 Stocks to Sell in the Next Market Correction: Ring Energy (REI)
The decline in oil prices over the past few years has been an outlier in the sense that it came while the U.S. and world economies were doing better, not worse. And that raises the question of just what will happen to oil prices when the global economy hits a rough(er) patch.
Relatively unknown small-cap Ring Energy Inc (NYSEMKT:REI) could be one of the first oil explorers to slip if the market gets concerned about macro trends. Any broader weakness likely would push oil lower (and the dollar higher, compounding the move on crude). Such a move would hit most E&P stocks — but REI looks most at risk.
For one, REI has been one of the best performers in the space, actually gaining 2% so far in 2017 and rising 53% over the past twelve months. But resistance has held rather firmly at $14, just above its current price. Secondly, Ring recently expanded its capex budget for 2017 by $50 million. Committing to that capex, only to see oil prices decline even further, likely would badly undercut REI’s share price.
Ring isn’t necessarily betting its future on its 2017 exploration. The company has no debt, though it may have to tap its revolver in the second half. But if investor nervousness drops crude lower, this time REI almost certainly will follow.
10 Stocks to Sell in the Next Market Correction: Caterpillar (CAT)
Caterpillar Inc. (NYSE:CAT) has been one of the biggest beneficiaries of the bull market spanning the past 18 months. CAT stock now has doubled since last February — despite the fact that business hasn’t gotten that much better.
2017 earnings guidance has been raised twice now, to be sure. But this still is a company coming off four straight years of declining revenue, which is a first in the company’s history. Investors now clearly expect several years’ worth of improvement, as evidenced by a 23x multiple to 2017 guidance of $5 in per-share earnings.
Caterpillar’s direct correlation to macro trends, like construction and resource exploration, means those expectations would change if macro sentiment does. And even a modest correction could bring the stock’s long run to an end.
I don’t think CAT is quite as overvalued as it looks. And there are reasons for optimism through the end of the decade, as the company benefits from substantial cost-cutting over the past few years.
But there’s still quite a bit of macro help baked into CAT shares at the moment. And if investors get at all nervous, one would think they’d quickly look to take profits here.
10 Stocks to Sell in the Next Market Correction: Nordstrom (JWN)
Obviously, retailers have had their own correction the last few years. Nordstrom, Inc. (NYSE:JWN) is no exception. JWN shares still are down almost 40% from early 2015 highs, and have declined modestly so far this year.
Of course, as far as department stores go, that’s actually a rather good performance. Sears Holdings Corp (NASDAQ:SHLD) is down 44% just in the past year. J C Penney Company Inc (NYSE:JCP) has been almost halved just since December.
Meanwhile, the recent carnage in retail — like O&G — is coming in what should be a good environment. And that raises the question of just what happens when macro trends turn south. JWN’s high-end exposure and still-high valuation (15 plus FY18 EPS) suggest it would take another leg down.
If the broad market turns down, it almost certainly will take retail with it. And JWN’s relative outperformance could reverse in that scenario.
10 Stocks to Sell in the Next Market Correction: Nvidia (NVDA)
This isn’t a knock on the Nvidia Corporation (NASDAQ:NVDA) business. Nor would a market correction necessarily affect Nvidia’s long-term opportunities in automotive and data center chips, in particular.
But the gains in Nvidia stock have been such that when the market re-discovers risk, NVDA almost certainly will take a hit. After all, this is a chip stock trading at 54x next year’s earnings and 12x this year’s revenue. Should investors move toward lower-risk equities, or high-quality bonds, they likely will exit NVDA in the process.
To be sure, many, many investors and analysts have called for a correction in NVDA. Pretty much all of them have been wrong. But NVDA stock did get rattled by a couple of downgrades earlier this year, and like TSLA its current valuation is based in large part on confidence (though Nvidia’s gaming business does provide a stronger near-term base).
If the market turns south, it’s hard to imagine NVDA escaping unscathed.
10 Stocks to Sell in the Next Market Correction: LendingTree (TREE)
LendingTree Inc (NASDAQ:TREE) is the perfect short for a trader betting on a market correction. After all, TREE combines:
- credit exposure: through its lenders, who would pull back on spend if defaults increased;
- real estate exposure: fewer and cheaper homes being bought means fewer and smaller loans; and
- a huge valuation: about 25x the midpoint of 2017 Adjusted Ebitda.
Of course, the problem for TREE shorts is that the correction hasn’t come yet. As a result, they’ve been squeezed badly. TREE has gained 126% just this year. It’s quadrupled from its lows reached in the last correction.
When the next correction comes, TREE may take a hit. But given its performance over the past eighteen months, traders need to be very careful trying to time the top here.
10 Stocks to Sell in the Next Market Correction: United States Steel (X)
The nature of the steel business is that prices are tied to demand. When prices fall, steel stocks fall as well. And that would seem to imply that United States Steel Corporation (NYSE:X) will take a hit should investor confidence falter.
To be fair, X stock already has pulled back substantially from February highs above $40. A huge earnings miss in late April dropped the stock over 20%. But even with that decline, X has tripled from early 2016 lows.
There are some political considerations here as well, which might impact U.S. Steel stock without a major broad market change. But if that market weakens, steel prices almost certainly will follow. And that’s usually bad news for X stock.
10 Stocks to Sell in the Next Market Correction: Fastenal Company (FAST)
Industrial distributor Fastenal Company (NASDAQ:FAST) traditionally has a decent amount of cyclical exposure to begin with. Add to that secular concerns about pressure on distributors, and FAST could tumble if investor sentiment changes.
Both FAST and rival W W Grainger Inc (NYSE:GWW) have struggled of late, amid fears that Amazon.com, Inc. (NASDAQ:AMZN) will undercut pricing and the companies’ traditionally high margins. Those fears – and early signs of margin pressure – have kept a lid on both stocks. (GWW actually is near its lowest levels in almost six years.)
The question, then, becomes what happens to FAST stock if secular pressure is combined with a macro downturn. Nervous investors likely won’t stick around to find out.
10 Stocks to Sell in the Next Market Correction: Chemours Co (CC)
Chemours Co (NYSE:CC) stock has tripled just since the election. Chemours was spun off from E I Du Pont De Nemours And Co (NYSE:DD) in 2015, with DuPont offloading $4 billion in debt and significant legal liability in the process.
In less than a year, CC stock was in the single digits, and looked on a quick path to zero. But a rebound in titanium dioxide pricing and good news on the legal front has pushed CC stock up sharply, with gains approaching 900% from February 2016 lows.
But not all of Chemours’ problems have been solved. The balance sheet still is heavily leveraged, litigation continues, and pricing can (and usually does) reverse at some point. An ebullient market sees CC stock as a turnaround with huge upside.
A nervous market will see it very, very differently.
As of this writing, Vince Martin has no positions in any stocks mentioned.