These 5 'Toxic Stocks' Could Wreck Your Portfolio
A big chunk of the market is actually down a lot in 2016 -- and these five stocks are threatening new breakdowns this fall.
Jonas Elmerraji
Don't let the modest gains in the S&P 500 year-to-date fool you -- 2016 has been a deceptively easy year to see awful performance in your portfolio. So far, 202 of the stocks within the S&P are actually lower than they started the year.
That's about a 40% chance that a given stock has been losing you money in an up year.
Worse still, many of those 202 losing stocks in 2016 are down a lot. More than half of them are down double digits or more since the calendar flipped to January. In short, a big chunk of the market has been toxic to your portfolio this year. Odds are the selling isn't over yet this fall.
But those black clouds have a silver lining: Simply not owning the very worst performers could do more for your returns than owning the best ones as we continue down the final stretch of 2016.
To figure out which stocks to avoid, we're turning to the charts today for a technical look at five stocks that could be toxic for your portfolio in the month ahead.
For the unfamiliar, technical analysis is a way for investors to quantify qualitative factors, such as investor psychology, based on a stock's price action and trends. Once the domain of cloistered trading teams on Wall Street, technicals can help top traders make consistently profitable trades and can aid fundamental investors in better entry and exit points.
Just so we're clear, the companies I'm talking about today are hardly junk.
By that, I mean they're not next up in line at bankruptcy court -- and many of them have very strong businesses. But that's irrelevant to what happens to their stocks.
From a technical analysis standpoint, sellers are shoving around these toxic stocks right now. For that reason, fundamental investors need to decide how long they're willing to take the pain if they want to hold onto these firms in the weeks and months ahead.
For investors looking to buy one of these positions, it makes sense to wait for more favorable technical conditions (and a lower share price) before piling in.
So, without further ado, let's take a look at five "toxic stocks" to sell.
CVR Energy
Small-cap refining stock CVR Energy (CVI) - Get Reporthas been a hard stock to like in 2016. This billion-dollar energy company has sold off by more than 65% since the calendar flipped to January, in spite of the fact that small-caps and the energy sector have both been rebounding this year. Problem is, CVR Energy could still have a lot further to fall in 2016. A textbook example of a toxic trading pattern is in play in CVR Energy right now.
CVR Energy is currently forming a descending triangle pattern, a bearish continuation pattern that's formed by horizontal support down below shares (at $13 in CVR Energy's case), and downtrending resistance to the topside. Basically, as CVR Energy bounces in between those two technically significant price levels, shares have been getting squeezed closer and closer to a breakdown through its $13 price floor. When that happens, we've got a strong sell signal in this stock.
Relative strength, which measures CVR Energy's performance versus the rest of the broad market, has been an extra piece of evidence against this stock in recent months. No surprise, this stock's relative strength line has slumped as shares have underperformed the broad market in 2016, but that downtrend in relative strength is still intact here, predisposing this stock to underperform going forward. As long as that relative strength line keeps on pointing lower, CVI is a stock you don't want to own.
We're seeing the exact same trading pattern right now in shares of $2 billion department store chain Dillard's (DDS) - Get Report. The department store business may not have much in common with refining, but like CVR Energy, Dillard's is showing off a pretty textbook example of a descending triangle setup this October. For Dillard's, the key breakdown level to watch out for is support down at $55.50.
What makes that $55.50 level in particular so significant? It all comes down to buyers and sellers. Price patterns, like this descending triangle setup in Dillard's, are a good quick way to identify what's going on in the price action, but they're not the actual reason it's tradable. Instead, the "why" comes down to basic supply and demand for shares of the stock itself.
The $55.50 support level in Dillard's is a place where there has been an excess of demand for shares; in other words, it's a spot where buyers have been more eager to step in and buy shares than sellers have been to take gains. That's what makes a breakdown below $55.50 so significant - the move would mean that sellers are finally strong enough to absorb all of the excess demand at that price level. Keep a close eye on where shares end up in the sessions ahead...
2016 has actually been an outstanding year so far for shares of $5 billion oil and gas firm Energen (EGN) . Since the start of January, this mid-cap E&P has managed to rally 30% higher, leaving the rest of the market in its dust. But that rally is beginning to show some cracks this fall, and investors might want to think about taking some of those recently-won gains off the table at this point.
That's because Energen is currently forming a double top pattern, a classic bearish reversal setup that looks just like it sounds. The double top is formed by a pair of swing highs that peak at approximately the same price level; the trough that separates those two highs is the line in the sand that, if violated, triggers the sell. For Energen, that's the $51 support level that's being tested this week.
Price momentum, measured by 14-day RSI up at the top of Energen's chart, adds some extra confidence to the odds of a breakdown here. Our momentum gauge made a pair of lower highs at the same time its price chart was showing off its double-top pattern. That's a bearish divergence that signals buying pressure is waning in Energen this fall. Once $51 gets violated, you don't want to own it anymore.
Keeping with the energy sector theme brings us to Hess (HES) - Get Report, a $16 billion exploration and production (E&P) company. While Hess is up about 4% since the start of the year, most of that upside performance actually came in the first few months of the year. Since peaking back in April, Hess has been selling off in an orderly downtrend that's still intact this fall.
So, as Hess touches the top of its price channel for the eighth time this week, it makes sense to sell the bounce lower from here.
The trading setup in this stock is about as simple as they get. Hess' price channel is formed by a pair of parallel trendlines that have identified the high-probability range for this stock to remain stuck within. And sure enough, those trendlines have corralled about 99% of Hess' price action since the downtrend kicked off back in April. Every test of the top of the channel has given sellers their best opportunity to get out before this stock's subsequent leg lower.
Waiting for that bounce lower before clicking "sell" is a critical part of risk management for two big reasons: it's the spot where prices are the highest within the channel, and alternatively it's the spot where you'll get the first indication that the downtrend is ending. Remember, all trend lines do eventually break, but by actually waiting for the bounce to happen first, you're confirming that sellers are still in control before you unload shares of Hess.
Last on our list of potentially toxic trades is a big one: $107 billion software stock SAP (SAP) - Get Report. SAP is another stock that's showing some cracks following otherwise strong price action recently. While shares are up just over 10% since the beginning of 2016, SAP has been forming a textbook reversal pattern since the middle of August; shares are within striking distance of breaking down this week.
The price pattern in SAP is a head and shoulders top, a reversal pattern that signals exhaustion among buyers. The setup is formed by two swing highs that top out at approximately the same level (the shoulders), separated by a higher high (the head). The sell signal comes on a breakdown through SAP's neckline, down just below the $86 level.
Momentum is a factor in SAP right now. Momentum has been making a series of lower highs since the head and shoulders started forming in August, signaling that buying is fading at the same time the bearish reversal pattern is getting close to triggering. For now, SAP's price setup is just waving a yellow caution flag, but it becomes a full-blown sell signal if $86 gets violated.
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.
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