Since early March, the S&P 500 has risen 44% to its recent high, it is unlikely to go on at this pace for very much longer. We are still seeing overall losses in earnings and losses in revenues. Efficiency measures are lessening the losses in earnings, but this cannot go on forever. In order for the economy to grow, we will need overall increases in revenues.
Currently we seem instead to be riding a wave of almost irrational exuberance. The earnings bar was set at approximately -36%. The S&P 500 stocks are beating that so far (as of the end of last week) by 10%. They are still reporting on average substantially lower earnings than 1 year ago.
The fundamentals for a continued rise in the markets are just not there right now. The rise can go on. It may ride the tide of earnings beats until the end of the earnings season (or it may not). At that point, barring some unforeseen magic, the market will almost have to retreat. It may not wait that long.
If this retreat does occur, I have picked out two stocks that should outperform to the downside.
Marriott (MAR) is a high end hotel chain. Its profits are consumer driven. It is supposed to suffer further decreases in earnings through out this year. Then next year it is currently estimated to hold steady on those reduced earnings.
However, this may not happen. In fact the analysts have decreased their estimates for MAR earnings for both 2009 and 2010 significantly in the last month. MAR did beat earnings estimates (July 16 reporting date), but it was by very little.
This has caused the stock to hold its price for the moment. When a significant retracement starts, it will retrace significantly. The unemployment rate is still going up. It will likely be higher than it is now through out 2010 (i.e. 10+ %).
This single factor will cause MAR’s earnings to go even lower than they are now. Unemployed people do not spend money on high end hotels. People who are worried about becoming unemployed do not either. Businesses cut back their budgets. Many businesses may specify lower end hotels over the next year or two.
That redirected business may be hard for MAR to get back. The current TTM PE is 78.0. The predicted FY 2009 PE is 25.7. The predicted FY 2010 PE is also 25.7. The risk on these last two numbers is definitely to the downside. The trend in the analysts’ estimates is to the downside. The revenue estimate for 2010 is slightly lower than that for 2009. No one is seeing an upside soon.
This lack of hope is what will send this stock downward. Its PE is too high. MAR’s predicted PEs are still too high. Its predicted PEs have substantial downside risk. There is no ray of sunshine. It has a debt to capital ratio of about 63%. It will struggle with its debts in a high vacancy market. It has a Price to Cash Flow ratio of approximately 15.
This stock has already started trending downward in a market that is still trending upward. Even a small earnings beat did not stop this. It should take off downward when the entire market begins to retrace. The put to call open interest on MAR is 1.23. The chart is below:
The second stock I have selected has been a popular stock lately -- “too popular” to my mind. Green Mountain Coffee Roasters (GMCR) operates in the specialty coffee industry. It has been growing its earnings. It has been growing its revenue. This is supposed to continue.
Why am I suggesting it as a short then? First it is in the high end retail business. As the unemployment level rises and stays high for the next couple of years, the high end retail market will get hurt. People will conserve. GMCR sells to offices, hotels, retailers, and directly to consumers. All of these groups will be trying to conserve money. This will hurt GMCR.
Next, GMCR has a great chart. It has done nothing but go up. It has consistently beat earnings estimates. However, that is exactly the problem. The market has liked it so much that it has bid it up to a ridiculous multiple. GMCR is trading at 64 times TTM earnings. It is trading at 65 times 2009 predicted earnings. It is trading at 46 times 2010 earnings.
It is not reasonable to expect it to keep such a lofty valuation in the face of the almost surely high unemployment of the next two years. Even the analysts have started having their doubts. They have lowered their earnings estimates for both 2009 and 2010 in the last month.
This is likely a sign that a change of direction is near at hand for GMCR. I do not mean that it will sink into oblivion. I merely mean that it will retrace from its lofty heights to a more reasonable earnings multiple. GMCR is predicted to grow at about 28% per annum over the next 5 years. This number may well be at considerable risk. A 28 PE might be more reasonable for this kind of growth, especially when the growth is at risk.
Both the debt to capital ratio of 40% and the TTM Price to Cash Flow ratio of 42 indicate there is ample to worry an investor if this company experiences any substantial headwinds. The company has 35% short interest, so keep in mind that it is vulnerable to a short squeeze. If the market starts going against you, you will likely want to exit your short quickly. The beta is 1.3.
The stock is 95% owned by institutions; when the institutions start bailing, which should be soon, the stock could go down dramatically.
In addition to the fundamentals, the chart below would tend to substantiate my thoughts on a retracement possibility. GMCR is $26 above its 200-day sma. It is $10+ above its 50-day sma. It is near its top Bollinger Band. The bottom Bollinger Band is about $15 below its current price. The Williams %R is signaling that GMCR is overbought. The Money Flow Index is neutral in an up market. The Money Flow Index seems extremely likely to turn negative in a retracing market. It definitely shows that interest in bidding the stock up further is waning.
Still, this stock is trending upward. You would not want to short it without the market behind you. With an overall market tailwind, it is likely an excellent short though. The trick will be to get in at the right price. It has bounced off of its 50-day moving average any number of times.
If you get a chance to short this stock above $70 in the near term, that is probably a good play. If you wish to wait for the market to be assuredly heading downward, you probably want to try hard to get in at $65 or higher.
The downside move may be limited to the 50-day sma line. More aggressively it could move to its lower Bollinger Band. It is highly overbought. The 200-day sma line is probably the very deepest you could expect it to fall in the near term. The company reports earnings July 29. Given the company’s history it should beat. This may temporarily drive the stock price upward. You may wish to wait until after earnings to try to short the stock. The put to call open interest in GMCR is 1.41.
If you are looking for other shorts, I have recently written articles on LM (see here and here), HOG (see here), and CBEY (see here) which may prove to be profitable shorting opportunities in a retracing market.
CBEY put to call open interest is currently 3.10 on Schwab.
HOG put to call open interest is currently 1.36 on Schwab.
LM put to call open interest is currently 0.88, which is again curious since GS’s is 1.26. LM is trading at more than a 100% premium to GS. Rational thought would make one think LM has to come down.