U.S. Bancorp Inventory: Why I Lately Took Income In USB (NYSE:USB)
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I last wrote about US Bancorp (USB) in July 2020 in my article Stocks I Bought On The Dip: US Bancorp, which was part of a 20-article series I wrote in mid-2020 about all the S&P 500 stocks that I bought during the March sale. In USB’s case, I actually missed the initial sell-off in March and instead bought a drop the stock suffered shortly thereafter on May 13, 2020. It was the last S&P 500 stock I bought during the spring 2020 decline. Since then, the stock has performed very well.
Data from YCharts
The stock’s total return is over 100%, nearly double the return of the S&P 500 Index (SPY) since I bought it. I actually took profits a few weeks ago, right around the 100% return. If you would like to know more about my process of buying the stock, please read the original article linked above where I explain the full process for my purchase decision. In this article I will explain why I am now taking profits.
Different strategies for different types of stocks
In my last article on Dollar Tree (DLTR), I explained my process for taking profits in less cyclical stocks. However, USB is a cyclical stock, so I use a different process for both buying the stock and selling the stock. But before we get into that, I want my book to explain what makes a company “cyclical” or “deeply cyclical.”
FAST graphics (annotations by Cory Cramer)
In the 20-year time frame FAST graph above, we can see that when we add the 2008 and 2009 declines together, USB’s earnings declined by over -50% during the last recession of any length in 2008-9. And during the much shorter and unusual recession in 2020, earnings fell about -26%. I define highly cyclical companies as those whose earnings fall more than -50% during a downturn. USB fits into that category, so I’m treating it as a cyclical stock. When profits can be expected to typically drop less than -50%, I use a different valuation method (which I explained in my Dollar Tree article).
Notably, not all banks have a history of highly cyclical earnings. I also bought PNC Financial (PNC) and several other banks during the March 2020 downturn, but I view PNC as a less cyclical business and therefore my approach to PNC is completely different than USB. I don’t typically use sectors and labels to describe a company as ‘cyclical’. I’m using recent historical data along with a little judgment and common sense on each stock and on the individual company.
The reason I use two different valuation approaches is that the earnings of highly cyclical stocks fluctuate so much that it becomes very difficult to value them based on earnings, and often most earnings valuation models give exactly the wrong sell and price biases Buy signals when business is cyclical. For example, USB’s P/E ratio was 30 in December 2009. That wasn’t exactly a screamingly good valuation, although the total return since then has been around +230% and it was obviously a good time to buy.
Because earnings aren’t very useful for highly cyclical stocks, I use very long-term historical price patterns to determine my entry and exit points.
Data from YCharts
Over the past 30+ years, USB has seen a history of price drops ranging from 50% to 75%. Since the 2008 recession hit financial companies head on in a way that is unlikely to be repeated anytime soon, I used a -50% drop as a guide to getting into the stock rather than the deeper -75% drop level . Because of the magnitude, the chart above doesn’t quite show the full extent of historical price declines, so I’ll zoom in on the March 2020 drop in the chart below so we can see it better.
Data from YCharts
You can see in the chart above, ending the day I bought USB, that I missed the initial bottom in March, but after things calmed down a bit in April, I noticed the bottom of the second dip in mid-May from USB and caught him. And that’s how I came to own USB when it was lower than -50% from its highs.
My method of taking profits
There are two primary factors that have contributed to my profit taking on USB. The first and most dominant factor is the price and whether or not the price is near the top of the previous cycle. If the price is near or above the previous cycle then I consider taking profits if the business is cyclical. This is because fundamentals will always be a lagging indicator for highly cyclical stocks. The market pros who trade these stocks will almost always start selling in anticipation of the next downturn well before it hits. Sometimes financials stocks fall relative to industrials closer to the end of the cycle, but you still can’t get a handle on fundamentals. Because of this, my philosophy is that I can’t predict how high a cyclical stock can go. I just do not know. But what I do know is that if the general economic environment is similar, the market will likely be willing to pay a similar price to what it has been willing to pay in the past. This allows me to forecast that a quality cyclical stock will usually retrace its previous highs, so I can at least be confident that it will normally do so. Once that happens, I usually develop some kind of exit strategy if I own the stock.
With cyclicals that I buy when they’re -50% off their highs, I know I can usually expect a 100% return if the stock returns to those highs, so it’s pretty easy to keep an eye on to keep. I bought USB for a little under $30 a share, so I knew once it hit $60 I would at least start thinking about an exit.
Data from YCharts
Notably, USB broke the $60 mark last spring and then did it again last fall, and I wasn’t selling at the time. The reason I didn’t sell at the time was because it seemed like we were still pretty far from being late in the economic cycle and since USB only tended to fall during recessions there wasn’t much risk of holding the stock further because We were nowhere near a recession. Also, my other banks for which I used fundamental analysis were still trading at reasonable valuations. For these reasons, I didn’t sell very quickly for most of 2021.
This December, however, saw a big change. The US administration, led by Senator Joe Manchin, decided that inflation was a problem and that it wanted to withdraw fiscal stimulus from the economy. Combined with this change, the Fed quickly reversed course, deciding that inflation was also a problem, and began tapering its stimulus to the economy as well. I believe that withdrawing stimulus so quickly will result in a boom/bust environment for stocks and if the government and central bank don’t change course in the next 3-6 months, they will trigger a bear market . Not wanting to hold cyclical stocks in a bear market and USB was near its previous high, I took profits.
The price of USB stocks kept going up after that (which is totally fine with me because I’m not really trying to time a perfect top). The price is likely to have risen because investors generally think higher rates are good for banks. And that could be the case in a long and drawn out recovery. But it won’t be true if a recession hits in 2023, which is where we’re headed if stimulus ends as expected.
Of course, as we have seen, all this can change quickly by the end of the year. Once the bear market hits, inflation may not be viewed as negatively as it is now and the Fed and Manchin will change their minds. We don’t really know the answer to that. But I think we know that control of Congress will likely be split between the parties in 2023 and 2024, leading to deadlock and no new stimulus, so we have a clock ticking to the end. Stimulus, and the likelihood of a bear market increases dramatically without it. I don’t want to own most cyclical stocks in this environment. It’s not unthinkable that in a recession in 2023, USB could tumble back down -50% from its highs.
What I did with my USB money
One of the difficulties investors face when selling a high-value winner like USB is what to do with the money. With inflation currently quite high, cash isn’t all that attractive. This year, I decided to put what I call my “standard” money, money waiting to find a home in a new single stock, into a balanced 60/40 proxy iShares Core Growth Allocation ETF ( AOR) to plug. Below is a chart of AOR’s performance since inception versus USB.
Data from YCharts
We don’t have the full price action of the 2008-9 decline, but the likely pattern between the two stocks is pretty clear even during the 2020 decline. AOR has the ability to make steady gains if the market continues to move higher, but would likely experience only half the gain as USB during a recession. And if inflation is more stubborn than I think, AOR will at least protect against it. Whenever I sell a stock this year and don’t have an immediate replacement, I put the money into AOR.
When I sell cyclical stocks, I base it on where I think we are in the economic cycle and what the market was willing to pay for the stock during previous cyclical peaks. That often means I sell cyclical stocks before they hit their new highs, and I’m fine with that. For cyclical stocks, the downside potential is much more risky than the upside potential as we get later in the cycle.
Just as I was finishing writing this article, USB’s earnings were rolling out and SA has breaking news that the stock price is down -7%. So now it’s basically back to the price at which I took profits. I have no idea if the price will stay there or reverse and make new highs. But I do know that the downside risk is greater than the upside premium over the next 1-3 years.