2023-12-28 08:27:57 ET
Summary
- The recent performance of Carlyle Group has surpassed our expectations, delivering a whopping 43% return since we initiated our bullish view with a "Buy" rating on November 6.
- From a technical perspective, our Fibonacci Retracement study also suggests CG's stock price may be struggling to break above the 50% level and could be due for an imminent pullback.
- Taking profits on sharp gains and recycling capital may be a sensible move to lock in gains and further enhance portfolio performance.
- Accordingly, we are taking profit on our bullish view on CG and downgrading our rating from "Buy" to "Sell" for now.
- Should we see a decent pullback of around 10% in the coming months, we would consider re-establishing our long-term bullish view on CG.
The recent performance of The Carlyle Group Inc. (CG) has surpassed our expectations, delivering a whopping 43% return since we initiated our bullish view with a "Buy" rating less than 2 months ago on November 6.
We had initially expected a more modest climb that would take CG's P/E multiple from its then 9.7x to around 12x within 12-24 months. But CG's recent surge alongside the S&P 500 Index's (SPX) attempt to break above its all-time highs, has exceeded even our most bullish expectations.
TradingView.com, Stratos Capital Partners
CG's sharp rally has presented a problem for us: is the rally overbought and therefore a good tactical opportunity to lock in those gains, or is the move a fair reflection of improving fundamentals and thus worthy of a rating upgrade?
Tactics Over Strategy
Given that trend-following is part of our multi-strategy approach to investing, we would normally refrain from selling into a forceful rally, especially on an undervalued stock with healthy fundamentals.
The key argument against selling into an uptrend is that occasionally bullish momentum can last well beyond our wildest expectations. And second-guessing a trend means potentially missing out on a 100% or even 200% gain. Missing those big winners too frequently means severely undermining the long-term performance of a portfolio. Even in the case of asset bubbles, riding a bubble could still be extremely profitable as long as one managed to buy in at the lows. In CG's case, we have certainly caught the stock at a deep discount and are in a good position here to ride the uptrend and see where it goes.
To be clear, what we have just described is a purely systematic approach to trend-following, in which fundamentals have no role in guiding how the trader would exit from a profitable trade. Typically, these traders would simply set a trailing stop-loss, step aside, and watch how far the trend could go. Such an approach is certainly a good method of taking emotions out of trading.
However, the realities of professional investment management mean that there is always pressure on portfolio managers to maximise alpha and micromanage positions. In most cases, precise market timing usually works against the trader, increasing transaction costs while achieving tiny performance improvements, if any.
But in certain cases, we do see the benefit of taking a more tactical approach to managing profitable positions when risks-rewards are heavily skewed.
Taking Profits On Sharp Gains And Recycling Capital
Unless one is utterly committed to trading a fully mechanical and systematic trend-following strategy, there is no reason not to take advantage of opportunities to enhance portfolio performance when the risks-rewards are favourable.
From our perspective, time is a key factor in determining if opportunities to make tactical moves are sensible. This is because investment performance is always measured against time. For example, achieving a 20% return on a stock in a year is nothing special or worth bragging about. But one should be humble enough to take a 50% return especially if that was achieved within a really short period of time. There are two key arguments for taking profits on positions that satisfy the time and return criteria we have just described.
First, taking profits when a position has far exceeded one's return target serves to lock in gains and reduce the risk of suffering sharp pullbacks in overbought situations. From a technical perspective, our Fibonacci Retracement study also suggests CG's stock price may be struggling to break above the 50% level and could be due for an imminent pullback towards $38.35.
TradingView.com, Stratos Capital Partners
Secondly, taking profit on big winners also frees up capital that can be reinvested in other opportunities with better risk-reward. This can help to further enhance portfolio performance over time, especially when there are ample investment opportunities available.
In the present environment, we do see ample opportunities to recycle capital given how the bull market has been rather narrow. Some readers may find this concept rather familiar to portfolio rebalancing. But instead of rebalancing by reallocating between asset classes, we prefer a more tactical approach of rotating within opportunities in equities. Redeploying capital into laggard equity sectors may potentially provide another round of outsized returns. Thus, investors can remain fully allocated to equities, yet enhance returns through tactical positioning of the equity portfolio. In a separate article, we recently highlighted our high-conviction ideas for 2024 and we encourage interested readers to check it out.
To be clear, we are not taking profit on CG due to deteriorating fundamentals. We still like CG's long-term fundamentals and strategic shift to diversify into private credit and secondaries. For long-term investors who are not too concerned with short-term fluctuations and are happy to ride through the volatility, we would suggest staying long and selling only when valuations become more expensive at around 18x to 20x P/E.
From a more tactical perspective, however, the recent surge in CG's stock price has now brought valuation multiples back to more reasonable levels of around 12.9x Forward P/E. Although we see the potential for further upside for CG over the medium term, we also see an increasing risk of a pullback given that the stock looks overbought in the short term. This is consistent with our view that bullish momentum on the S&P 500 Index may stall in the near term.
In Conclusion
Accordingly, we are taking profit on our bullish view on CG and downgrading our rating from "Buy" to "Sell" for now . Should we see a decent pullback of around 10% in the coming months, we would consider re-establishing our long-term bullish view on CG.
For further details see:
Carlyle Group: Taking Profit On Sharp Rally And Recycling Capital