MorningWord 8/20/12: Volatility Clouds Forming for Salesforce

MorningWord 8/20/12:  As Enis referred to earlier in his MacroWrap, RiskReversal.com does not exist to ride the popular investment wave.  Our options trading usually disregards the current market trend as we look for opportunities to define our risk and make counter-trend  plays where we feel that investors expectations from a qualitative standpoint don’t exactly line up with what we are seeing  quantitatively, or vice versa.

Salesforce.com (CRM) may be exactly one of these situations as the stock has just rallied 22% in a straight line from 6 months lows made earlier this month.  The company is scheduled to report Q2 earnings Thursday after the close and the options market is implying about a 9.5% move post earnings which is rich to the 7.6% avg move over the last 4 qtrs and basically inline with the 9.6% move over the last 8qtrs.  

Even with CRM up a whopping 45% ytd, massively out-performing most of its large cap tech peers (aside from AAPL in the mega-cap space) the stock has had a tendency to lag the broad market on bottoms and actually go on to make lower lows before turning on a dime.  The chart below shows this relationship in late Dec/early Jan and then again just this month.  I make this point for a couple reasons.  Most obvious though is that while CRM tends to trade with the general trend of the broad market, it has the ability to trade in its own little world when it wants to, it has the ability to de-couple from the broad market trend.  If you were to short the relative weakness at the 2 circled areas as a result of the relative weakness you would have had your faced ripped off, but can be a great beta short near market tops.

[caption id="attachment_15757" align="aligncenter" width="490" caption="1yr CRM vs SPX from Bloomberg"][/caption]

 

As the stock creeps higher I would suggest that the closer we get to the previous highs the greater the potential for disappointment on what has been a fairly volatile event for the stock in the last 2 years.  That said, as evidenced by the implied move, the potential movement is not being ignored, as the stock has realized about mid 40s vol over the last 3 months with out any company specific events.  But for a high valuation, high vol name, with short interest at about 10% of the float, and investors inclined to shoot first and ask questions later in names like this (see CMG and PCLN), no matter what your directional bias, using options to add yield, leverage or define your risk could be the way to go.

Stay tuned for a formal preview of the quarter, and ways to play.

 

MorningWord 8/17/12: As many readers know, we have been Bearish for sometime now and while we are not ready to throw up our hands in disgust as it relates to the price action the SPX, our strong belief that the current investment climate is fraught with complacency and ever-increasing risks is steadfast.  As Enis alluded to in his MarketWrap earlier, our trading has been cut back a bit as there is not a chance in hell we are going to reverse course on our thesis at a time when the risks to what we see as a low conviction rally are only intensifying and likely to come to a head in Sept/Oct.  We are sitting on our hands and waiting for what we think is the most opportune time to lay out shorts that best fit with our thesis.

While we are not willing to concede defeat just yet in my bearish leanings of 2012, we are taking a hard look at it, and trying to poke holes in it, and I will suggest that every so often it makes sense to take a step back, whether it be on a single name or a macro thesis and look at a position with a Fresh Set of Eyes as if you were looking at the position for the first time.  I did this in CSCO on Thursday prior to its fiscal Q4 earnings report after contemplating what to do with a losing position in the name that was facing a low probability of success.  In Thursday’s post, after detailing what I felt were the potential outcomes, I had the following to say:

SO WHAT TO NOW WITH MY LOSING POSITION?

RATHER THAN FURTHER COMPOUNDING A LOSER, AGAIN, I AM GONNA STICK WITH WHAT I HAVE, I AM RISKING WHAT I AM WILLING TO LOSE.

BUT  If I was looking at this with an entirely fresh set of eyes, I would probably be pretty tempted to buy the move, which now sits at about 6.5%, it has ticked down a bit in the last 24 hours.

This would probably be the way to do it playing for an out sized move:

CSCO ($17.50) Buy Aug 17/18 Strangle for .55

In Hindsight, Buying the Move, was the way to play, as it was in fact cheap, and at one point yesterday when CSCO was about about 10%. the Aug strangle would have been a one day double.  SO many of you may ask why I didn’t pull the trigger, I had the idea and I laid it out, and it wasn’t gonna take much to at least break-even if the stock just moved in line with the implied move.  Well, the answer is simple, trading is hard, and one of the biggest challenges for active traders is to know when to take a step back and not potentially compound a problem, which in this case I had already done once by adding to the position with higher strike puts.

SO what is my take away from the whole CSCO debacle?

I started with a stated Low Conviction trade on Aug 2nd,

My View: I want to make a low premium, defined risk directional bet that CSCO misses and guides lower and the stock re-tests the 52 week lows.  I want to be clear here, I would not short a cheap stock like this with some of the positives that I mentioned above, But I will allocate some trading capital to the idea. This is not a high conviction trade as I will need a lot of things to go wrong in a short period of time, but I like the risk / reward set up, risking .35 to make 1.65 if the stock matches the 2011 low following what has been a historically volatile event for the company.

And then added to the loser just 4 days later on Aug 6th, and said the following;

I know I am being a little undisciplined by doubling down, but I am going to just stick my toe in the water a bit and buy a lesser amount of the Sept 16 Puts than I own of the Sept Puts 15s.  My conviction level isn’t any greater now, but if the company does what I thought they could do last week, the likelihood of a drop in the shares in my opinion increases with the stock higher now.

But 2 weeks late and a 15% rally in the stock prior to the earnings event helped me SEE that adding to my thesis, that the market was clearly signaling as wrong, would be the wrong thing to do, and maybe just maybe thinking about the position from a quantitative standpoint rather than a qualitative one was the trade.

So I was reminded of lessons that I have learned on multiple occasions over my career; 1. generally stay away from low conviction trades, although they all can’t be hand on heart conviction, 2. don’t add to losers, 3. cut your losses, and 4. sometimes take a step back and look at the situation as you were not involved and what would you do at this very instant.

 

 

 

MorningWord 8/16/12: WMT’s Q2 results are out this morning which basically look in line with expectations, the company raised the midpoint of their EPS guidance for the balance of their fiscal year, but the stock is trading down in the pre-market by about 3% as sales and margin guidance were slightly less than expected.

Today’s price action in WMT will be a very interesting test for a market that seems to be stuck in what bulls would likely suggest is a fairly enviable spot-flat-lined at 1400.  But stocks like WMT (prior to today up ~25%) have been at the heart of the SPX’s more than 10% rally since early June, domestically focused on mid to low level consumers, strong balance sheet and reasonable dividend yield.  

I worry though that these defensive sectors have driven much of the rally in an increasingly narrow way and if there were any real fundamental reasons to take profits in names like WMT or sectors like Telecom, we could see a fairly broad market decline in a very short period of time, IF we don not see a rotation into previously poor performing sectors.

Last night on Fast Money, Marc Faber author of the Gloom, Boom and Doom report (of which I am obviously a subscriber) mentioned declining breadth in the Nasdaq, and highlighted the potential near term risks to the rally.  I obviously agreed with this point and mentioned that the Composite New High Index (that we refer to from Bloomberg) vs the SPX (below) is showing dismal readings compared to QE1 rally of 2010 and the QE2 rally of 2011.

[caption id="attachment_15671" align="aligncenter" width="490" caption="Bloomberg Composite New High Index vs SPX from Bloomberg"][/caption]

 

This chart clearly illustrates the the lack of breadth and to Mr. Faber’s point, fewer and fewer stocks are holding the rally together.

Make no mistake about it, stocks like CSCO coming back from the dead is clearly a bullish thing, if this rally is going to have any legs it will most definitely need to broaden out a bit, as stocks like WMT can’t just go up for ever.

[caption id="attachment_15672" align="aligncenter" width="490" caption="WMT weekly chart since inception from Bloomberg"][/caption]

 

MorningWord 8/15/12: To state the obvious, U.S. large cap equities, for all intents and purposes have decoupled in the last year from most developed and emerging market indices. The out-performance of the SPX to the markets of faster growing countries equity markets, such as China’s Shanghai Composite and Brazil’s Bovespa (below) over the last year has been nothing short of startling when you consider that the likelihood of a global economic recovery without the participation of the above mentioned economies leading the charge seems increasingly unlikely.

 

When looking at SPX since 2005, the white line in U.S. dollars, and the orange in Euros, further demonstrates the safe haven status of U.S. equties as they essentially made new 12 year highs in Euro terms.  

[caption id="attachment_15619" align="aligncenter" width="490" caption="SPX since 2005 in U.S. $ vs Euros from Bloomberg"][/caption]

 

This set of circumstances raises 2 questions:

1)  Can U.S. stocks continue to outperform without global strength?  (Deere is the latest corporate to report weak results, specifically citing weakness in southern Europe, India, China, and South America)

2)  Alternatively, are U.S. stocks anticipating an eventual recovery in global markets that other stock markets are late in anticipating, and are U.S. stocks correct in doing that?

We are still of the camp that the answer to both questions is a resounding No.  If so, this battle to hold 1400 in SPX won’t last for much longer.

 

MorningWord 8/14/12: We spent a bit of time yesterday looking at GRPN and trying to figure out if the almost 25% implied move following their Q2 print offered a trading opportunity.  Enis and I differed on how to play (as usual, he was right to look down), but make no mistake about it, the margin for error in a name like this wasn’t huge and trades offering attractive risk/reward propositions were not exactly plentiful.  

First things first, smart trades can be hard to come by for stocks into events that have a single digit stock price with one dollar strikes, a little more than a half of a year of trading history, a shareholder base that is shooting first and asking questions later, a business model that is being questioned as viable and a valuation that the stock will likely never grow into (to name a few deterrents).

If we have learned anything from the not so distant history of the internet tech bubble of the late 1990s, Stocks like GRPN trade up on HOPE (oh and BS estimates from their IPO underwriters), and trade down on uncomfortable realities.  This is just how it is, the unsuspecting public get the wool pulled over their eyes by what the financial press and their brokerage firms alike label as the next great investment opportunity.

It didn’t take long for the mini-Social Media/Web 3.0 bubble to burst, as almost all high profile web ipos of 2011/2012 (except for LNKD, oh and that implosion is coming to a theater near you likely in Q412).  Obviously there are some decent concepts that these companies were built on that are being unfairly discarded with the plunging stock prices, but at this point, investors just see losses and there is a good bit of hate selling that is driving these stocks to levels questioning these companies’ future viability.

For example, ZNGA has a market cap of $2.25b, $1.64b in cash, and only $100m of debt, so an enterprise value of only $682m.  The company had about $1.14b in sales last year, which is expected to grow modestly this year to only $1.24b on about a nickel of earnings.  Earnings obviously don’t matter at this stage for a purported growth company, but the problem is, they aren’t really growing.  SO investors may not wait to hear about Cash Burn and just keep selling, as they see no real technical support until ZERO.

Support at ZERO implies a decent risk/reward scenario for interested longs with longer term time horizons, but for us, we will continue to look for ways to play massive sentiment swings and what appear to be anomalies in the vol market in the Social Web.

 

 

MorningWord 8/13/12: What could be better on a quiet Monday morning than a little rant focused towards the endangered profession of Sell-Side equity research analyst.  Don’t get me wrong there was a time when these people moved stocks, and often times actually had some foresight, but now, just a bunch of kids looking to cut their teeth in the industry, or aging CFAs usually one or 2 steps behind their Buy-Side colleagues.

This morning Bank of America Merrill Lynch’s Telecom Equipment analyst (who I actually here from friends at the bank is very good at what he does) Upgraded Sprint Nextel (S) from a Neutral to a Buy with a $6 12 month price target, and raised estimates:  [private]

We have increased our 2013E and 2014E Adjusted EBITDA estimates from $5.4bn to $5.8bn and from $7.1bn to $7.6bn, respectively. Our revised forecasts are 8% and 10% above consensus. We have also increased our 2013E and 2014E EPS estimates from -$1.09 to -$0.94 and from -$0.38 to +$0.40.

The analyst prefaces his upgrade and thinks he is shedding some fresh light on the story:

We’ve been a longtime skeptic on Sprint’s stock and our comfort level at raising our rating comes at the cost of having missed a strong move off the recent bottom. The move has been a reaction to much better than expected 2Q results, a hike in guidance, and, more recently, the prospect for accretive M&A. Nevertheless, we believe Sprint’s shares merit purchase here for the following reasons:

1. Our new estimates lead us to believe Street estimates will rise through 2013,
a stock catalyst that proved especially powerful in the wake of 2Q results.

2. Meaningful upside to our target remains using conservative valuation
assumptions.

3. New disclosures this quarter lead us to believe Sprint will generate positive
EPS in 2014 which should broaden investor interest in the lowest PE multiple
to growth stock in our coverage. An important wrinkle we’ve baked into our
model the Street has not, is that accelerated depreciation which is
depressing earnings through 2013 will drop off in 2014, allowing the
company to generate positive earnings which should increase the size of the
potential investor base, and also allow Sprint to realize the benefit of $4.8bn
in accumulated NoLs.

MY VIEW: I guess I can’t argue with any of his analysis, I am not a telecom analyst, or an analyst of any kind, and if this experienced CFA has done a lot of work and believes that his new above consensus earnings estimates warrant a high stock price than so be it.   My Biggest takeaway from this upgrade is the expected joy from the thousands of Brokers in Merrill’s “Thundering Herd” that probably think they just got an early Christmas gift, as they will no doubt be out in a BIG way pushing their clients to BUY lots of Sprint at $5 a share, which due to low stock price which should result in high volumes and thus lot sof commission$$.

Sorry to be so cynical, but come on, has that much changed other than the guidance that the company just gave on their Q2 call that BofA believes their clients should be buying the stock here rather than 2 months ago when the stock was more than 50% lower.  And I guess I would ask, where the hell were you all spring and early summer,and why were you not trying to figure out how the stock in the lows $2 range would either end up with it’s equity be rendered worthless in the coming months or double or triple??  Isn’t that your job to be in front of moves like this?  So when I look at a chart like this I have one thing to say, you better be right, or you will look like the biggest monkey in the world.  I have no axe to grind either way, but it appear that the analyst is relying on a good bit of his enthusiasm on the stock from current levels on company guidance, and I guess that seems like the sucker play of the year when you consider how poorly this company has executed over the last 5 years.  We at RR.com don’t buy stocks up on spikes like this no matter how good the story sounds.  

 

MorningWord 8/10/12:  Equities seem unstoppable at the moment, volatility has ground to a halt and most of the fears that precipitated the 10% April to early June sell off appears to be off the front page of the WSJ for the time being.  From a macro standpoint, the news cycle went from slowing U.S. growth, Euro debt contagion/bank insolvency to reflation and band-aids.  That’s all fine and good, but we don’t buy it, largely because the internals of the market rally stink and on a daily basis it seems that we are getting individual data-points from once high-flying stocks that suggest otherwise.  

This week alone we have had 2 once consumer discretionary darlings (PCLN & MNST) taken apart on weaker than expected results or outlook.  Now many could argue that these high valuation stocks are merely a victim of their past success, and some would also argue that taking out some excess in the market is a bullish thing, especially as the market rally looks to broaden out.  I get both arguments and agree on some levels, but I would add one important point, when investors are willing to take out whatever excess in a single name in one fell swoop it signals to me a heightened level of nervousness that has the ability to spread like wild fire.

And to be honest, the moves in PCLN, CMG & MNST etc, are a bit of a sideshow, as I think investors should be more concerned with the price action, and the news out of large multi-nationals like MCD.  Just this week MCD released July same store sales that were down in all 3 major regions (North America, Europe and Asia) for the first time since 2004.  As Enis pointed out in his nearly award winning appearance on Talking Numbers on CNBC the other day, the stock is in the process of breaking the massive uptrend that has been in place since the lows in 2009.

[caption id="attachment_15447" align="aligncenter" width="589" caption="MCD 5 yr chart from Bloomberg"][/caption]

 

So at this point, we want to try to be a little patience here, and time our bearish bets a little better than we have done in the last few weeks, we will continue to look for both directional opportunities where we think the fundamental outlook is out of whack with recent price action (MNST) and where the market in general miss-prices the potential for volatility (BAC).

MorningWord 8/9/12: Hindsight sucks in trading as most of the time it exists to make you feel a bit more stupid than you already feel, especially when you are wrong. Last week I made an ill timed bearish trade in CSCO when the stock was at about $15.80 and then only to compound the problem I added to it this week when the stock was at $16.80.  Well now after a 15% run in less than 2 weeks, “the Street” is getting behind the name in front of next week’s Q4 earnings report, 2 upgrade this morning and the stock is trading up to about $17.80 in the pre-market.  

My Sept Put Premium has gone out the window.  A reader this morning asked when I say “Uncle”, and the truth is, I really already did.  When I originally laid out the idea I suggested:

I want to be clear here, I would not short a cheap stock like this with some of the positives that I mentioned above, But I will allocate some trading capital to the idea. This is not a high conviction trade as I will need a lot of things to go wrong in a short period of time, but I like the risk / reward set up, risking .35 to make 1.65 if the stock matches the 2011 low following what has been a historically volatile event for the company.

Now I am not being defensive because I have plenty of losers and not sure why I would just pick this one to talk about, but when entering a trade like this I have essentially already cried “uncle” when purchasing out of the money premium in front of the event, it is either going to work or it is not, but as usual RR way, especially on event trades I was risking what I was willing to lose to make this bet.

Make no mistake about it, placing long premium trades on an event is much like placing a bet with a bookie on the Super Bowl, at halftime if your team is down 31-7, their is no re-do.  Don’t mean to sugest that us options traders are doing a legal form of “gambling” but there are obvious similarities, and just as you want to employ a little risk management on your next bender to Vegas, we do so by defining our risk, and risking what we are willing to lose.  This is a very different proposition than investing, and we make no illusions about that here, RiskReversal.com exists to give a window into one component of our trading, how we use options for leverage, speculation, yield enhancement and most importantly risk management .

 

MorningWord 8/8/12: Since the “Draghi Whatever it Takes” bottom on July 26th, the DAX is up more than 10%, the SPX up 4.7% and the Shanghai Comp 2%.  With much focus of late on the supposed fixes to Europe’s debt issues and the expected easing by central banks at the first sign of continued economic weakness in the West, there has been little attention paid to the one economy that in most market participants’ minds has a shot of reigniting global growth:  China.

While central bankers in the West threaten further easing, China has been easing fairly aggressively of late with 2 rate cuts since early June & 3 instances of lowering lenders’ reserve ratios since November to combat slowing GDP that hit a new 3 yr low in Q2.  Coupled with a slowing economy, China appears to be facing the long stretch of a protracted unwind of an equity market bubble as the Shanghai Composite lags all major indices down almost 2% on the year and raising concerns of the China Securities Regulatory Commission which appears to be taking actions to help prop up their lagging equity markets by reducing trading fees and loosening polices for investment by non-Chinese buyers.

The price action in the Shanghai Composite is atrocious in my opinion and the chart below only reinforces the potential for much further weakness if stimulus measures fail to reinvigorate their lagging economy.  The chart mapping China’s GDP vs the performance of the Shanghai Comp since 2005 clearly shows how correlated the equity market crash was to declining GDP , from the 2007 highs when equities topped 6000 and GDP hovered btwn 11 and 12% both measures cratered in lock-step in what can only be called a less than gradual pace.

Easing measures by policymakers are usually in response to poor conditions.  The market will usually anticipate the turn in growth before the trough, but the Shanghai market is clearly showing a concern that the trough in growth is still a ways away, easing measures or not.  It’s a perception in stark contrast to western stock markets, who currently perceive easing measures as the elixir to cure all ills.

 

MorningWord 8/7/12: A year ago this very week, the SPX concluded a peak to trough draw-down of nearly 20% that started in early July largely related to Europe’s Sovereign debt crisis but quickly morphed into a U.S.-centric issue focused on slowing domestic growth and then S&P’s downgrade of U.S. Treasuries.

 

Since retesting, and breaking the intra-day lows in OCT, most major equity indices have not looked back, with the SPX up nearly 30% and quickly approaching the April highs.  Time Heals All Wounds?

A year later things certainly feel less panicky, especially when you consider the fact that this year’s peak to trough draw-down of nearly 11% was half the size and took twice as long  to complete as last years…..ORDERLY to say the least.

SO this is when I go down a little laundry list of charts that have served my bearish instincts well over the last 18 months.

The first relates to market breadth (or lack there of), the 3 year chart  of the SPX vs Bloomberg’s Composite New High Index.  As the chart below shows fairly clearly, the market bottom in 2009 corresponded with a fairly large group of stocks making new 52 week highs at market highs, which persisted into 2010, with readings well north of 1000 at intermediate term highs… as the rally got some legs in 2011 these readings tempered a bit between 500 and 1000.  Since last summer/falls market bottom the readings have been in a fairly dismal range for the most part between 100 and 500 due in part to the increasing relevance of names like AAPL and a few other defensive large caps that have been responsible for a lot of the S&P’s performance.  But come on people, as the SPX is poised to make new multi-year highs, yesterday’s reading of 243 is downright anemic and speaks more to me about the potential for near-term disappointment than the likelihood of sustained break-out rally.

This is also when I pull out my SPX vs spot VIX chart that has generally served me pretty well on short term basis as an input as to just how complacent equity investors have become.  There is obviously nothing scientific here, I generally like to visualize the inverse relationship and try to get a sense for how long history suggests it can persist on an intermediate term basis, which it clearly could for the time being.

 

If the SPX breaks out to new highs, the VIX will see new 5 yr lows, which really doesn’t mean a whole heck of a lot, but when you look out at the VIX futures curve pointing to about 23.50 in December (one of the lowest readings for a 4 month out contract in a while), it screams one thing to me, no matter what your directional bias, that being long options to express that bias could make sense from a risk management standpoint.

I am not going to go into the litany of potential risks to economic and market health at the moment for the fear of sounding like the “boy who cried wolf,” but make no mistake about it they persist.   I also recognize that the investment world we live in is desperate for yield, and on a relative basis, with the S&P trading at just 13x this years earnings with a yield north of 2%, and 10 yr U.S. treasuries at ~1.5%, it ain’t such a hard decision for most.

SO at this point, with investor complacency high after a massive short term sentiment shift, and most looking up rather than down, stock replacement strategies could make sense in situations where you have nice gains.  But for those who are fearful of missing a potential rally, long calls, rather than long stock at these lofty levels could make sense.