- Many investors find it difficult to sell high-quality winners. But when high prices push expected future returns low enough, even the stocks of the best businesses should be sold.
- My goal is to demonstrate the long-term validity of taking profits in overvalued stocks by understanding sentiment cycles.
- I also share a rotational strategy that allows investors to take advantage of these cycles.
- In this update, I include the expected 10-year CAGRs for the stocks we're still tracking.
- Looking for a helping hand in the market? Members of The Cyclical Investor’s Club get exclusive ideas and guidance to navigate any climate. Get started today »
This article is a follow-up to a series of articles I recently wrote about how to avoid losses and how to profit from sentiment cycles. If you are already familiar with the strategy, feel free to skip down to the "Highlighted Stock of the Month" section and read from there. If you are new to the series, I'll explain the background and goals of the series in the next few sections to get you up to speed. Part one of the series, "Ignore Sentiment Cycles At Your Own Risk," explained what sentiment cycles are and how even the stocks of high-quality companies can sometimes become overvalued enough to sell. I also shared a working theory of the factors that I think contribute to the formation of a sentiment cycle with any particular stock. In part two, "Mitigating Sentiment Cycles," I shared a long-only investment strategy that can help investors avoid some of the losses associated with a sentiment cycle by rotating out of the overvalued stock and into a more defensive position; then, when the price of the overvalued stock comes down, rotating back into the stock and being able to own more shares than when you sold it without spending any extra money.
For example, let's say one owns the stock of company XYZ and it trades at $100. The business is a great business, but the price has become so expensive that the implied future returns if someone bought the stock at that price are so low that it makes sense to sell it. Now, let's say there is a defensive ETF like the Invesco S&P 500 Low Volatility ETF (SPLV) which also trades at $100 but is likely to trade with much less volatility than the market and unlikely to fall as far and as fast as an overpriced stock under most conditions.
Let's say someone sells XYZ and rotates into SPLV while both are priced at $100. Then, over the course of the next several months, the price of XYZ comes down to earth and falls to $80, while SPLV stays at $100. If one owned 100 shares of XYZ initially, they can now sell their SPLV shares and buy 125 shares of XYZ because the price is cheaper. This results in a 25% "free share gain" compared to if one had just held the stock of their great business throughout this entire period.
That's a basic explanation of how free share gains and a long-only rotational strategy work. Back in 2018, I wrote a long-running series about how to do this with highly cyclical stocks, and I continue to update that series each quarter. The current series you are reading now is about the stocks of businesses whose earnings are not highly cyclical. These businesses will all have earnings with low-to-medium earnings cyclicality, but they will be stocks that have become overpriced mostly due to the sentiment changes of the market.
Outline of the Simple Rotational Approach
In "When To Sell And When To Buy Back Again," I explained several different levels of sophistication an investor can take while using a long-only rotational strategy. If you would like more details on the strategy, give that article a read.
For this series, I am sharing what I call a "simple mixed rotational strategy." The main goal, other than warning investors that their high-quality stocks will probably not produce great returns if they are held at high prices, is to demonstrate the usefulness and effectiveness of the rotational strategy in real-time rather than using a back-testing approach. Back-tests can be useful, but not nearly as useful as watching how a strategy works in real-time when unique and unpredictable situations arise, like, say, COVID-19.
Now, let's outline how the strategy works.
The first step is identifying a high-quality business with a great long-term history of consistent and steady earnings growth. All of the stocks in this series are stocks that I am interested in owning at least for the next 10 years. These are not low-quality, short-selling candidates. Occasionally, I eventually find something I don't like about the business and hold off buying it even after the price falls (in this series, that actually happened with Lowe's (LOW), and I wrote an article about that) but initially, all the stocks in this series appeared of high enough quality to interest a potential purchase. My primary audience when I share the articles are investors who already own the stocks. My goal is to let them know if their stock is overvalued enough to sell, with the ultimate goal of buying it back at a lower price and increasing the number of shares they previously owned for free.
The second step is to identify if the stock is expensive enough to sell. In April 2019, I started specifically examining stocks that looked overvalued on the surface to see if they were sell-worthy based on their expected 10-year forward returns. I call these articles "10-year, Full-Cycle Analyses." About two-thirds of the stocks that I examined did turn out to be "sells" after closer examination, and these are the stocks you'll find in this series.
My current standard to declare a stock a "sell" is that if the 10-year forward return expectations are lower than a 4% CAGR. All of the stocks in this article will have had a 10-year CAGR expectation of less than 4% at the time I wrote about them, or eventually had their prices rise after I wrote about them to prices that would have produced CAGR less than 4%. (You can find links to the original articles on my profile page. Type the ticker symbol into the "filter by ticker" box and it will pull up the articles I've written on that ticker. You will need a SA Premium subscription to read many of them, but you can check the publication dates if you'd like to double-check my work or see my sentiment rating at the time.)
The third step after one sells is to decide what to do with the proceeds of the sale. I call this one's "default position", which is the place money sits while it is waiting to be invested in individual stocks. It is often assumed that a cash equivalent is the default position, but I actually prefer to stay invested unless it is clear we are headed into a recession in the very near future. Up until the end of February, I did not think a recession or serious economic slowdown was imminent, but at the end of February, I did determine that a recession was imminent. So, since the beginning of March, we have been holding cash instead of the defensive ETFs I usually hold late in the economic cycle (more on this in the next section).
So, we identified a quality business, sold the stock because it was expensive, and put our money in either a 50/50 mix of SPLV/XMLV or SPLV/RSP, and then at the end of February, moved that money to cash. The next step is rotating back into the target stock and gaining free shares. For the simple mixed approach, there are two ways we go about buying back the original stock. The first way is to rotate back in whenever a 20-25% free share gain presents itself. And the second way is to rotate back in whenever the expected 10-year forward CAGR expectation reaches 8% for the stock in question, which I consider the long-term market average and "fair value." I'm going to use a mix of both ways in this series as a way to demonstrate how they work, and the benefits and drawbacks of each approach.
Over the course of the past 16 months, an interesting thing happened with the low volatility and utility ETFs I started suggesting were good defensive alternatives to expensive stocks in January 2018: they got expensive themselves. The market correction of late 2018 caused many investors to pile into low-beta and steady-earning stocks in 2019, including the ones that comprise the ETFs I was using for defense. That was good for me because I already had a large allocation to these funds, so I benefited from rising prices due to the late arrivals. The problem then became that I couldn't find anything defensive in equities that wasn't already pretty expensive itself. So, in March 2019, about a year ago, I put out a "recession strategy" in the Cyclical Investor's Club, whereby if two (mostly) objective conditions were met, the default ETF positions would be moved to cash.
On 2/28/20, I judged that those conditions were met and the default ETF positions were moved to cash (investments I had made in individual stocks remained invested, though). The next day, I wrote a blog that explained the history of all this and the thinking behind it. It's titled "Recession Mode Is Here," and I suggest everyone who follows this series read it. This plan wasn't anything new, and I had been tracking these conditions every month in the Cyclical Investor's Club because I knew the market was expensive (including the stocks that composed the defensive ETFs), even if I did not know it would be a virus that would push us over the edge into recession.
Since March, in addition to using percentage returns, I will track the growth of a theoretical $10,000 investment in the target stock and compare it to cash held as of the end of February in order to determine how many free shares could be gained as of May 31st. Read the February update for a full run-down of where each position stood at the end of February if you would like to see where the cash totals for each trade came from. I have the historical performance charts in that article.
A big part of this series is about the demonstration of various levels of reward versus opportunity risk. There are two main reasons I've found that investors are reluctant to sell high-quality stocks even when they admit those stocks are very expensive. The first reason is usually that they are worried that they may never be able to buy the stock at a lower price. The second reason is that they don't want to pay taxes on their capital gains, or they think once capital gains taxes are paid, any share gains they might get wouldn't be enough to offset those taxes.
Taxes are highly personal, but I wanted the simplest approach in this series to at least be able to offset most long-term capital gains taxes, and I also wanted it to have a very high probability of success. My estimates were that I could have an 85-90% success rate at achieving a 20-25% free share gain with this group of stocks, and I estimated that should be more than enough to cover long-term capital gains taxes and also offset about 10-15% worth of "losers" (stocks that never achieve a 20-25% free share gain opportunity). The point of choosing these levels as a goal was to demonstrate this strategy is viable even when taking into account long-term capital gains and the occasional mistake. This is geared toward investors who are really attached to a stock and have probably owned it a long time, and who are worried about not being able to buy it back at a lower price if they sell. The goal is to demonstrate the basic viability of the strategy for this group of people.
The next layer of the strategy has to do with the "fair value" approach. This part of the strategy is meant to aim for greater free share gains, but with those potential greater gains, it also includes greater opportunity risk that a stock might not trade at "fair value" again for a long period of time. In this sense, there is a trade-off - the stocks that do "hit" will usually produce greater gains, but a greater number of the stocks may not hit fair value, therefore inflicting a greater opportunity cost. I don't have an estimate of what the opportunity cost might be for the stocks in this series using a "fair value" approach. For stocks whose earnings are more cyclical, I have had about an 80-85% success rate, but part of this series is indeed an experiment to see what sort of a "fair value" success rate I can get. I define "fair value" as an expected 10-year CAGR of 8% using my full-cycle analysis.
It is important to point out that neither of the two goals laid out in this series (a 20-25% free share gain goal, nor an 8% 10-year CAGR goal) is what I use as personal goals myself. I am a value investor, so I aim to purchase below "fair value" and with a margin of safety. In this case, for less-cyclical stocks, that means I aim to buy when the 10-year CAGR expectation is greater than 12%. This will occur more rarely than an 8% expected CAGR, but I make up for that fact by not getting attached to any particular stock. That way, if I sell an overvalued stock, I don't have to wait for that particular stock to fall to value levels, and I put the money into any value stock that meets my standards. So far, this approach has worked well and opportunities have presented themselves. While I'm still holding lots of cash, I was able to find 35 buying opportunities during the recent downturn, and since 1/12/19 when the Cyclical Investor's Club launched its portfolio of ideas, it has returned +28.32% compared to the S&P 500's +19.73% through the end of May. To put this in perspective, at the beginning of 2020, the CIC portfolio was trailing the S&P 500 with the CIC portfolio returning +24.72% compared to SPY's +26.63%. So, the stocks we were able to buy during the downturn have been very lucrative so far. (For what it's worth, I didn't own a single "big tech" stock going into the recession, nor did I own any popular consumer staple stocks like Costco (COST), nor did I buy any COVID-related drug stocks. None of that was necessary to beat the market. All I did was look for good businesses at great prices.)
Highlighted Stock of the Month: Apple (AAPL)
This series is as much about me learning new insights as it is about sharing what I know with readers. I view it as research-in-progress, and I credit this sort of reflection on my investing process as one of the main ingredients for my success as an investor. Out of all 43 stocks in this series that I suggested readers sell in 2019 and early 2020, I only owned one of them personally, and that stock was Apple. I documented my selling of Apple stock in my article "I Bought Apple In 2013: Now I'm Selling, Here Is Why" which was published on 1/30/20. As noted in the title, I first bought Apple stock in 2013 and had held it for nearly 7 years, it achieved a total return over that time period of about 500%. Apple stock had grown to about an 8% weighting in my portfolio, which was my largest position at the time. But when the stock became overvalued at the end of January, I sold it. I noted in the article that I planned to hold that money in cash for a while I looked for new investments to place it in. Unlike what I'm demonstrating in this series, I didn't care whether or not I specifically repurchased Apple stock again. I love Apple, and think it's a great business, so it would be wonderful if the stock price once again fell to value levels, but if it doesn't, I am perfectly comfortable buying other stocks with the money instead.
One of the interesting things about this is that I use an approximate 1% portfolio position size for all new stock purchases. So, given the size of the Apple position, I would have to find 8 new stocks in which to deploy my money. It's worth noting here that I don't rebalance positions for the sake of rebalancing. If a stock grows into an outsized position but remains fairly valued, I'll hold it forever and let it grow as large as it can. I only sold Apple because I judged it was overvalued, not because it was overweighted in my portfolio.
From the time I sold Apple through today, I was able to find over 30 new positions to buy, so I was able to put that 'Apple money' to work even though, due to the fungibility of money, I couldn't tell you the exact 8 stocks the Apple money went into. However, I thought there were a couple of questions worth exploring regarding my selling of Apple and the reinvestment of the proceeds. The first question is how well I would have done simply holding my Apple stock. But the other questions I thought might be interesting to examine is how I would have done if I bought my Apple stock back, compared to the stocks I actually bought during the downturn with my 'Apple money'. The idea here is to explore whether it is a good idea to get fixated on a high-quality winner like Apple and to insist on buying back that particular stock, or whether it's better to simply buy the best values you can find in the market.
Since the publication date of that article, Apple's return is essentially flat. (I actually sold my stock at a little bit lower price a couple of days before the publication date at around $309 per share, so the price today is actually a little bit higher than when I personally sold, but not much.) Now, I'm sure there are a few people out there who would say that because Apple's price has recovered that it wasn't worth selling, and therefore it proves buy-&-hold investing is superior. But what this doesn't take into account is what sort of return I got from my Apple money by reinvesting it in undervalued stocks. Since I can't identify the 8 specific stocks where the money was reinvested I can't say with precision where the Apple money went, but as of the end of May, the average return of the 30+ stocks I bought since I sold Apple is +45.38%. That's far, far, better than what I would have gotten by holding on to my Apple stock. There's not really even a contest between the two, even including taxes.
But what I thought was a more interesting experiment was to see how this return would have compared to if I had specifically bought my Apple stock back during the dip. In order to make the strongest potential case against my hypothesis that I was better off buying stocks I judged to be undervalued rather than buying back Apple at a lower price, but at a price that was still a bit overvalued, I assumed that I would have bought Apple stock at the very lowest closing price in late March. Basically, I want to see how well I would have done buying Apple stock back with perfect timing, even though it wasn't undervalued at the time, back in March.
Without a doubt, an investor who timed Apple perfectly in March would have done very well. But I was able to buy a basket of over 30 stocks, in real-time, and in real-life, without perfect timing, that provided even better returns by buying those stocks when they were significantly undervalued. (And for what it's worth, I think that basket of stocks continues to have more upside potential than Apple from here.)
If one can truly find good companies and great prices, value investing is an extremely effective investing strategy. One has to simply be willing to focus on the expected forward returns of a company, rather than its brand name, popularity, or, in some cases even the quality of the business itself. Having a quality business is not sufficient to make a great investment. That business must also be trading at a reasonable price.
In the following sections, I'm going to review the free share gain winners, followed by the fair value winners and where all the remaining stocks stand as of May 31st.
Free Share Gain Winners
Many of these stocks fell too fast during the downturn for me to write update articles on, in those cases I have assumed the trade was over at the 25% goal I set for the rotation at the beginning of the series. As one might expect after experiencing the best couple months for the market in several years, we didn't add any free share gain winners in April or May. Out of 43 stocks in the series, 32 of them we have already met our free share gain goals, though, so we are doing quite well with the free share gain goals. Here are the "free share gain" winners so far in the series.
|Ticker||Free Share Gains||Ticker||Free Share Gains|
11 of the 43 positions we are still tracking. Here are the 11 stocks that haven't yet crossed the free share gain threshold yet: Clorox (CLX), ResMed (RMD), Ball Corp. (BLL), Waste Management (WM), Church & Dwight (CHD), Texas Instruments (TXN), Procter & Gamble (PG), Brown-Forman (BF.B), McCormick (MKC), Northrop Grumman (NOC), and Walmart (WMT). I'll post those charts later in the article.
Fair Value Winners
As of the end of last month, we had thirteen successful fair value winners: Union Pacific, Expedia, CSX Corp., Norfolk Southern, Starbucks, Stryker, CGI, Lowe's, Automatic Data Processing, Paychex, Edwards Lifesciences, Mastercard, and Sherwin-Williams. So we currently have 13 out of the 43 stocks that have met their fair value goal of 8% 10-year CAGR expectation. Here are the free share gains for the completed trades so far.
|Ticker||Free Share Gains from Full-Cycle Analysis|
This leaves 30 stocks we are still tracking, waiting for the opportunity for them to trade at "fair value." As I've done during previous updates, I'm going to break these down into different categories based on the free share gains possible as of the end of the month, and then I'll aggregate those findings at the end.
Stocks with +10% to +20% free share gain
Interestingly, we have no stocks in this category this month. The market rally over the past two months has significantly moved all stocks high enough that none remain in this category for now.
Stocks with 0% to +10% free share gains
Rollins (ROL) 4/22/19
When we rotated the ETFs to cash, they were worth $9,844. If one rotated back into Rollins today, they could gain +0.79% more free shares. Currently, the 10-year expected CAGR is 0-1%, so Rollins is still overvalued and remains a "sell".
McDonald's (MCD) 7/16/19
When the ETFs were moved to cash they were worth $9,588. If the money was used to buy McDonald's stock now one could purchase +7.31% worth of free shares. Currently, MCD's 10-year expected CAGR is 3-4%, so it's a "sell" again based on forward earnings expectations.
Medtronic (MDT) 9/26/19
When the ETFs were moved to cash, they would have been worth $9,529. Rotating back into Medtronic now would produce +2.68% more free shares. Currently, Medtronic has an expected 10-year CAGR of 4-5%, so it still has quite a way to fall before hitting fair value.
Waste Management (WM) 1/21/20
When the ETFs were moved to cash, they would have been worth $8,918. If one rotated back into WM now, they would gain +0.13% worth of free shares. Currently, Waste Management has a 10-year expected CAGR of 3-4%, so it is now a "sell" again.
Hershey (HSY) 9/11/19
When the ETFs were moved to cash, they would have been worth $9,465. If one rotated back into Hershey today, they would gain +3.77% worth of free shares. Currently, Hershey has a 10-year expected CAGR of 4-5%, so it still has quite a bit further to fall before it trades near fair value.
CME Group (CME) 12/11/19
When the ETFs were moved to cash, they would have been worth $9,349. If one rotated back into CME Group now, they would gain +3.11% worth of free shares. Currently, CME has a 10-year expected CAGR of 4-5%, so it still has quite a bit to fall before it gets to fair value.
Stocks with 0% to -10% free share gains
Texas Instruments (TXN) 10/31/19
When the ETFs were moved to cash, they would have been worth $9,488. If one were to rotate back into Texas Instruments today, they would have a loss of -7.72% worth of free shares. Currently, Texas Instruments has a 10-year expected CAGR of 2-3%, so the TXN is currently a "sell" based on forward return expectations.
Equifax (EFX) 2/15/20
When the ETFs were moved to cash, they would have been worth $8,736. Rotating back into Equifax now would produce -8.42% fewer free shares. Currently, Equifax has a 10-year expected CAGR of 1-2%, so this stock is currently a "sell" again based on expected forward returns.
Northrop Grumman (NOC) 10/23/19
When the ETFs were moved to cash, they were worth $9,510. If one rotated back into Northrop now, they would have lost -0.96% worth of free shares. Currently, Northrop has a 10-year expected CAGR of 5-6%, so it's still somewhat close to fair value, but not quite there. It's possible we might not quite reach our free share gain goals with this one, even if the price falls to fair value.
Intuit (INTU) 9/5/19
When the ETFs were moved to cash, they were worth $9,434. If one rotated back into Intuit today, they could gain -5.93% fewer free shares. Currently, the 10-year expected CAGR is 0-1%, so Intuit is a clear "sell" at these prices based on forward returns.
Copart (CPRT) 1/21/20 (original 7/30/19)
When the ETFs were moved to cash they were worth $8,918. One could now purchase -1.66% less Copart stock if they rotated back in. Currently, Copart's 10-year expected CAGR is 1-2%, so Copart is well beyond the "sell" threshold again based on expected forward returns.
Estee Lauder (EL) 8/19/19 (original 4/30/19)
When the ETFs were moved to cash at the end of February, they were worth $9,551. If one rotated back into Estee Lauder today, they would lose -3.27% worth of free shares. Estee Lauder's current 10-year CAGR expectation is 3-4%, so after Estee Lauder's big run-up in price this month it is now a "sell" again.
Procter & Gamble (PG) 2/21/20
When the ETFs were moved to cash, they would have been worth $8,810. If one rotated back into P&G now, they would have a -4.54% free share loss. Currently, the expected 10-year CAGR for P&G is 1-2%, so it is still a "sell" at these levels.
Stocks with -10% to -20% free share gains
Nike (NKE) 9/18/19
When the ETFs were moved to cash, they would have been worth $9,514. If they were rotated back into Nike now, one would lose -18.56% worth of free shares. Currently, Nike's expected 10-year CAGR is 0% to 1%, which makes it still a "sell" at these prices.
Illinois Tool Works (ITW) 10/24/19
When the ETFs were moved to cash, they would have been worth $9,501. If one rotated back into ITW today, they would lose -14.94% worth of free shares. Currently, ITW's 10-year expected CAGR is 2-3%, so the ITW is currently a "sell".
Fair Isaac Corporation (FICO) 8/7/19
When the ETFs were moved to cash, they would have been worth $9,570. If one rotated back into FICO today, they would have -19.96% fewer free shares. Currently, FICO has a 10-year expected CAGR of -5% to -6%, so it is still quite overvalued and is a "Strong Sell".
Brown-Forman Corp. (BF.B) 11/8/19
When the ETFs were rotated to cash, they would have been worth $9,369. If one were to rotate back into Brown-Forman today, they would have a loss of -9.72% worth of free shares. Currently, Brown-Forman has a 10-year expected CAGR of -1% to 0%, so it is now a "strong sell" at current levels.
McCormick (MKC) 8/26/19
When the ETFs were moved to cash, they would have been worth $9,630. If one rotated back into McCormick now, they would lose -13.81% worth of free shares. Currently, McCormick has a 10-year expected CAGR of -1% to 0%, so McCormick is now a "strong sell".
Target (TGT) 11/18/19
When the ETFs were moved to cash, they would have been worth $9,365. Rotating back into Target now would produce -18.63% worth of free shares. Currently, the 10-year expected CAGR for Target is 2-3%, so it is a "sell" based on forward return expectations.
Apple (AAPL) 1/30/20
When the ETFs were moved to cash, they would have been worth $8,946. Rotating back into Apple now one would have -10.30% fewer shares. Currently, Apple has an expected 10-year CAGR of 1-2%, so it remains a "sell" based on forward expected earnings.
Cintas (CTAS) 5/16/19
When the ETFs were moved to cash they were worth $9,544. If one rotated back into Cintas now they could gain -17.25% worth of free shares (basically even). Currently, Cintas's 10-year expected CAGR is 1-2% so this stock is now a 'sell' again based on forward earnings expectations.
Home Depot (HD) 11/18/19 original 6/28/19
When the ETFs were moved to cash, they were worth $9,365. If one moved back into Home Depot today, they would lose -12.55% worth of free shares. Currently, Home Depot has a 10-year expected CAGR of 1-2%, so it is a "sell" based on forward expectations.
Accenture (ACN) 9/12/19
When the ETFs were moved to cash, they would have been worth $9,430. If one rotated back into Accenture now, they would have lost -11.07% worth of free shares. Currently, the 10-year expected CAGR is 1-2%, so Accenture is now currently a "sell" based on forward return expectations.
Teleflex (TFX) 10/16/19
When the ETFs were moved to cash, they were worth $9,606. If one rotated back into Teleflex now, they have a -17.22% free share loss. Currently, Telefex's 10-year expected CAGR is -2% to -1%, so it is a "strong sell" at this price.
Roper Technologies (ROP) 1/9/20 (original 9/6/19)
When the ETFs were moved to cash, they would have been worth $9,119. If one rotated back into Roper now, they would lose -16.90% worth of free shares. Currently, Roper has a 10-year expected CAGR of 3-4%, which is low enough to make Roper a "sell" again.
Church & Dwight (CHD) 1//22/20
When the ETFs were moved to cash, they would have been worth $8,921. Rotating back into Church & Dwight now would produce a -17.25% free share loss. Currently, CHD has a 10-year expected CAGR of 3-4%, which makes the stock a "sell" again.
Walmart (WMT) 11/19/19
When the ETFs were moved to cash, they would have been worth $9,369. If one rotated back into Walmart now, they could buy -11.96% fewer shares. The nature of the coronavirus seems to have propped the price of this stock up. Currently, Walmart has a 10-year expected CAGR of -1% to 0% and is a "strong sell."
Stocks with greater than -20% free share gains
Ball (BLL) 12/12/19
When the ETFs were moved to cash, they would have been worth $9,313. If one rotated back into Ball now, they could buy -20.90% fewer shares than when they rotated out. Currently, Ball's 10-year expected CAGR is 1-2% and it's still a "sell."
ResMed (RMD) (9/23/19)
When the ETFs were moved to cash, they would have been worth $9,544. ResMed has been pretty volatile, but right now if one rotated back in, they could buy -25.00% fewer shares than when they rotated out. Currently, the 10-year expected CAGR is 0% to 1%, which makes ResMed a "sell" at this price.
Clorox (CLX) (2/14/20)
When the ETFs were moved to cash, they would have been worth $8,736. If one were to rotate back into Clorox now, they could buy -44.00% fewer shares than when they rotated out. Currently, Clorox's expected 10-year CAGR is -1 to 0%, which makes it a "strong sell." (I updated Clorox's earnings estimates to reflect their recent surge in sales, but I also included a recession expectation in the estimates as I always do.) I like the fact that we managed to capture a good outlier like Clorox in the series. Even though the stock was overvalued back in February, the unique circumstances of the coronavirus will likely improve earnings for them during the recession.
Since each of the 43 stocks was divided into two positions, there are a total of 86 positions being tracked in this series. The chart above shows the distribution based on the percentage of free shares gained or lost. Out of the 86 positions, 44 of them are completed trades with free share gains of +20% or greater, and 1, UNP, was completed with a free share gain of 19%. So, over half of the positions now have their free share gains locked in, and the remaining 41 positions we are still tracking and they will fluctuate each month. Last month, if we excluded the stocks that already had their free share gains locked in, the remaining positions formed a nearly perfect bell-curve. This month there has been a dramatic shift toward negative free share gains. My view is this is mostly the result of the market being overbought right now, but I could be proven wrong in the coming months. Even with the dramatic rise in the market over the past two months, there are still only 6 positions in the -20% free share gain category compared to 44 positions in the +20% free share gain category, so the market would still have to rise significantly in order for this project to have been a failure. (Actually, at this point, it's nearly impossible for it to be a total failure, but if all the remaining stocks continue to go up without dipping again, then it could produce a fairly equal number of big winners and losers, and I'm aiming for much better results than that.)
What to do with the cash position now?
My basic standard for when to move the cash position back into some sort of ETF was when the S&P 500 crossed the 200-day monthly moving average. That actually happened last week, but I decided for the Cyclical Investor's Club portfolio of ideas, that I would keep the default positions in cash (which right now is about 40% of the portfolio). But, I think from now through the November US election and into the new year, there is likely to be a lot of volatility in the market, and that there are many downside risks that remain. In addition to that, the CIC portfolio of ideas contains enough cyclical stocks in it that were purchased at such good values during the downturn, it has actually continued to outperform the S&P 500 index on the way up, even while holding 40% cash. So, for me, there really hasn't been much opportunity cost pressure to move that cash into a market that still looks expensive to me.
That said, I could end up being wrong about this, and all the central bank and government support may indeed keep the market inflated for a long time with no significant dip. If I was going to rotate my cash back into a market ETF I would probably stay defensive with Invesco's S&P 500 Low-Volatility ETF, which is currently situated well for another COVID-related decline. If in the future, I end up being wrong about staying in cash, I'll come back to this month and see how following my original plan and rotating back into this market ETF would have performed. My plan right now is to re-assess the cash position in January of 2021, and if we haven't seen a dip by then, I may rotate the cash into a market ETF at that point.
I'm going to keep following up on this series monthly to see how it turns out. Personally, I would like to see an 80%+ overall success rate of reaching the 20%+ free share gain goal, and I still think that is very possible.
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