The earnings season is always an interesting time to reflect on investment ideas. This is the opportunity for management teams to report on their progresses and challenges. All companies, and maybe especially those with large capitalizations, are trying to look their best. The mistake that most investors make is to expect good reactions to good reports. If that was the case then more than 90% of all earnings reactions would be up. Clearly that is not reality. Nevertheless, the rally has gone too long and there are mega-cap stocks to fade up here.
The most recent sign of exhaustion was the reaction to Amazon (NASDAQ:AMZN) stock on Friday. The company reported the night before. It had an incredibly strong quarter with absolutely no disappointments. Yet, the stock could not hold its greens and closed red for the day. This does not reflect on Amazon’s future. It is a short-term, knee-jerk reaction to the earnings as a coin flip.
Today’s call to fade stocks from these high levels is not a criticism of their fundamentals. Don’t mistake this for a reason to short the companies outright — they are doing well. They say to not fight the tape, so we’re merely attempting to take advantage of temporary weaknesses within strength.
Over decades of investing, I’ve learned to not overstay my welcome in winning trades. Regardless of how much I like a stock, I expect it to have temporary weaknesses. These make for good times to book profits and prepare to reset for another run.
All stocks have to trade within the market collective. The Nasdaq for example could not rally on excellent news. Big tech names, including Apple (NASDAQ:AAPL) and Microsoft (NASDAQ:MSFT), reported blowout earnings. yet the weekly scoreboard was red.
If you cannot rally on good news than there might be some selling ahead. Follow-through this week will be crucial to watch. Meanwhile here are the three mega-cap stocks to fade for the next couple of weeks.
Mega-cap Stocks to Fade: Caterpillar (CAT)
In spite of the global struggles from the pandemic, 2020 turned out to be a great year for CAT stock. Going into 2020, it had struggled to regain its highs from the 2018 correction. In January of that year the stock started a terrible descending channel. It finally bottomed with the Covid-19 crash, and then the magic started.
CAT stock rallied 174% where it sits now.
For the last two months, Caterpillar has been consolidating in a sideways action at its highs. Usually this is good news for the bulls because they can use it to build new foundations. But this time there is a good chance that it’s different. There could be signs of exhaustion that the bears are ready to take the reins for a bit.
If I am right, CAT stock could be ready to fall and retest $200 per share. If it does, that wouldn’t be a disaster. In fact, this is how normal price action unfolds. My thesis has support stemming from looking at the monthly chart. Caterpillar had a similar run from April of 2016 that ended in a big correction two years later. Coming into last month, the stock had 13 monthly green candles in a row. April was the first red one since the 2020 crash.
My note today is to try and avoid a big potential let-down. If it doesn’t happen, then there would be no harm in trying.
Second on our list is Visa, and it’s just as strong as CAT. In fact, of the three today, I like it the best for the long term. Fintech is a fan favorite on Wall Street for good reason. This is an extremely exciting industry which is bleeding into crypto. The arguments today also extend to MasterCard (NYSE:MA) and American Express (NYSE:AXP) to some degree. They trade in unison more often than not. Newcomers like the Square (NYSE:SQ) and Paypal (NASDAQ:PYPL) hog the headlines but these three old dogs are adapting to meet the challenges.
Usually Visa stock stock doesn’t outperform MasterCard. Of late, though, it has done so — and by a wide margin. Last week it set two records on Thursday and Friday. Moreover it has had six incredibly strong candles in a row. While V stock is making new highs, it makes sense to book some profits and let it rest a bit.
Fintech stocks hit the skids late March. Specifically, Visa fell almost 10% in three days. It has since rallied back almost 15% so it’s time to rest. I expect there could be another dip to retest $225 per share. It will likely go the way of the whole market this week.
The reaction to earnings last week was positive but not extraordinary. It could rally some more but it’s at the upper end of the trading channel. The regression analysis leaves room for my mini-bear thesis to unfold. Dropping to $220 per share would be merely reverting to the mean. Long term, I would catch all big falling knives in it.
Mega-cap Stocks to Fade: Bank of America (BAC)
Bank of America’s business model is as boring as it gets within its sector. This is not a bad thing, it’s merely a description of how it operates. It has always played within the rules and is a giant U.S. money center. JPMorgan (NYSE:JPM) and Goldman Sachs (NYSE:GS) are famous for trading desks, Wells Fargo (NYSE:WFC) is the black sheep. And then there is BAC, which is known for … Well, nothing special. It’s a cranker of a corporation and I have no beef with that.
I am a little concerned about two points of contention. The first is its valuation. Currently BAC stock is way too expensive relative to itself. The price-to-earnings and the price-to-book are 80% and 40% higher than they were in 2018. Their profit margins are falling and their debt ratios rising. The business is facing headwinds and there could be more trouble coming.
The second reason comes from the charts. BAC stock just hit the massive failure levels of 2008. This is not to say that the situation now is similar. But there are investors who have been stuck there. After 13 years this is their exit point if they want it. It is up in pre-market so there are no imminent signs yet. It’s a constant reminder that my call to fade mega-cap stocks is not a full-on bearish bet. BAC stock has an additional aide from bond yields. Bond prices cannot hold their rallies which is giving BAC a boost like this morning.
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.