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Margaret Moran
Margaret Moran
Articles (159) 

Why Gurus Are Selling Out of These Industries

In the past three months, the most guru sells have been in these business sectors

March 06, 2020 | About:

Since around Feb. 19, U.S. markets have experienced whiplash as speculation over the novel coronavirus (Covid-19) runs rampant. A few months ago, some analysts speculated that we might see a market correction in 2020, but none could have guessed the reason.

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Despite not knowing the reason ahead of time, many gurus were already preparing for increased market volatility. According to GuruFocus Hot Picks, a Premium feature, the most popular guru sells for the past three months as of March 6 were for companies in the technology and banking industries. For various reasons, stocks in these industries are among the most dangerous to hold when the market takes a turn for the worse.

Technology

Over the past three months as of March 6, 38 gurus have sold shares of Microsoft Corp. (NASDAQ:MSFT), 24 have sold shares of Apple Inc. (NASDAQ:AAPL) and 16 have sold shares of Cisco Systems Inc. (NASDAQ:CSCO). In total, 13 tech companies were sold by 10 or more gurus during this time frame.

“While current U.S. growth remains above‐trend, helped by fiscal stimulus, this positive impulse is peaking now, and will combine with an increasing drag from tightening financial conditions,” Daniel Loeb (Trades, Portfolio) wrote in a November letter to shareholders. “We have delevered our portfolio, reduced our tech exposure meaningfully, and grown our short book. We expect to be net sellers over the next few months if markets rally.” Loeb’s firm, Third Point LLC, went on to sell out of its Microsoft investment in the fourth quarter of 2019.

In bear markets, tech stocks often see some of the most movement due to their trend toward overvaluation. Investors that bought the stock on optimism for future share price growth alone are far more likely to sell their shares once they realize the bubble has burst, which tends to exacerbate the decline. According to the Peter Lynch chart below, Microsoft has been overvalued since 2014.

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Since Feb. 19, Microsoft shares are down 14.4% compared to the S&P 500’s 14.1%. From this, we can see that Microsoft hasn’t lost much more than the index overall. This is likely due to a variety of factors, including Microsoft being an S&P 500 component and value investors buying on the recent lower prices.

Apple, on the other hand, has only lost a cumulative 11.3% from Feb. 19 after recouping about a third of its initial loss on the downslide. Since discounted cash flows often give Apple a value estimate of upwards of $350 per share based on the company’s 2019 earnings results, investors have been even more eager to acquire shares, even viewing the coronavirus scare as a good opportunity.

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Whether or not the new coronavirus will cause further fluctuations of U.S. market volatility is a question that will only be answered in hindsight. Regardless of the reason for market downturns, though, they often result in lower profits for tech companies as customers keep a tighter hold on their pocketbooks, though there are exceptions with fast growers. Both Microsoft and Cisco saw lower net income during the Great Recession, but Apple’s net income grew due to the high-flying success of the iPhone.

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Now that prices have dropped more than 10% for many tech stocks, does that mean it’s time for investors to start buying these stocks again? Not necessarily. As Peter Lynch once said, “You can flip a coin over where the market is headed over the next year.” Value investors should only buy shares of a stock if they think those shares are priced below their actual worth (which is more likely to be the case now that prices are down).

Additionally, virus-related volatility might not be over yet. Cisco and several other tech companies announced earlier this week they would no longer participate in the HIMSS Global Health Conference and Exhibition, a large-scale health IT conference in Orlando that draws tens of thousands of attendees every year. On Thursday, the entire conference was cancelled for the first time in 58 years.

The HIMSS cancellation is only once of many ways in which economies around the world are shutting down due to fear of the new coronavirus. In February, China’s manufacturing purchasing managers index fell to 35.7, down from 50 in January and marking its lowest level since 2004. In other words, during the span of a single month, factory shutdowns from efforts to contain the outbreak have shrunk the entire country’s manufacturing rate back to what it was 16 years ago.

Tech companies with factories in China, including Apple and Microsoft, have already warned investors that the halts in production will cause them to miss their earnings for up to the first half of calendar 2020. When these companies begin reporting earnings misses one after one, we are likely to see further price volatility in the tech sector.

Big banks

Over the past three months as of March 6, 26 gurus have sold shares of Bank of America Corp. (NYSE:BAC), 20 have sold shares of Citigroup Inc. (NYSE:C) and 19 have sold shares of JPMorgan Chase & Co. (NYSE:JPM). In total, there were six major U.S. banks that were sold by 10 or more gurus during this time frame.

When economic hardship hits, interest rates are the U.S. Federal Reserve’s weapon of choice to combat decreased spending. In the past seven recessions, the Fed has reduced the target rate by a minimum of 5% in order to encourage people to borrow money and get it flowing back through the system. This is good for the economy, but since interest is how banks make money, rate cuts (and the poor economic conditions that tend to accompany them) mean lower profits for banks.

After the Fed’s emergency coronavirus-related rate cut on Tuesday, the target rate is now 1% to 1.25%. Analysts are expecting it to be cut again, while President Trump has been pressuring the Fed to reduce the base rate to zero.

In the past, the Fed has only cut the interest rate to zero once, and that was on Dec. 17, 2008, which was in the middle of the worst U.S. recession since the Great Depression. Regardless of whether interest rates are zero or 1% to 1.25%, though, these levels are far lower than any the U.S. has ever seen outside of recession and recovery conditions. Without any firepower left in its weapon of choice, the Fed ends up having to follow in the footsteps of the eurozone and Japan and resort to negative interest rates.

Can banks still be profitable for investors with interest rates that are zero or below? Most likely, the answer is no, at least not if the majority of their operations are traditional banking (i.e., checking, savings and loans) as opposed to investment banking or some other major source of fee-based income.

Japan has had negative interest rates since 2016. As you can see in the chart below, the share prices of Japan’s largest banks, Mitsubishi UFJ Financial Group Inc. (NGO:8306) and Mizuho Financial Group Inc. (TSE:8411), have not changed much overall since 2008, while Japan Post Bank (TSE:7182) has also not done well since becoming publicly traded.

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On the other hand, U.S. bank stocks have been more profitable investments in the wake of the 2008 collapse. JPMorgan Chase, Bank of America and Citigroup were all profitable investments from 2009 to 2019. In the chart below, you can see that the banks’ share prices rose faster as the Fed began increasing interest rates in 2016.

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When interest rates are low or in the negatives, both banks and their shareholders are unlikely to see encouraging profits, especially compared to banks in countries with interest rates higher than 1%. Both rate cuts and the economic conditions that prompt them are negative signs for banks, so when the Fed decides that a cut is necessary (especially consecutive or emergency rate cuts), it’s a big sell signal for stockholders.

Disclosure: Author owns no shares in any of the stocks mentioned. The mention of stocks in this article does not at any point constitute an investment recommendation. Investors should always conduct their own careful research and/or consult registered investment advisors before taking action in the stock market.

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