Seeking Alpha

Tracking How Far They Fell: April Edition

by: Cory Cramer

In January, I began publishing articles that examined how far several large-cap industrial and service stocks might fall during a bear market, and I suggested some alternative investments.

This article will examine how those industrial and service sector stocks are tracking against the more defensive alternative investment ideas.

All 11 of the industrial stocks I wrote about in January and February underperformed my suggested alternatives.

However, my primary service sector alternative, Berkshire Hathaway, did not perform as well, and I propose some possible reasons why.

I also offer my views about what we might expect going forward in 2018.


In mid-January, I began writing a series of articles that examined how far some popular large-cap industrial stocks might fall if we were to have a downturn within the next three years. I continued writing about stocks in the industrial sector through the month of February, eventually covering a total of 11 popular large-cap industrial stocks: Caterpillar (CAT), Boeing (BA), Cummins (CMI), Deere (DE), General Dynamics (GD), Northrop Grumman (NOC), Eaton (ETN), Emerson Electric (EMR), United Technologies (UTX), 3M (MMM), and Rockwell Automation (ROK).

While all the articles were generally bearish in nature and meant to be a warning to current investors that even the stocks of good companies could fall quite far during a bear market, I didn't stop there. In each article, I suggested alternative investment ideas for the stocks in question. With the exception of 3M, whose suggested alternative investment was Johnson & Johnson (JNJ), those alternative investments either took the form of the PowerShares S&P 500 Low-Volatility ETF (SPLV), Vanguard Utilities ETF (VPU) or a split between the two of them.

Beginning in March, I switched to the service sector and covered five stocks: Union Pacific (UNP), Costco (COST), FedEx (FDX), S&P Global (SPGI), and CSX (CSX). For those stocks, my primary alternative stock idea was Berkshire Hathaway (BRK.B). This article will examine how those stocks and alternatives are performing so far, too, and I'll also share some of my observations about the market, as well as some general takeaways or investing lessons we might learn from tracking these results. In addition to that, I'll propose a couple questions that I'm currently thinking about and seeking answers to.

I'm going to be posting total return Y-Charts for each one of these stocks and their suggested alternatives in this article. The dates for the charts are from the day of publication of the article, until the end of April for each stock. I think it's important to post the charts for each stock because, while the sum total return is important, it is equally important to see the price relationships between the stocks and their alternatives as they move through time. I'll also include the SPY as a reference point as well, even though I'm not really using it a true benchmark per se. The reason for these parameters is to keep me consistent and honest with the tracking of the performance over time so readers know I'm not cherry-picking dates. Even without a pro-subscription, readers can go to my profile and see the publication dates of the articles if they would like to double-check my work.

Takeaway #1: Good defensive ETFs work.

Of the 11 industrial stocks I wrote about in January and February, all 11 have underperformed their defensive ETF alternatives through the end of April. I don't know how long this will continue. There is a reasonably good chance we have another year of solid economic growth ahead of us, and that could buoy some of these industrials between now and the time of the next recession. But it's good to see that the defensive ETFs I recommended are performing how they are supposed to perform. That's really all I can ask for. By far the hardest part of the "How far could they fall?" series if finding good alternatives for quality stocks that happened to be overpriced. The fact that within 3 months all of the alternatives have outperformed the target stocks is just icing on the cake.

Now let's take a look at the first seven industrial stocks:

Chart CAT Total Return Price data by YCharts

The chosen alternative for Caterpillar was SPLV, and even though CAT has turned in two fairly impressive earnings reports since the January 15th article, the price of the stock is down over 14% and shows no signs of recovery yet. During the same time period, SPLV is only down 2%, which is half as much as SPY. This trend is likely to continue for a while unless CAT continues to bring in great earnings beyond the next couple quarters. If it does that, it might be able to draw some investors back in. But it's going to be hard to make up the ground it has lost since January.

Chart CMI Total Return Price data by YCharts

I really hope I was able to save some folks some money with Cummins. I know there were a couple comments on the original article from January 22nd where a few investors had decided to lighten their positions after reading my article. In three short months, rotating out of CMI and into VPU would have saved an investor nearly 20% already and outperformed the S&P 500 index by 10%. On top of that, investors would be up 4% so far this year even while investing very near the market peak. Even though Cummins stock is down significantly, keep in mind, that it is a very deep cyclical stock. I wouldn't be looking to rotate back in yet.

Chart DE Total Return Price data by YCharts

I wrote my Deere article on January 24th, and while it wasn't clear to me that Deere was as overvalued as some of the other industrials, I think the underlying fundamentals regarding the future are much shakier, and that's why we've seen the steep decline in price. I'm not a farming expert, but, living in Iowa, I do catch a bit of the farming market news each day on the radio, and the current debate over the renewable fuel standards, as well as ethanol exemptions for an increasing number of refiners, seem to be tilting away from propping up grain prices. Additionally, one of my friends shared with me several reports about low milk prices and wheat surpluses. I haven't done a deep dive into this at all, but I think at the very least, there is a lot of uncertainty for Deere's customers right now, and we are seeing that translate into weak support for the stock. I would still wait before jumping in if you are a value investor, even after its nearly 20% decline.

Chart EMR Total Return Price data by YCharts

For my February 7th Emerson Electric article, I suggested both SPLV and VPU as possible alternatives. Since this article was published just before the bottom of the mini-correction, EMR hasn't underperformed as much as the others, but I also identified it as shallower cyclical stock than Cat, Deere, or Cummins, so we wouldn't expect it to fall as far. Still, even investing near that temporary February bottom, VPU and SPLV outperformed both EMR and SPY.

Chart ETN Total Return Price data by YCharts

My Eaton article was published on February 14th, and once again, the alternatives are very steadily outperforming over time, both relative to Eaton and the S&P 500.

Chart ROK Total Return Price data by YCharts

The Rockwell Automation article was published on February 22nd. I remember there being quite a few bulls in the comments section of this article, but as we can see, Rockwell isn't any more immune to cyclical price pressures than the other stocks we've seen so far. I was ultimately looking for 30% outperformance by the alternatives and so far we are about halfway there.

Chart UTX Total Return Price data by YCharts

My United Technologies article was published on February 25th, and I was more negative on UTX than most other SA contributors I've read. It's possible that they might find a way break up or spin off parts of the company and temporarily lift the stock price. But my view is that the more likely medium-term trend is down. And in two months time, we've seen the alternative investments outperform by 10%. Unless we get a big announcement from UTX, I expect more downside, and it's probably not a stock I would be interested in buying.

Takeaway #2: Defense stocks finally begin to fall.

In last month's 'Tracking how far they fell' article, I noted that defense stocks were holding up well, but that I still expected them to fall the closer we got this fall's US congressional elections. Now they have begun to underperform.

Chart NOC Total Return Price data by YCharts

My Northrop Grumman article was published on February 1st, and as you can see in the chart, it had been substantially outperforming both the S&P 500 as well as my suggested alternatives until a couple weeks ago. It sold off around earnings time, but I haven't investigated to see if there was a fundamental reason for the sell-off. It looked like they had an earnings beat and upped guidance. But these sell-offs can happen even with good earnings if the price of the stock is expensive. My sense was these stocks had been trading mostly on headline news, so there is a good chance the price could pop at any moment in time with the right news, but the bigger risk over the medium-term is still to the downside in my opinion.

Chart GD Total Return Price data by YCharts

My General Dynamics article was published on February 8th, right at the trough of the mini-correction. (That's why almost all these returns are positive.) And much like Northrop Grumman, we see a sell-off a couple weeks ago. Perhaps this had to do with peace talks on the Korean peninsula, who knows? (Maybe someone could offer some theories in the comment section.) But it is highly likely GD has a whole lot of downside left over the medium-term. It's still worth exiting in favor of the alternatives at this point.

Question #1: Could Boeing be the next 3M?

Chart MMM Total Return Price data by YCharts

I wrote about both 3M and Boeing in late January. I offered Johnson & Johnson as a potential alternative to 3M shareholders and while it has done better than 3M, JNJ has underperformed the S&P 500 so far. I wrote an entire article on 3M a few days ago. It's titled "3 Reasons 3M Fell (And When I'll Start Buying)" and you can read it here.

Chart BA Total Return Price data by YCharts

I wrote about Boeing back on January 17th, and I think I received more pushback in the comments section than on any other article I've written. All things considered, Boeing stock has held up relatively well. It has modestly outperformed the S&P 500 since my article. And while my alternative for Boeing, SPLV, is outperforming right now by a couple of percentage points, on a relative basis, Boeing has performed much, much better than all the other industrials I have written about. Other than potential trade wars that likely won't happen, there has been almost nothing but good news for Boeing since January.

Boeing is probably the most interesting stock I've written about this year. While I've noticed considerable generational and political divides on several stocks in this market, Boeing seems to cross-over virtually all of them. The last time I checked it was the heaviest weighted DOW component. It attracts technology investors, dividend investors, aerospace and defense investors, aviation enthusiasts...everyone loves Boeing.

What I haven't been able to quite figure out about the stock, is how Boeing investors will react during an economic downturn. My sense is that expectations for the stock are irrationally high, but I'm not sure how much downside current investors would have to experience before they would abandon the stock at a greater rate than the overall market. While I'm pretty sure any big downside trigger for Boeing will likely be macro in nature, I'm not sure if we should watch Boeing in order to get a read on the macro or watch the macro in order to get a read on Boeing. I'm going to think about this some more over the next couple months, but I would be interested in anyone else's thoughts as to what it would take to trigger a disproportionate sell-off in Boeing stock.

All-in-all the 11 target industrial stocks on average are down -10.58% since the publication dates of the articles while the alternative ideas are up +1.18%. (In the event I mentioned more than one alternative in an article I averaged the performance of the ideas and treated the result as one score.) In the March update, these results were -5.3% for the industrials and +0.41% for the alternatives. So we continue to move in the expected direction.

Now let's move on to the service sector.

Question #2: Is Berkshire Hathaway's underperformance justified?

For those of you who have read this far and think I'm a stock-picking genius, things are about to change once we take a look at the five service sector stocks I wrote about in March. For the first of those stocks, Union Pacific, I offered my two previous alternatives of SPLV and VPU along with a new alternative, Berkshire Hathaway (BRK.B) as alternative ideas. For the remaining four service sector stocks from March, I stuck with only Berkshire as the alternative. First, let's see how they all compared relative to Union Pacific, and then I'll get into my commentary.

Chart UNP Total Return Price data by YCharts

My Union Pacific article was published on March 6th, and we really have a mixed bag here. My three alternatives have an average return of 0.30% vs UNP's 1.78%. That's pretty close, and given my time-frame of 3-5 years, not particularly notable at all after two months. But one of the reasons I like to track these is to see if these stocks are behaving like I would expect them to. And Berkshire Hathaway has not been behaving like I expected it to. Let's first look at Berkshire's performance vs. the other four service sector stocks I wrote about in March beginning with Costco, followed by FedEx, S&P Global, and CSX, then I'll get into my commentary:

Chart COST Total Return Price data by YCharts
Chart FDX Total Return Price data by YCharts
Chart SPGI Total Return Price data by YCharts
Chart CSX Total Return Price data by YCharts

Alright, let me begin by putting some of this into context. My reasoning for suggesting Berkshire as a good alternative had to do with the fact that I thought Warren Buffett's ability to purchase shares of Berkshire Hathaway stock if the price-to-book value fell below 1.2 would likely put somewhat of a floor under the stock in the event of a bear market or a recession to a greater extent than other stocks would have. I also thought that Berkshire was fairly valued at its current levels (or, roughly any price-to-book value under 1.5). Berkshire is still trading well within that range, so my original thesis isn't threatened in any way. (In fact, I just bought some more Berkshire stock this week.)

However, what puzzles me is Berkshire's underperformance over the past couple months relative to the S&P 500. I just can't put my finger on a good theory as to why it's happening. When I look at some of the overcrowded spaces like large-cap dividends and certain high-profile technology names, clearly Berkshire doesn't fit in either of those categories (which is one reason why I think it's fairly priced right now).

Additionally, the railroads turned in solid quarters (and were rewarded by the market), yet people seem to have forgotten that Berkshire owns a railroad. Utilities have outperformed almost everything since February, yet people seem to have forgotten that Berkshire owns a major utility. Rising rates will likely help banks' earnings this year, and Berkshire has a large stake there as well. Orders for planes have been coming in like crazy, yet people seem to forget Berkshire owns Precision Castparts. I know there is obviously a big insurance component to Berkshire but is that component so bad that we think Berkshire hasn't been making money hand over fist this past quarter? Is Berkshire now being treated as an industrial stock by the market? Is it that the market doesn't like Berkshire's disciplined approach and large cash position? Are Berkshire's long-time stockholders dying off? I would really be interested to hear anyone's opinions about Berkshire's recent underperformance, and the potential cause. I feel very confident about my position in Berkshire, but I also like to be aware of the reasoning (to the extent there is some) behind those investors selling the stock.

Berkshire's annual meeting is this coming week, so that could be the potential spark that propels the stock-price higher. In the meantime, if BRK.B hits $170 per share, I'll be buying lots more without hesitation unless I can identify a good reason not to between now and then. One adjustment I am making is to balance any recommendations for Berkshire stock as an alternative with at least one other stock (probably VPU right now in most cases). The reason for this is after thinking about the scenario of my Berkshire buyback thesis, while I do think there are a lot of investors who will buy into Berkshire stock on the way down as it nears that 1.2 price-to-book number, I don't think Buffett would likely pull the trigger on buybacks until after the market had hit bottom and was recovering, and he still couldn't find a bargain out in the market to buy. For this reason, there are some limits to using Berkshire as a defensive investment, if the plan is to rotate back into a stock like Costco or FedEx near the bottom of the cycle. While I still think Berkshire will fall less than many stocks, especially if we experience an extended recession or economic stagnation, in a short and quick downcycle scenario, it might not be the best vehicle, and should probably be balanced with something else.

Thus far the five target service industry stocks have an average return of 2.78% while the alternative ideas, consisting mostly of Berkshire, have returned -3.68%. The total average returns for all 16 target stocks covered in this update is -6.40% while the alternative ideas have returned -.34%. For a reference, during these same time period, the S&P 500 has returned -3.05%.


Stocks from the industrial sector are performing very much how I expected them to relative to their defensive ETF alternatives. The handful of service stocks I've covered so far are doing fine, but Berkshire Hathaway as an alternative hasn't been behaving as expected, particularly with respect to its underperformance of the S&P 500. I'm very curious to here readers' theories as to why. I'd also like to hear any thoughts on what might trigger a Boeing sell-off (even if you think it won't happen for many more years).

For next month's installment, I'll be adding 8 more service sector stocks to the five I briefly covered this month. They are: Carnival (CCL), Southwest Airlines (LUV), Ross Stores (ROST), Paychex (PAYX), Magna International (MGA), Best Buy (BBY), W.W. Grainger (GWW), and Tiffany (TIF). This should give a much more diversified view regarding the service sector than we had this month, where two out of five were railroads. Additionally, I chose a wider variety of alternative investments for these eight than with the first five so there should be more to write about. And, I'll probably divide the discussion into two articles instead of one, since discussing 24 stocks and their alternatives can get a little unwieldy in a single article. So the service sector should get its own article next month. I haven't yet checked in to see how any of these new service sector stocks have been doing, so it should be interesting.

As for what to expect from me in May, I plan to focus on the financial sector for this month's "How far could they fall?" series. I also plan to mix in a few more idea pieces than I did in April, which was fairly heavily focused on single ticker stocks.

Disclosure: I am/we are long BRK.B. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.