Last year’s fourth quarter was ugly for U.S. equity markets. The S&P 500 actually entered a bear market — defined as a 20% decline from highs — on Christmas Eve. Investors looked for stocks to sell everywhere, with semiconductor stocks like Advanced Micro Devices (NASDAQ:AMD), cyclical names, and retailers among the hardest hit.
This summer, equity markets pulled back as well — if not quite to the same extent. The S&P dropped 6% in just six sessions starting in late July during the peak of Q2 earnings season.
With third-quarter earnings reports from major companies like Microsoft (NASDAQ:MSFT) and Amazon (NASDAQ:AMZN) on the way, the obvious risk is that history will repeat. A Q2 “earnings recession” seems likely to again play out in the third quarter. Investors have mostly shrugged at early good news, including strong reports from banks like Bank of America (NYSE:BAC) and JPMorgan Chase (NYSE:JPM). Anything less than strength thus could lead to selling pressure in a market still not far from all-time highs.
For investors who are nervous about market performance in the coming weeks, there are several sectors — and the following 10 stocks to sell — to avoid. Admittedly, timing the market is always dangerous, and it’s certainly possible that recent choppy trading could lead to a long-awaited bounce higher. But if it doesn’t, these 10 stocks may well be in trouble.
10 Stocks to Sell: Advanced Micro Devices (AMD)
From a long-term perspective, there’s still a lot to like when it comes to Advanced Micro Devices (NASDAQ:AMD) stock. AMD just a few years ago was a second-tier supplier of chips for lower-priced PCs. New CPU and GPU products, however, have made the company a legitimate competitor to Intel (NASDAQ:INTC). Market share gains have led to impressive revenue and earnings growth and drove AMD up nearly 1,500% from 2016 lows.
But the rise in AMD stock hasn’t been a straight line. Most notably, the stock lost nearly half of its value between September and December of 2018. Admittedly, the “crypto hangover” had much to do with the fall, as it did for fellow chipmaker Nvidia (NASDAQ:NVDA).
Still, this has been a volatile stock. And AMD stock seems at particular risk if sentiment changes. It’s not cheap by semiconductor standards at nearly 30x 2020 consensus EPS. Worries about datacenter demand persist. It’s seen big drawdowns before. A recent rally off support of $28 suggests near-term strength. But if earnings disappoint at all, and AMD stock reverses, busting through that support could lead to huge downside from a current price of $31.
Rent-to-own retailer Aaron’s (NYSE:AAN) might seem like an odd choice for this list. The company’s business, at least during the financial crisis, was actually counter-cyclical. Tighter credit at traditional retailers left customers with Aaron’s and rival Rent-A-Center (NASDAQ:RCII) as the only options.
But a decade later, this is a different company. Over half of profit comes from the company’s Progressive Lending unit, which doles out that credit. Low unemployment and higher wages have benefited Progressive’s core customer and driven impressive growth. But if there is any weakness in that lower- to middle-class consumer, Progressive is at significant risk.
And so AAN stock is at risk if investors project that weakness before it even arrives. That’s exactly what happened last year, when AAN stock went from $55 to $40 in less than three months. Not even a solid Q3 earnings report, in which Aaron’s modestly raised the midpoint of its full-year profit guidance, could reverse those declines.
AAN now trades at $74 after a recent breakout. Expectations are high. There is no room for error — both in results from Aaron’s and the sentiment surrounding the company.
To be fair, online furniture retailer Wayfair (NYSE:W) already has pulled back. W stock has dropped 37% from March highs, and some investors might assume that the worst is behind the stock.
That’s not necessarily the case, however. It’s not as if Wayfair stock is cheap. The stock does trade at a seemingly reasonable 1.4x price-to-revenue multiple. But gross profits are low and net profits remain sharply negative. Many investors believe the company’s model is unsustainable, a key reason why 24% of the company’s float is sold short.
Meanwhile, W stock plunged last year, losing nearly half of its value in a couple of months and touching $80. Should fears of a recession rise, they would hit the always-cyclical furniture space. And if investors shun risk, W stock obviously would be one of the first to be sold.
In other words, this can get worse. Wayfair stock may be cheaper, but in a “risk-off” environment few investors will see it as cheap.
Churchill Downs (CHDN)
Churchill Downs (NASDAQ:CHDN) is best known for its namesake track which hosts the Kentucky Derby. But this isn’t just a track play anymore. The company’s TwinSpires online betting platform and its growing casino operations both drive a good chunk of growth.
CHDN stock has soared of late, perhaps due to optimism toward sports betting legalization in the U.S. TwinSpires’ existing platform in theory could be repurposed for gambling outside of horse racing. And this has been an impressive company, with strong performance at its casinos and ever-increasing profits from Derby Week.
That said, gambling of all kinds is a cyclical business. And CHDN has soared while other operators, notably Eldorado Resorts (NASDAQ:ERI), have weakened. With the highest earnings multiples in the space, CHDN stock has the farthest to fall if cyclical fears return. Indeed, the stock touched a 52-week low last December at the bottom of the market and has since gained a whopping 75%.
Home Depot (HD) and Lowe’s (LOW)
Some might well argue that investors shouldn’t even bother selling Home Depot (NYSE:HD) and Lowe’s Companies (NYSE:LOW). HD stock has outperformed LOW over time, but both names have been winners. Home Depot is one of the best retailers in the world. Lowe’s is undertaking a turnaround, though disappointing first quarter earnings undercut the optimism somewhat.
That said, neither stock seems to price in any type of near-term recession risk. HD stock, in particular, seems to be valued like a defensive play, with an earnings multiple not terribly far from that of Walmart (NYSE:WMT). LOW stock is cheaper — but it should be, and has been, given its second-place status.
Again, I’m sympathetic to the case that investors should just own quality businesses. And Home Depot certainly qualifies. (The jury still is somewhat out on Lowe’s reinvigoration efforts.) But given big YTD gains in HD stock, and with LOW stock not far from all-time highs, there’s obvious downside risk if macroeconomic sentiment weakens at all.
Some of the biggest victims of last year’s sell-off were housing and construction stocks, among them insulation installer and distributor TopBuild (NYSE:BLD). And that sell-off went too far.
In December I chose the iShares US Home Construction ETF (BATS:ITB) as my choice for the Best ETF of 2019. Part of my argument was that construction-related stocks had dropped too far amid the fourth quarter carnage. Valuations across the sector were cheap — and in some cases absurdly so, with homebuilders Lennar (NYSE:LEN) and D.R. Horton (NYSE:DHI) trading at 5-6x earnings.
The issue at the moment is that the case has played out. ITB has gained about 50% so far this year, and looks poised to re-take all-time highs. Valuations across the space have expanded. Investors a year ago seemed too worried about a looming recession. Now, they seem almost oblivious to the risk.
BLD stock highlights the shift. The stock fell over 50% last year to December lows. It has since gained 144%, with barely a single pause in its rise. But now the stock trades at over 12x EV/EBITDA (enterprise value to earnings before interest, taxes, depreciation and amortization). That’s a big multiple for a distributor with relatively low margins, and a premium to other similar stocks in the space.
On the whole, it does seem like the easy money in housing stocks has been made. And at these valuations, there’s simply much more downside risk if negative sentiment toward the industry and/or the economy returns. BLD has been one of the biggest gainers in a hot sector this year — and thus has the most to lose if the group cools off.
Herman Miller (MLHR)
There’s another cyclical sector that has done quite well this year: office furniture manufacturers like Herman Miller (NASDAQ:MLHR). MLHR stock finally broke out of sideways trading that had held for a full five years, gaining 56% so far in 2019.
To be sure, Herman Miller has earned those gains. It has posted a series of strong earnings reports, most notably a fiscal Q4 release in late June that sent MLHR stock up over 16%. The entire industry seems to be doing better than it has in a while, with rivals Knoll (NYSE:KNL) and Steelcase (NYSE:SCS) both at or near multi-year highs.
But for most of this decade, the group has struggled to drive consistent growth. Optimism coming out of the 2016 U.S. presidential election quickly curdled as sales fell across the industry. Swings in economic sentiment have weighed on the stocks in the sector: MLHR dropped about 25% in three months late last year.
What has been consistent in the group is that uncertainty generally leads to caution — and delayed revenue. And there’s a substantial amount of uncertainty out there at the moment, between Brexit, the trade war, and the 2020 presidential election in the U.S. Those factors alone suggest some caution. Add rising macro risks to the equation, and investors likely will start selling as they worry Herman Miller will have trouble doing the same.
If an investor were looking to pick a single stock to bet against on a broader macro thesis, Wingstop (NASDAQ:WING) would fit an awful lot of the criteria.
Huge gains? Wingstop stock has tripled in roughly two years. High valuation? WING trades at 100x next year’s earnings. Weakening chart? That too: the stock already has pulled back 15%. Exposure to the broader economy? Of course, as restaurants are notoriously cyclical businesses.
Some investors already have taken the short side of the trade, as over 12% of the float is sold short. Macro risks aside, shorting WING stock looks intriguing. A change in investor sentiment could be the catalyst for that trade.
Chipotle Mexican Grill (CMG)
Admittedly, it may be that Chipotle Mexican Grill (NYSE:CMG) simply is bulletproof at this point. Anyone who bet against CMG stock has been run over, as shares have nearly doubled in 2019 alone. The E.coli outbreak that damaged the brand, and the stock, is in the past. CMG stock looks awfully expensive, at 47x forward earnings, but it looked expensive when I erroneously predicted it would be a 2019 loser back in December.
Even last year’s sell-off didn’t do that much damage to CMG stock. It’s possible investors see the business as more defensive than most restaurants, given its lower price point, committed base of customers, and convenience.
All that said, it’s hard to see CMG surviving a correction unscathed. There are plenty of investors sitting on big profits who might cash out if the stock weakens at all. The valuation has been high for a while, but not this high in years. Quick-service restaurants like McDonald’s (NYSE:MCD) historically have been defensive stocks; it’s not yet known whether that will be the case for a “fast casual” concept like Chipotle.
Again, betting against CMG, in any form, has been unwise. But there is a path for the stock to come back to Earth, particularly if investors start worrying about the U.S. consumer and valuations in a still-expensive market.
As of this writing, Vince Martin is long shares of Knoll. He has no positions in any other securities mentioned.