We're only a handful of trading sessions into 2017 but the big market averages are off to a pretty positive start. As I write, the S&P 500 is already up 1.35% since Tuesday, with 80% of S&P components higher than they ended 2016.
But as auspicious as those early stats sound, there's a more concerning side to the story: the fact that the other 20% of the S&P 500 is already starting to underperform the S&P 500 by a big margin. This isn't a new phenomenon. Last year, one in five S&P components underperformed the index by 15% or more. As a new set of laggards emerge this year, it makes sense to heed the warning signs.
These are the stocks you don't want to own in the new year.
Put simply, avoiding the worst-performing stocks could boost your returns far more than picking the very best ones in the year ahead. So, to figure out which stocks you should be avoiding as we close out the year, we're turning to the charts for a technical look at five that could be about to turn "toxic".
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.
Up first on the list is biopharmaceutical giant Gilead Sciences (GILD - Get Report) . Gilead is a stock that's been hard to like in recent months. In the last 12 months, shares have lost a quarter of their market value, underperforming in a meaningful way. The bad news for Gilead bulls is that shares are teetering on the verge of another leg lower.
Gilead has spent the last few months forming a descending triangle pattern, a bearish continuation setup that opens the door for lower price levels ahead. The descending triangle in Gilead is formed by horizontal support down below shares at $71, coupled with a downtrending resistance level to the upside. As Gilead's share price has pinballed between those two technically important price tags, shares have been getting squeezed closer and closer to a breakdown through $71. If and when that happens, it's time to sell.
An extra red flag that's showing up on Gilead's chart right now is relative strength. Relative strength measures GILD's performance versus the rest of the market, and it should come as no surprise that it's been declining in the past year. More concerning is the fact that our relative strength line is holding onto the downtrend that started last spring - as long as that downtrend in this indicator stays intact, Gilead is predisposed to be a market laggard. Buyer beware.
Hannon Armstrong Sustainable Infrastructure Capital
We're seeing the exact same price setup in shares of billion-dollar efficiency and renewable energy financier Hannon Armstrong Sustainable Infrastructure Capital (HASI - Get Report) . Hannon Armstrong has been under pressure since shares peaked back in September, selling off more than 23% during that stretch. The short-term sell signal comes on a move materially below $18.50.
What makes that $18.50 level in particular so significant? It all comes down to buyers and sellers. Price patterns, like this descending triangle, 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 $18.50 support level in Hannon Armstrong is a place where there has been an excess of demand for shares since November; 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 $18.50 so significant - the move means that sellers are finally strong enough to absorb all of the excess demand at that price level. So, if HASI violates $18.50, you don't want to own it anymore.
Meanwhile, Lumentum Holdings (LITE - Get Report) has actually looked pretty attractive lately. Since last January, this $2.2 billion tech stock has rallied 67%, beating the big market averages by a big margin. But Lumentum's rally is beginning to show some cracks this winter - shareholders might want to think about taking some of those recently-won gains off the table here.
Lumentum has been forming a double top pattern since September. The double top is a bearish reversal setup that looks just like it sounds - it's formed by a pair of swing highs that top out at approximately the same price level, separated by a trough that identifies the breakdown level for shares. In Lumentum's case, the breakdown comes on a violation of support at $34.
Price momentum, measured by 14-day RSI in LITE's chart above, is an extra red flag to pay attention to in this price setup. That's because our momentum gauge rolled over in October, making lower highs during the double top pattern. Momentum is a leading indicator to price, and the lower peaks create a bearish divergence that suggests buying pressure is waning here. If $34 gets violated, look out below.
The price action is pretty straightforward in shares of large-cap paint and coatings stock PPG Industries (PPG - Get Report) -- and it's not looking good. PPG has been in a textbook downtrend since peaking back in April. Now, as shares move up to test the top of their price channel for the eighth time, it makes sense to sell the next bounce lower.
PPG's downtrend is formed by a pair of parallel trendlines that have corralled effectively all of this stock's price action over that nine-month stretch. Put simply, every time this stock has touched the top of its price channel, shares have gotten swatted lower. And PPG is testing that ceiling again this winter.
Waiting for the next 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 PPG.
International Flavors & Fragrances
Last on our list of potentially bearish trades in the near-term is International Flavors & Fragrances (IFF - Get Report) . This flavor and scent supplier has been trailing the market in recent months, losing almost 20% of its market value since the highs it hit at the end of September. And now, shares are testing a breakdown that could open up more downside risk in January.
IFF has been forming a head and shoulders pattern since mid-November. The head and shoulders, which signals exhaustion among buyers, is identified 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 IFF's neckline gets materially violated -- that happens at the $117 price level, a price tag that IFF closed below yesterday.
It's worth noting that IFF's price setup isn't "textbook". That's because, typically, the head and shoulders is a reversal pattern that shows up at the end of an uptrend, not a continuation pattern after an initial down leg like IFF has shown. That said, while the setup may not be textbook, it's still tradable. If shares can't find their way back above $117 in today's session, it makes sense to steer clear of IFF until its downside move has worked itself out.