Individual investors are intensely focused on the concept of risk. And why shouldn’t they be? Finding an appropriate level of downside risk is paramount. However, too few give equal weight to the potential upside risk in their decisions. Permabears and doom-and-gloomers often watch from the sidelines as the market rallies beyond the fear of the day.
We’ve been able to enjoy such a rally in the wake of the election. As the uncertainty surrounding future government policy dissipates, investors have a broad range of new opportunities.This week, our models’ picks give us an opportunity to explore both upside and downside risk.
To help us cut through the fog, we are joined by Blue Harbinger (AKA Mark Hines).
What level of risk is right for you?
The Stock Exchange provides an expert-level debate on technical and fundamental analysis. (Important background is available here). Comments, dissent, and specific stock questions are welcome!
This Week—Is Athena late to the party?
It’s an extremely common mistake for investors to chase a stock on a rally, then panic and sell at the first downturn. This buy-high, sell low strategy is an obvious loser. Athena is our answer to everyone who wants to find a trend, enjoy the ride, and hop out near the peak. Let’s see what she has on tap this week.
Athena: Drill, baby, drill! Continental Resources, Inc. (CLR) was on a roll in November – though I couldn’t say why. All I see is solid upward trend and a spike in price to cap it off.
Blue Harbinger: Continental has some competitive advantages and challenges relative to other energy exploration companies, but its price still remains highly correlated with the price of oil. For example, Continental has competitive WTI break even prices of around only $30-$35 per WTI barrel, and it was an early mover in the Bakken Shale (Williston Basin). However, it will take a long time to develop its huge acreage.
A: I hadn’t factored in time for future development, but to me that sounds like potential for future growth.
BH: Two other things I know you didn’t factor in – the incoming administration (of which you have no knowledge), and attempts by OPEC to reduce crude supply.
Regarding the incoming Administration, it seems the regulatory balance may shift slightly towards pro-business, pro-profits and pro-growth, instead of pro-environment. That may work in Continental’s favor, but the bigger factor remains oil supply/demand, something the Administration has very little control of.
Regarding the attempt of OPEC to reduce supply, would-be buyers may have already missed that boat. Oil shot up on Wednesday (11/30) as OPEC agreed to its first oil production limits in eight years. Oil, as measured by US Oil Fund (USO) was up 8.65% on Wednesday, and Continental was up 22.88%. Caution is prudent with regards to initiating any new positions, because Continental will likely be very volatile in the near-term.
A: Well that’s all very interesting, but I’m only looking to CLR for the next couple weeks. Am I wrong to see upside here?
BH: We certainly won’t see any concrete policy shifts in your time frame, but that may not matter. Sometimes the appearance of a shift to market-friendliness can move a stock just as much.
I’m not looking for anything nearly as risky as Athena. Looking out a year or two down the road, I expect broad-based gains from the biotech sector (IBB).
We’re reaching the bottom of a year-long slip, and the market seems to be correcting its perception of what IBB has to offer.
BH: From a contrarian standpoint, biotechnology and pharmaceutical stocks are attractive. And ETF IBB is a decent way to play the space because it provides diversified exposure at a decent price (the expense ratio is 0.47%).
F: Who’s the contrarian here? It looks like the market is coming to terms with a drastic change in this sector. Could the recent election be having an impact here too?
BH: It makes sense to consider IBB with regards to the goals of the incoming Administration and Congress. Hillary Clinton caused several big drops in IBB over the last year simply by taking issue with the way drugs are priced. Now that her Presidency seems off the table (at least for the next four years), and the threat of the House and Senate being flipped has been removed, the prospects for biotechnology and drug-makers looks better. IBB did pop (up nearly 10%) the day after the election, but it has given back nearly half of those gains.
If you are a long-term contrarian investor, it may make sense to consider some of the individual stocks within the ETF because you don’t have to pay the 0.47% annual expense ratio. For example, the two largest holdings (Celgene and Biogen) have only underperformed the broader market (as measured by the S&P 500) slightly over the last year. However, the third largest holding, Gilead, has dramatically underperformed. We don’t own Gilead, but we wrote about its attractiveness at the end of May (Gilead: A Trump Stock Worth Considering), and it’s valuation has only become more attractive since then.
Fantasy football is going to be the death of me. I liked OBJ a few weeks back, but I didn’t like the Giants next few matchups. I left him on the bench. Naturally, he started playing his best games of the season. This on-again-off again approach isn’t working for me.
BH: Did you want to talk about stocks here or what?
O: Right – you gotta stick with what you know. I’m back on airlines & airline manufacturers. I liked ’em near the end of October and I like ’em again now. Check out BA. This one looks like a winner through the end of December, at the least.
BH: Industrials in general (as measured by the Industrials ETF, XLI) have performed well since the election, and Boeing has performed well too. Industrials (like Boeing) tend to be cyclical, and the market seems to like the incoming administration’s pro-growth message.
From a valuation standpoint, Boeing is not unreasonable considering its price-to-earnings ratio (both twelve-trailing-months and forward) is within its historical range.
O: Glad to see we agree (for once). Any reason to hold onto this one for a while longer?
BH: Boeing continues to spit off a lot of free cash flow that it has been using to reward shareholders with big share repurchases and healthy dividend payments. The dividend yield sits 2.9%, which is above average compared to the S&P 500, and may be attractive to many income-focused investors, especially considering interest rates are low and rising (i.e. bonds don’t offer a lot of yield and their prices will decline as interest rates go up).
I spy brighter days for Under Armour (UA). The recent selloff here was overdone, and some recovery is expected. Since I’m familiar with profit-taking techniques like trailing stops, some recovery is all I need.