Mar 4 2020 - 5 Stocks To Short Right Now

We look at five stocks with high potential to fall in 2020.

The list includes stocks in lodging, digital advertising, housing, and finance.

Upside risk is present with any short position, so consider option strategies to limit that risk. DM me for specific ideas.

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At the top of this 11-year-bull market, I warned readers to hedge their portfolio against a market selloff. I was lucky enough to open many bearish plays at the very top of this market, and even took some profits the other day.

But I am not completely out. Rather, I am still looking for short positions to ride down with this bear market (see my most recent article on the SPY, still pending). Below is a list of my top five companies to short in 2020.

This is not a perfect list, as for the sake of making a “top 5” list, I had to prune out some other great potential shorts. If you have any great short ideas, mention them in the comments section below.

5. Wyndham Hotels (WH)

Travel is being stifled in 2020, with nonessential travel to many of the countries hit hardest by SARS-CoV-2 being canceled or postponed. Clearly, this points to short opportunities in the travel and lodging businesses. My short choice here is Wyndham Hotels (WH), which has some of the highest exposure to the Chinese market in its industry.

This mid-cap hotel franchiser is starting 2020 in a distressed financial state. It currently appears that Wyndham would have to raise capital to to be able to meet its debt obligations.

(Source: Simply Wall St)

Liquidity ratios are low, especially working capital to total assets, which is 0.008. This is not always a problem, as companies can continue existing with large amounts of debt so long as they are using their assets to produce earnings. However, WH’s EBIT to total assets is at dangerously low levels (0.067).

WH saw much of its growth in China. Its Chinese franchising was on track to save the company’s EBIT. Organic growth will easily be stunted in 2020, as travel becomes dangerous due to the threats of COVID-19. Already, all of WH’s hotels in China have closed, and the majority should remain closed for the interim.

As the company cannot sustain EBIT growth and will most likely see a contraction, I could see WH facing bankruptcy concerns in 2020 or 2021. The company has chosen to bear too much risk by constantly taking on debt as a way to finance growth. Yet growth has not been impressive; the business model is a bust.

As the current company’s net current asset value (current assets minus total liabilities, divided by outstanding shares) is essentially zero, the stock price is only justified by future prospects. But if the company cannot consistently generate EBIT, which is becoming increasingly clear, and the economy takes a nosedive, as is also becoming clear, a stock price of anything above zero is unjustified.

I do not think the stock will hit zero this year but do think we will see the price cut in half, to around before the year’s end.

4. Facebook (FB)

Shorting Facebook (FB) in 2020 seems like a contrarian play due to its lack of exposure to China. Indeed, it is a sort of contrarian play, and for multiple reasons. For one, a popular stock such as FB has a strong investor profile, and everyone as well as his grandma is looking for an opportunity to buy the dip.

Unfortunately for grandmas everywhere, FB won’t easily find a true floor. An economic downturn in China means an economic downturn globally. With a weakening economy comes a lower demand for advertising.

Now, let me be on-record that I have never written a bearish article on FB. The 20-or-so articles I’ve written on Facebook have all been bullish; I’ve been telling readers to buy since the stock was trading in the 0s. That said, even being the leader in the leading advertising sector (in terms of growth) cannot save Facebook from seeing negative earnings growth if the economy does not support positive growth.

FB has seen an amazing rally, being one of the handful of hype stocks in a hype industry. Hype is part of FB’s stock price. Like a bodybuilder injecting synthol, FB does have much muscle underneath, but the synthol-like inflation due to hype will leave as quickly as it entered.

This company is certainly strong and worth buying, but its current stock price is inflated above its expected price relative to its financials, its industry, and the market. The rally in tech stocks has outpaced that of the market in general, and this is a pattern that ultimately mean-reverts, dragging even the best companies down. You can see that the selloff over the last couple weeks has already started this mean-reversion process:

(Source: Stockcharts)

I stand by my prior statements that FB is a strong company worth investing in. It will weather the corona storm but come out at a lower price, almost certainly. The time to dip-buy will come, but now is the time to short.

3. The Trade Desk (TTD)

If you dislike the idea of going contrarian on a strong company, consider using a short on another company in the digital advertising industry - The Trade Desk (TTD) - as an alternative to shorting FB. TTD also has a few other advantages over FB on the short side. For example, this company has significant Chinese exposure.

March seems to be a pretty safe entry point for a TTD short, even in a bull market. It has the largest negative Sharpe ratio of all the months and the largest average loss. From a seasonal perspective, now is a good time to enter a short position on TTD:

(Source: Damon Verial; data from Tiingo)

While TTD is unlikely to see the hype deflation that FB will see, it is probably the better short trade from a risk/reward perspective. If the leader of digital advertising, Facebook, falls, it will drag TTD with it. Yet the dip-buying habits of those looking for popular brands or glamour stocks will be less present here.

2. ANGI Homeservices (ANGI)

The housing market tends to get hit hard during an economic downturn. A China-driven recession could hurt the housing market to a great extent, as to a large degree the housing markets of key cities in the US have been driven by Chinese investors. Travel restrictions on the Chinese and quarantines in Chinese cities stifle the flow of that investment. Even just considering US homeowners and buyers, a recession would lead to less demand for new homes, home sales, and renovations.

Here, I want to target the latter market – renovations. ANGI Homeservices (ANGI) is one company that should be hit disproportionately hard in 2020. ANGI is essentially the largest middleman for home renovation projects, and as we enter an economic slowdown, conservative homeowners who still wish to engage in renovations will have more incentive to bypass ANGI and its recent, expensive acquisitions (e.g., Handy).

Management has stated that a recession will have little effect on the company’s business. I am thus tempted to call this, too, a contrarian play. Yet both the dumb money and smart money are selling ANGI on the back of the coronavirus threat, showing a difference in management sentiment and investor sentiment. Put simply, both informed and uninformed investors believe that ANGI is overpriced in light of future economic prospects.

Right now, technical analysis supports a short entry, despite the recent drawdown. ANGI has strong momentum properties and tends to see the relative strength index as a better momentum signal than an oversold/bought signal. RSI(14) dipping below 30, as it has recently done, is a strong short signal, succeeding 65% of the time over a two-week duration:

(Source: Stockcharts)

The stochastics indicators work the same way for this stock. An oversold fast stochastic line is in fact a better short signal than a long signal. It is a bit weaker in its effectiveness than RSI but is great for confirming the RSI short signal, as it is doing now.

1. JPMorgan Chase (JPM)

The Federal Reserve is almost certainly going to be cutting rates, as per CME’s Fedwatch Tool. Lowered rates are passed on via the major banks. And lowered rates mean lowered profits. That’s the easy part of this thesis.

The more difficult part has to do with the valuation of a bank. I have looked at many of the major banks over the years, typically employing excess returns valuations to these institutions. Understanding this sort of valuation can be the key to determining both whether a bank is overvalued and whether a bank will move quickly as well as logically with the excess returns that bank can produce.

After running an analysis over the big boys, I find JPMorgan Chase (JPM) to be the best short of the bunch. This is because its stock price tracks closely to its excess returns valuation, more so than other banks. (See, for example, the excess returns valuation vs. stock price charts I created last time for JPM and that of Morgan Stanley.) As excess returns should fall quickly in a lowered rate environment, the stock price should be dragged down with it more quickly than for stocks that move with less correlation to its excess returns valuation.

Many major macroeconomic headwinds help the short case. A recession is good for no one, especially banks. JPM seems to know what is coming with SARS-CoV-2; JPM recently has slowed its international business via travel restrictions. This is a setback to its operations in China, a key region of investment growth. Even with rates stuck, JPM is trading stagnant; in the future it must deal with even lower rates.

I fail to see any reason for a bullish thesis here, and even past bulls will see the economic and global emergency as a reason to sell more than anything. JPM will find its return on equity fall with a weaker economy and with lower rates. This is probably the most no-brainer short in the financial industry for 2020.