3 Stocks to Fade Headed into the Sell-in-May Season

Stocks to fade - 3 Stocks to Fade Headed into the Sell-in-May Season

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My write up today is a bit of a downer because it’s a rare bearish one. I am usually one to look up for positive moves. But I have reason to worry a bit for the next three weeks. The goal today is to find stocks to fade into this period of uncertainty. This is by no means a call to short the stock markets outright. The bull is too wild to tame in general terms. But there are a few vulnerable gazelles within it that we can trap.

Yesterday, the stock market had a bit of an episode in the afternoon. The scoreboard was green, then a out of nowhere the indices fell off a cliff. The S&P 500 for example lost 20 points in minutes. In percentage terms the drop was negligible, the score was still only -0.2%. However, at the time I was chatting with active traders and the mood immediately turned to panic. This is all to say that the stock market has been bullish for so long that our expectations are now out of whack. We react in unreasonable ways to any red ticks.

Such high expectations raise the possibility of severe disappointment. Luckily, the macroeconomic conditions don’t warrant a crash. Unless we get a black swan event, the corrections should be mild. The bulls are in control, and they will buy the dips. However a small correction in the indices could cause debacles in frothy setups. My bet is that we will get a tizzy in the next three weeks. Therefore, today we will find stocks to fade in advance. These are ones that are way too far ahead of their skis and that will fall harder than the averages.

I am not a perma-bear. Most of my writing is for upside opportunities. However, I am very realistic about the actual price action unfolding in front of me. I remain long in many quality tickers. I also have balance by way of shorting the indices through options. In plain English, I am bullish long term but bearish shorter term.

What most investors forget is that our stock picks have to trade inside the entire market prism. Regardless of how good our prospects are, they need the markets to play along. We often suffer losses because of outside factors, and stocks can fall to no fault of their own. The specific fundamentals could still be solid, but the technicals warrant a pullback. Today’s picks have very little to do what the actual long-term thesis of the stocks. They are mostly about their current stock charts for the next three weeks.

The three stocks to fade are:

  • iShares MSCI Germany ETF (NYSEARCA:EWG)
  • Bank of America (NYSE:BAC)
  • CBOE Volatility Index (INDEXCBOE:VIX)

Stocks to Fade: iShares MSCI Germany ETF (EWG)

iShares MSCI Germany ETF (EWG) Stock Chart Showing Downside Potential
Source: Charts by TradingView

EWG stock has had an incredible rally from the bottom of the pandemic March crash. From low to high it spans nearly 100%. My biggest issue with that is its relative position to its all time highs. This is not the first time EWG does this, and the last time it ended badly for the bulls.

The S&P 500 has been setting new records for months. Last year, they crushed the all-time high from 2018. They are now almost 50% above 2018 crash site. This year, they extended the gains twice as far from it. EWG stock, on the other hand, has not yet reached its accident scene from 2018. Furthermore, they haven’t even recovered from the highs they posted in 2007.

This is all to say that for 13 years, it has been setting lower highs. My bet is that it will fail again short of exceeding 2018 levels. Since this is my assumption, I would also have to make it my stop-loss level. This means that I would immediately change my mind if indeed EWG exceeds $36 per share.

The easiest way to short a stock is to use options. Shorting equities outright is asking for serious trouble. Just ask those who tried it with GameStop (NYSE:GME) stock this year. The problem with the traditional way is that it opens us up to unlimited risk. If I get it wrong, my losses would accumulate for as long as a stock is rallying.

Using the options to take a bearish position is much tamer. I can simply buy put options or a debit put spread and I am done. For that, I would pick the June expiration so not to sweat every minute ticking. The risk is minimal in comparison. The upfront cost is the maximum I can lose. My opportunity would be to double my money or more if I’m right. Having finite risk circumvents the headache of being short a stock in the traditional sense. This is especially true during incredibly bullish markets.

Bank of America (BAC)

Bank of America (BAC) Stock Chart Showing Downside Potential
Source: Charts by TradingView

Bank of America will report earnings this week. This comes after the reports from JPMorgan (NYSE:JPM), Goldman Sachs (NYSE:GS) and Wells Fargo (NYSE:WFC) on Wednesday. The investor reactions to those was mixed. The king of the banks, JPM stock failed to find love. My hunch is that BAC stock will suffer the same fate if not worse on its report.

I was a big fan of owning bank stocks when they were cheap. For the last six months, they have gone on an incredible rally. While this is great for the bulls, fundamentally they are now extremely expensive. If you compare them to other companies they are still cheap, but my beef is with how expensive they are relative to themselves. Bank of America P/E now is 65% more expensive than 2019.

Moreover, it has a lot of exposure to mortgages where there might be trouble. Part of the bailout package last year was mortgage relief. Banks had to allow borrowers to go into forbearance with minimal effort. All they have to do is say they suffered hardship with no proof and immediately stop paying on their loans. Although this is not a forgiveness program, it raises the problem of unwinding it and soon. Meanwhile, the payments are accumulating, and for a good portion of the participants, it won’t be easy. The trend is improving, but there still is a lot of money coming due in the next few months.

Just like in the previous example, I do not want to short BAC stock outright. If I’m long the stock, I would simply book profits. Investors who want to short it should can mirror the same strategy from above. I don’t mind chasing JPM or GS stocks because they don’t trade like traditional banks. Bank of America still has not recovered its all time highs from 2006. This should be a reminder that this is not a momentum stock. It will need great news to rally, and I doubt that management will provide that.

The central banks policies are meddling with their ability to earn. Quite honestly, the goings on are so convoluted that I doubt there are experts left in the field. All the proof I need is in their fundamental metrics. Revenues are shrinking, margins are trending lower, and debt ratios are rising. Moreover, cash flow from operations last year was less than half of that of 2019. This is after 2019’s being 15% smaller than 2018, so it’s not a pandemic thing. This is all to say that investors chasing their stocks to the moon should be more realistic.

CBOE Volatility Index (VIX)

CBOE Volatility Index (VIX) Stock Chart Showing Potential Fight Above
Source: Charts by TradingView

With my third pick for the day, I will look down while looking up. I chose to suggest an upside trade in the VIX. Wall Street refers to it as the fear index but I disagree. The pandemic broke it for that purpose. The VIX is now as good at measuring fear as the CPI is good at measuring inflation. In case you missed it, I was being sarcastic. Fearful markets don’t set records every week, and they don’t buy junk stocks. All of this has been happening for months on end while VIX was above 20.

For more than a year, the VIX stock stayed at extreme highs. Then it spent the entire month of March fighting to hold 20. Then finally this month it broke decisively below it. My thesis is that the rhetoric will rekindle a headline to spook investors. The VIX fans will spike it to or above 20 one last time before giving up the ghost for good.

This is an important nuance in my write up today. I started by saying that these are extremely bullish markets. I also said that they will buy the dips, and that’s what I will be doing. In the heat of the moment, if and when the dip comes, people will panic. They will reach to buy “protection” while those who got ready now will be selling to reap the rewards.

To be a ready one, I can buy VIX June $17 calls now when not many are looking. The maximum risk on those is the money I spend up front. This also will double as insurance to my longs. The beauty about it is that unlike car insurance, here I can change my mind. I can sell the calls back for partial gains or losses at any time.

Before we end this, I have a few important notes and reminders. We are going into a seasonably weak stretch on Wall Street. They gave it its own tag line, which is “sell in May and go away.” Counteracting that this year we have the largest stimulus ever. We also have another $1.4 trillion gift from the Federal Reserve. More recently, the White House is talking about an additional $2 trillion in fiscal spending. This is to remind us that all of our assumptions should be at best with medium convictions. As soon as I see signs I’m wrong, I will act on them and get out of the way. Being stubborn will cause a lot of pain.

On the date of publication, Nicolas Chahine did not have (either directly or indirectly) any positions in the securities mentioned in this article. 

Nicolas Chahine is the managing director of SellSpreads.com.

Article printed from InvestorPlace Media, https://investorplace.com/2021/04/3-stocks-to-fade-headed-into-the-sell-in-may-season/.

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