The S&P 500 is hitting new all-time highs this week, another milestone that most investors would agree is a good thing for the stocks in their portfolios. Only, it's not. At least, not exactly.
That's because while the big market averages are plowing into positive territory this December, a pretty material chunk of the individual stocks that make up those big market averages aren't. In fact, as I write, nearly a third of the stocks in the S&P 500 are actually down since the start of 2016. Of those, around half are down 10% or more this year.
In short, a noticeable segment of the S&P looks toxic to your portfolio's health right now. And while most investors focus on the fact that "the market" is setting a new high-water mark, most are missing the idea that simply not owning the worst performers could mean more for your returns at the end of the day than owning the best ones.
To figure out which stocks to avoid, we're turning to the charts for a technical look at five stocks that could be laggards 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 frankly 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. And 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 -- and when to sell them.
Great Plains Energy
Up first on the list is $6 billion utility Great Plains Energy (GXP) . Don't get thrown off by the fact that Great Plains is basically holding onto breakeven territory here - this stock has been looking toxic since it peaked back in late March, shedding more than 16% of its market value in the intervening months. Now, on the heels of this week's rate hike, Great Plains is signaling the potential for another leg lower.
Great Plains Energy is currently forming a textbook example of a descending triangle pattern, a bearish continuation setup that's formed by horizontal support down below shares (at $26 in GXP's case), and downtrending resistance to the top-side. Basically, as GXP bounces in between those two technically important price levels, it's been getting squeezed closer and closer to a breakdown through support at $26. If and when that $26 price level gets violated, it's time to sell.
Relative strength, which measures GXP's performance versus the rest of the broad market, has been an extra piece of evidence against this stock in recent months. Great Plains' relative strength line rolled over this spring, and it's been in a downtrend ever since, making this stock statistically likely to underperform the S&P going forward. The bottom line is, if $26 gets violated, it's time to sell GXP.
The exact same price setup is showing up in shares of $16 billion Italian communications stock Telecom Italia SpA (TI - Get Report) . Like GXP, Telecom Italia is currently forming a descending triangle pattern, in this case with its support level down at $7. If that $7 line in the sand gets crossed, TI opens up a lot more downside risk.
What makes that $7 level in particular so significant? It all comes down to buyers and sellers. Price patterns, like this descending triangle setup in Telecom Italia, 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 $7 support level in Telecom Italia is a place where there has been an excess of demand for shares this month. 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 $7 so significant -- the move means sellers are finally strong enough to absorb all of the excess demand at that price level.
Meanwhile, 2016 has actually been a great year for shares of $8.4 billion industrial stock A.O. Smith (AOS - Get Report) . A.O. Smith is up almost 27% since the calendar flipped to January, beating out the broad market averages in the process. But AOS shareholders might want to think about taking some of those recent gains off the table here; this stock's rally is starting to show some cracks.
A. O. Smith is currently forming a double top, a bearish reversal setup that looks just like it sounds. The price pattern is formed by a pair of swing highs that top out at approximately the same price level. Those highs are separated by a low at $44 that, if violated, signals an end to the uptrend and a lot more downside risk ahead.
Like any of the other technical trades on our list, it's important to be reactionary with A. O. Smith. That's because, while shares are waiving a caution flag with this double top pattern, shares are still holding their uptrend at this point. AOS doesn't become a high-probability downside trade until $44 gets violated. If you own shares, don't try to guess when the move is going to happen, just sell it when it does.
Enterprise Products Partners
You don't need to know much about technical price patterns to figure out the one showing up on Enterprise Products Partners' (EPD - Get Report) chart right now. Instead, the price action in this $53 billion midstream energy stock is about as simple as it gets. EPD has been trending lower since July, selling off in a well-defined price range. And shares are testing another "sell zone" this week.
Enterprise Products Partners' downtrend is formed by a pair of parallel trendlines that have defined the high-probability range for shares to stay stuck within over the last five months. So far, every time EPD has touch the top of its price channel, shares have gotten swatted lower. And as shares test that level for a fifth time this week, it makes sense to sell the next bounce lower.
Waiting for this week's 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 Enterprise.
EPD isn't the only midstream energy stock that's showing some cracks right now -- energy infrastructure giant Kinder Morgan (KMI - Get Report) is another. Kinder Morgan has fared far better than Enterprise this year, rallying more than 40% on a price basis since January. But now, shares are starting to look "toppy." Here's why.
Kinder Morgan is forming a head and shoulders top, a bearish reversal pattern that indicates exhaustion among buyers. The pattern 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 triggers when Kinder Morgan's neckline gets materially violated -- that happens just below the $20 price level.
The head and shoulders top in Kinder Morgan has been a long-term price setup, and that means it also comes with long-term trading implications when and if that $20 level gets violated. From a risk-management standpoint, once $20 gets busted, the downside target on KMI becomes prior support at $17. Keep a close eye on how Kinder Morgan trades as shares approach that make-or-break $20 price tag.