The Tell of When to Sell

 | Jul 17, 2014 | 7:10 AM EDT  | Comments
  • Comment
  • Print Print
  • Print
Stock quotes in this article:

gild

,

celg

,

rad

,

gsat

,

twtr

,

mrk

,

pfe

Nobody likes spoil-sports, least of all me. Yet that's exactly what we are getting after months and months of tranquility and it is beginning to worry me.

In the span of the last few weeks, I have received a number of calls and way too many Tweets from people who are complaining about small moves in stocks. One caller's very worried about the sudden 2-point swoon in Gilead (GILD). Another's upset about a buck-and-a-half decline in Celgene (CELG). Two Twitter followers feel scalded by a set of $0.20 and $0.30 declines in the stock of Rite Aid (RAD).

But yesterday took the cake when a nine-cent selloff in Globalstar (GSAT) caused a caller to be both apoplectic and scared.

OK, put aside the knowledge that Gilead and Celgene are up from $65 to $87 and $68 to $86 in a little more than three months' time. Overlook that Rite Aid is up 40% and Globalstar is up 132% this year!

Let's just deal with what kinds of stocks we are describing.

Much has been made, including by me, about Federal Reserve Chief Janet Yellen's recent foray into the stock market, the one where the Fed, in a statement, talked about stretched valuations of small-cap biotech and social media stocks. Five months ago there were some ridiculous IPOs that came at too high prices, nothing new there. It's been known to happen. Twitter (TWTR) went sky high after the offering, not because of earnings, but because of enthusiasm.

But I think it is reasonable for people, including Yellen, to accept that there are stocks that are riskier than others. Unless the whole market turns risky, as it did in 1987 and 2000 when valuations for all the market and all of tech became absurd, you just have to accept that some people in certain stocks are going to get hurt.

In 1987, at the height of absurdity, largely influenced by aggressive overnight buying from Japanese investors who were gripped by a worldwide stock mania, the entire market traded at about 27x earnings. We are now at 17x earnings and 16x next year's earnings. You can accept the risk at those levels, but you have to recognize that if there is ever a time for the Fed to use its margin rules to try to tame stock-wide speculation it was that one.

Same again in 2000, where there were many worthless IPOs trading in the tens of billions of dollars and a huge number of techs being valued north of $100 billion, many of them good companies that simply could not withstand 40x, 50x, 70x, even 80x earnings.

Again, a good moment for the Fed to cool things by causing the mania-artists to put up more money, as most of the foolish buying was done on margin.

Now, in 1987 before the crash, there was no place to hide. It was tough to find a stock that wasn't selling at too high a price to earnings multiple. In 2000, we had a tale of two markets, the overvalued techs and the relatively undervalued rest of the market. When the Fed chief raised the fed funds rate, not the margin rates, everything came tumbling down.

Which brings me back to this market. Many of the old-timers who think the whole market is overvalued because of low interest rates still think that the pockets of overvaluation can lead to an entire market downturn.

That was certainly the implication from the Fed's remarks.

Some think we are in 1987-like pre-crash positions, just waiting for the wrecking ball to fall. I heard that a couple of times yesterday at Delivering Alpha.

Others are afraid that the speculative stocks are going to overrun the rest of the market as they believe they did in 2000. I say "believe they did," because just as I said earlier this year when Yellen's comments would have made more sense -- that is if the Fed chief should be commenting at all about stock prices -- the really overvalued stocks were a very small cohort vs. the entire stock market. In 2000, the overvalued stocks represented a huge portion of the S&P 500. In 2014, added together, they didn't equal the size of a couple of big-capitalization stocks.

The market capitalization of the risky cohort of stocks didn't rise to a frightening level and the subsequent selloff took care of some of that overvaluation.

But it didn't remove the riskiness of certain securities, a point that seems to be lost on Yellen's Fed and also the complainers who are now hitting me up on the recent declines in the likes of Gilead, Celgene, Rite Aid and Globalstar.

You see, not all securities are created alike, even as it seems, after a prolonged run, that people don't understand or remember that.

For example, Celgene and Gilead are not Merck (MRK) and Pfizer (PFE). Celgene and Gilead both each have a dominant product. Celgene has the anti-blood cancer agent Revlimid, and Gilead has the hepatitis cure Solvaldi. Both companies are working diligently to develop other products and have some existing cash cow lines of pharmaceuticals that are helping. But if these two franchises are challenged, as they were during the spring swoon from a patent fracas for Revlimid to insurance company resistance for Gilead, the stocks will get crushed.

Merck and Pfizer, on the other hand, have many existing drugs that throw off cash and many irons in the fire. They pay good dividends, but none of their drugs has the growth of Revlimid or Solvaldi.

That makes Celgene and Gilead much more risky than Merck and Pfizer. With risk comes reward, like the huge spikes these two stocks have had. Merck and Pfizer are incapable of those kinds of spikes. Other than in 1987, it's not how they trade.

But after you have those big rewards, you have to accept that these stocks become much more vulnerable than Merck or Pfizer will ever be. If you come in at the tail end of the moves and you are down a couple, as I suspect is the case with the complaining speculators, you are going to have to take some pain. You are, now, though, betting that other drugs come through to keep powering the stocks or they make acquisitions that keep the growth rate going. If they don't, you are going to experience the profit-taking that makes for more sellers than buyers. What I am saying is that it's the nature of the beast and if you can't handle it then sell, because it is only going to get more volatile from here after this kind of run.

Which brings me to Globalstar and Rite Aid, which make Celgene and Gilead look like Merck and Pfizer. These two stocks are up from the dead. They don't have any serious earnings power, unlike Celgene and Gilead. They have no hope for dividends like Pfizer and Merck. Neither is a consistent grower. They are simply bets that a current turn is going to continue.

In both cases there was a true amount of pessimism associated with the stocks at one time. The companies they represented were supposed to fail. Now there is a lot of optimism that they will succeed. Any glitch is going to jar that optimism, which is the case with the Rite Aid shortfall last quarter. You won't get that type of shortfall from Walgreen (WAG) or CVS (CVS). Management is too consistent and the overall franchises are too solid,

But you will never get that kind of return from these two established giants either. Both Rite Aid and Globalstar have what I call weak holders, people who were along for the ride that have no idea what kind of fire they are playing with. If they do, then they would not be complaining about these relatively minor losses from upstart stocks as they travel from pessimism and skepticism to optimism, a trail first described by the late legendary investor John Templeton and reiterated by Cramer-fave Leon Cooperman at yesterday's Delivering Alpha conference. The weak holders are subject to both quick profit taking and panic simply because they neither know what the companies do -- they have done no homework -- nor do they know how they trade (erratically with great pushes upward followed by nasty pullbacks).

Which brings me full circle. If you do not know how these stocks trade, if you do not know the attendant risks, if you think you are owning Merck and Pfizer, then sell now because if things get more problematic. These stocks will get hammered. You will not be able to withstand the pressure to capitulate.

But if you assume the risk, you can have a pretty terrific reward, although not as terrific as those who bought in during the extremely pessimistic and perilous moments that faced these enterprises.

And with that admonition, accept the risk or sell. That's just the way the market works. I can't apologize for my sternness. I have a dual mandate; to help you make money and to keep you from losing money. The latter, right now, when it comes to riskier stocks, is simply the greater imperative.

Columnist Conversations

YHOO is trading $40.81, down 3.0% with IV30™ down 16.1%. Alibaba is trading at $92.41 on the first day ...
This chart is in reference to today's article on VIPS. This is a new pullback to consider if it retriggers. ...
The bull channel that has been in place since the late July/early August lows is clearly broken. Two wee...
Alibaba (BABA) is dominating talk on CNBC and the trading floor today and having impacts on the overall market...

BEST IDEAS

REAL MONEY'S BEST IDEAS

Columnist Tweets

BROKERAGE PARTNERS

Except as otherwise indicated, quotes are delayed. Quotes delayed at least 20 minutes for all exchanges. Market Data provided by Interactive Data. Company fundamental data provided by Morningstar. Earnings and ratings provided by Zacks. Mutual fund data provided by Valueline. ETF data provided by Lipper. Powered and implemented by Interactive Data Managed Solutions.


TheStreet Ratings updates stock ratings daily. However, if no rating change occurs, the data on this page does not update. The data does update after 90 days if no rating change occurs within that time period.

IDC calculates the Market Cap for the basic symbol to include common shares only. Year-to-date mutual fund returns are calculated on a monthly basis by Value Line and posted mid-month.