Tracking How Far They Fell: July 2019 Edition

by: Cory Cramer

In the first half of 2018, I warned investors about 27 cyclical stocks that could fall quite far in a bear market.

I suggested some alternative investments I thought would be more defensive and also suggested a rotational strategy that could increase one's shares of the target stocks at no extra cost.

So far, we've had 16 successful rotations with large free share gains. And this month, we add one more: Boeing.

This article will track the performance of the remaining 10 ideas through the month of July, as well as 2 more we've added in 2019.



Beginning in mid-January of 2018, I wrote a series of articles that examined how far some popular large-cap cyclical stocks might fall if we were to have a downturn within the next three years. 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 cyclical stocks in question. The four most frequent alternatives I suggested were the Invesco S&P 500 Low-Volatility ETF (NYSEARCA:SPLV), the Vanguard Utilities ETF (NYSEARCA:VPU), Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B), and the Invesco S&P 500 Equal Weight ETF (NYSEARCA:RSP), or some mix of them. I called this series of articles the "How far could they fall?" series. The goal of the articles was to warn investors of the potential downside these stocks had while also offering alternative investment ideas that current shareholders could rotate into while the prices of the target stocks were high. Then, after the target stocks had fallen significantly, rotate from the defensive positions back into the target stocks. The idea was that this process would prevent buy-and-hold investors from suffering big declines while also producing free share gains in the target stocks compared to a buy-and-hold strategy.

For example, if one rotated out of the target stock and into the defensive ETF while they were both priced at $100 per share, then during a bear market, the defensive ETF dropped to $80, and the target stock to $40 per share. At that point, you can rotate back into the target company stock and own twice the number of shares at no extra cost. Then, when the stock price eventually recovers, you have doubled your wealth compared to what it would have been if you held the target stock through the entire period (minus taxes, of course).

In order for all this to work, one needs to 1) identify a quality company, 2) understand when it is overvalued, 3) get somewhat close at identifying the late stages of the business cycle, 4) correctly identify a more defensive alternative, 5) have the guts to rotate back into the stock when it looks like the world is ending near the bottom of the cycle, and 6) wait for the stock to recover.

The "How far could they fall?" series essentially takes investors through this process with a fairly wide swath of large-cap names. In total, there were 28 stocks in 2018 that I both wrote a warning article about and also offered a defensive alternative I thought would be better at the time. There were a few stocks I wrote "How far could they fall?" articles on that I decided not to offer alternatives on, like Ross Stores (ROST) and T. Rowe Price (TROW), that were too hard to predict at the time. I didn't track those. And there was one that I recognized should have been put in that category a few months later, W.W. Grainger (GWW). I noticed after I reread my original Grainger article that I explicitly said in the article Grainger's turnaround was too hard to predict, and I didn't even perform a risk/reward analysis on it because of that, but then I went ahead and offered an alternative idea anyway, which I shouldn't have done. I kept tracking Grainger's performance until the end of November 2018 when it was nearly perfectly even with my suggested alternative, and I decided to correct my mistake, call that idea a wash, and stop tracking it. So, going into 2019, we were tracking 27 large-cap cyclical ideas and how they were performing vs. my chosen defensive alternatives.

The deep correction that started in October and bottomed in December 2018 created an opportunity to rotate out of many of the defensive alternatives back into the target stocks. I wrote a fairly detailed description of those moves in my article "Tracking How Far They Fell: 2018's Rotational Winners", in which I went through all 14 of the 27 rotational ideas I'd been tracking that had been completed in 2018, and we've added two more completed rotations with Caterpillar (CAT) in January 2019 and Deere (DE) in May. So far, in 2019, I've also added two more new stocks to track, Realty Income (O) and Ingersoll-Rand (IR). Here is the table, which shows the free share gains achieved from the rotational strategy for the 16 completed rotational trades so far:

Ticker Free Shares Gained Ticker Free Shares Gained
CMI 53% EMR 30%
STT 38% GD 50%
MGA 40% ROK 35%
MMM 32% ETN 28%
NOC 47% CCL 33%
FDX 41% PNC 23%
TIF 29% UTX 29%
CAT 37% DE 34%

These are great gains, all achieved in a year-and-a-half or less. For those readers who aren't used to thinking in terms of free share gains, here were the average returns during the times when we were out of these target stocks and in the defensive alternatives: Defensive Alternatives: +4.61%, S&P 500: -5.67%, and Target Stocks: -24.45%. So, for a group of 16 stocks, we had incredible outperformance while we were rotated out of them, and we even significantly outperformed the S&P 500 with this group over this time period.

This month, we add Boeing (BA) to the list of successful rotations:

Finally, the Boeing Rotation Comes to a Close

On January 17th, 2018, my article "How Far Could Boeing Fall?" was the second 'How far could they fall?' article published, and it was the most-read article I have written for SA to date. Compared to later 'How far could they fall?' analyses and follow-up articles, the analysis in that original article was pretty crude. But I did manage to get my basic message across: We were likely late in the economic cycle, Boeing was in a cyclical business, and it would likely trade down far off its highs during a downturn. I wanted investors to be aware of that danger and I offered Invesco S&P 500 Low-Volatility ETF (SPLV) as a good place for investors to put their money while they waited for Boeing stock to come down to earth.

Here is how the two investments, along with the S&P 500 (SPY), have performed since that article.

Chart Data by YCharts

SPLV proved as defensive as thought it would be during the late-2018 sell-off and is currently up +19.20% while Boeing is down -0.30%. I'm going to give myself the benefit of rounding and say that an investor could now, if they wished, rotate back into Boeing with an ~20% free share gain in Boeing if they had rotated out back in January of 2018. However, personally, I would not be a buyer of Boeing stock at these levels (but more on that later).

From the very beginning, Boeing has been a headache for me. Compared to the other cyclical industrials I suggested investors rotate out of in 2018, Boeing marched to beat of its own drummer. As I tracked it each month, the stock price tended to follow the path of the S&P 500, except with more volatility. This occurred while most other industrial stocks either fell quite far off their January 2018 highs right away, like Caterpillar and Cummins, or eventually succumbed to falling quite far during the later 2018 sell-off.

Then, even after the first 737 Max had crashed, in early 2019, Boeing stock rocketed to even higher highs, breaking any sort of pattern it might have previously been following. Fear of missing out is the only explanation I can come up with for the irrational Boeing stock price rise of 2019. By mid-February 2019, it became clear that I needed to write an update on Boeing.

On February 12th, 2019, I wrote an update article for Boeing titled "How Far Could Boeing Fall? (Revisited)". I wrote this article because we had apparently gotten through the correction of 2018, and Boeing was now making new highs. These events, along with the fact that I had added a lot of new analysis since my original Boeing article, inspired me to revisit Boeing once again. In that article, along with the follow-up of the original idea, I noted that investors who were still long Boeing had a chance to rotate out at that point in February 2019 and earn 25% more free shares when Boeing's stock price eventually fell. Here is how that suggestion performed:

Chart Data by YCharts

Investors who rotated out of Boeing and into SPLV at that point in time could have gained over 30% more shares for free rotating back into Boeing stock today. I'm not counting this as part of the official performance record since it was from a follow-up article, but I thought I would note it.

Some final thoughts on Boeing:

Overall, Boeing stock was a consistent outlier even before the 737 Max problems. Over the past few years, it essentially became a cult stock. Once we add in the 737 Max disaster, Boeing becomes even more of an outlier. Part of the motivation for the 'How far could they fall?' series was to warn investors about the dangers of highly-priced cyclical stocks and part of it was to suggest and experiment with different long-only strategies to deal with these cyclicals. I think Boeing stock will fall much deeper from today's prices. So, it is tempting to simply keep tracking it relative to SPLV and try to pick the bottom at some later date. Doing so, though, doesn't seem to be in the spirit of this experiment. Clearly, the future price is going to be affected by the unpredictable 737 Max problems. My original thesis for selling Boeing wasn't based on this sort of disaster occurring. So, in the spirit of my original experiment, I think it's best if I declare this rotational idea complete with the ~20% share gain opportunity we have today from the time of my original Boeing article.

100% Success Rate with 2018's Industrial Cyclicals

As I noted above, in early 2018, I started writing the 'How far could they fall?' series. My original intention was to warn investors about the dangers of industrial cyclicals late in the business cycle and offer alternative investments. It's important to note that I only focused on what I considered to be 'high quality' businesses, or at least stocks that I would be interested in owning myself if the price was right. Too often, I see investors make the assessment that a business is high-quality and then go on to ignore the price and buy it. Or, I see investors who bought at a good price several years ago, but refuse to sell the stock even when it becomes clearly overvalued. As a stock writer, it is much harder to write 'sell' articles on the stocks of high-quality businesses, so this series was not an easy task.

All in all, I wrote sell articles on 11 industrial stocks of the highest quality in January and February of 2018. All 11 rotational ideas have now produced free share gains of 20% or more (as depicted in the earlier table). This is an incredible accomplishment, and I think that it shows the core of my mission back in 2018 was a success. I hope I saved some investors some money and increased their wealth in the process.

Back in the spring of 2018, after I had finished covering a pretty big swath of the high-quality large-cap industrials, I decided to experiment and see if there were other stocks in which the same approach could be applied and if there were other 'defensive alternatives' that might work as well as SPLV and VPU. So, I moved on to the service and financial sectors. Several of these stocks proved to be cyclical as well and the rotational strategy worked fairly well. Others only show their cyclical colors during true economic recessions, and we are still tracking those because we haven't had a recession yet. On the flip-side of the equation, some of my new defensive ideas like Berkshire Hathaway and S&P 500 Equal Weighted ETF (RSP) have yet to prove as effective as my original defensive ideas of SPLV and VPU. While one other defensive strategy I tried has worked beyond my expectations and led to some new insights for future investing. Let's take a look at all these now.

Those Ideas We Are Still Tracking

Union Pacific (UNP) 3/6/18

Chart Data by YCharts

Union Pacific is near all-time highs. It's always interesting to look at this one because I noted three possible defensive alternatives in the article and so we can see their relative performance from the same date and how much Berkshire Hathaway has underperformed. While VPU is up almost 28% and SPLV 22%, Berkshire is flat. I'm going to discuss Berkshire's underperformance (and current value) in a future article, but you'll notice that most all of the stocks in which I suggested Berkshire for defense, we are still tracking. For tracking purposes, I average my three suggestions, and they have averaged a return of +16.93% vs UNP's +40% since publication. I wrote a follow-up on UNP not too long ago, and I still consider it a 'sell'.

Costco (COST) 3/8/18

Chart Data by YCharts

The phenomena of Costco's incredible run here is something I'm currently researching more broadly for the Cyclical Investor's Club and will probably write about some of my findings publicly within the next month or two. Needless to say, I underestimated Costco's ability to make a huge late-cycle run like this, but I've already learned a lot from it. Given Costco's dramatic drop in late 2018, I still think there is a chance to get even with this one during a recession.

S&P Global (SPGI) 3/19/18

Chart Data by YCharts

S&P Global is even higher than this now after a good earnings report. The question here is whether the stock has become less cyclical than in the past. I'm betting that it hasn't, but I could be proven wrong. It actually fell lower than Berkshire during the 2018 correction, so there is some evidence that the tide could go out fast.

CSX (CSX) 3/22/18

Chart Data by YCharts

Cracks finally started to show with CSX with its recent earnings report. I think this trend will continue if the economy weakens.

Southwest Airlines (LUV) 4/4/18

Chart Data by YCharts

Berkshire is currently outperforming LUV. Headwinds with the 737 Max aren't helping LUV here, and eventually, I think the cycle catches up and we get some nice share gains out of this one.

Paychex (PAYX) 7/11/18 (This not date of publication, but instead the date at which it hit $70, which was where I thought one should rotate out as noted in the original article.)

Chart Data by YCharts

Paychex was one of those stocks, like Costco, where after a more careful examination, I realized that their earnings weren't particularly cyclical and I should have excluded them from this series. My goal is to get back to even on this one and call it a wash. We're pretty close.

Best Buy (BBY) 4/17/18

Chart Data by YCharts

One of the observations I've had while tracking these ideas the past year and a half is that RSP and equal weighting has underperformed as a defensive alternative. We are now at a point with its relationship to Best Buy, that since the performance of the two is so close and the return has been almost the same, I am going to call this defensive idea a wash, and switch RSP to a 50/50 mix of SPLV/XMLV, which I think offer the best defensive combination today. So, going forward, from the end of July, I'm going to track Best Buy versus the new combo. I think during the next downturn there will be a big opportunity for share gains in Best Buy and if I was long Best Buy today, I would rotate out.

American Express (AXP) 5/2/18

Chart Data by YCharts

As part of an experiment in late-cycle strategy, I suggested a combination of Fiserv (FISV), a secular growth stock, and VPU a defensive utility ETF as alternatives for American Express. This strategy was hunch on my part that this combo could serve as a form of both offense with Fiserv and defense with VPU. The hunch worked better than I could have ever expected, with Fiserv up over 50% and the combination up +36.78% since publication. I'm currently conducting more research on this phenomenon and it has yielded some interesting results so far. I'll probably share more about this in the coming months.

Progressive (PGR) 6/19/18

Chart Data by YCharts

The combined alternatives have returned +14.48% but haven't kept pace with Progressive. The stock did fall a lot back in December, though, so I expect to have a reasonable shot at share gains if we have a recession.

Nike (NKE) 8/14/18

Chart Data by YCharts

The alternatives have returned +10.65%, which is a little more than Nike. I think Nike's extremely high valuation along with possible tariff problems could provide a solid share gain here.

Realty Income (O) 2/20/19

Chart Data by YCharts

Back in 2016, I shared an idea that was able to net close to a 20% share gain for Realty Income shareholders. The idea above is the second attempt at free share gains for Realty Income shareholders, and we are starting make a little progress toward that goal with the alternatives returning +8.35%, about 6% more than Realty Income so far.

Ingersoll-Rand (IR) 4/16/19

Chart Data by YCharts

Ingersoll-Rand has remained strong this cycle and is currently about 5% higher than the +4.51% the alternatives are averaging.

Of the 12 ideas we are still tracking, the defensive alternatives have returned +10.58%, the S&P 500 +10.89%, and the target stocks +21.53%. When one considers that the purpose behind offering the 'defensive alternative' ideas was as an alternative to cash, they are performing quite well, about the same as the S&P 500. Now, we just have to wait for a recession...


After we add Boeing to our 16 already completed rotations, we now have a performance of the 17 completed rotations for the defensive alternatives of +5.48%, SPY of -4.89%, and the target stocks of -23.03%. And if we put both the completed rotations together with those we are still tracking then the defensive alternatives have returned +7.59%, SPY +1.64%, and the target stocks while we were rotated out of them of -3.80%. So, even when we include the high-flying stocks like Costco that are still doing well, the defensive ideas are still significantly outperforming with a pretty good sample size of 29 stocks and well over half of the rotations completed already. And, we still haven't had a recession yet.

I've learned a lot by tracking these ideas over the past year-and-half already, and they continue to inspire more research. It seems pretty clear already that my general strategy was sound, but with some fine-tuning will be even better in ten or twenty years the next time this market situation arises again. That's one of the things that makes investing hard. So many similar situations have already occurred in the past, but oftentimes they are too far in the past for us to have experienced them in our lifetimes. I believe the sort of cycle we are experiencing right now comes along about every twenty years or so. That means if history repeats, then next one will come along about the time I'll be nearing retirement. I expect what I learn today to save me a lot of money at that point in time, so long as I can remember what I've learned.

Disclosure: I am/we are long XMLV, 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.