MorningWord 10/12/12: Declining Breadth & Nasty Squeezes

by Dan October 12, 2012 9:08 am • Commentary

MorningWord 10/12/12: Yesterday’s action in U.S. equities was a fairly clear indication of declining momentum as many of the prior market leaders seem to be losing a little steam.  The SPX and the Nasdaq opened up more than 70bps only to spend the rest of the day selling off to close on the day and leave the indices unchanged and at or near 1 month lows.  SO this leads to the obvious conclusion that while momentum of market leaders is waning, we are seeing a rapid decline in the breadth of the market.  When you look at the 3 year chart below of the SPX vs Bloomberg’s Composite New High Index it becomes very clear that a small amount of stocks/sectors have been doing much of the heavy lifting in rally from the 2011 lows, and only just recently when the SPX made new 5 year highs did we see any real broad participation.

SPX vs Bloomberg Composite New High Index

Which leads me to the point that Enis was driving home earlier in his MacroWrap about Rotation by the Big Money out of massive winners into relative under-performers.  It appears this has already started to happen, as many mutual fund mangers are quickly looking downhill the the last few weeks of their fiscal year, and looking to lock in some gains while also positioning to add some alpha in some under-perfroming stocks/sectors.

Enis gave some good examples in his post, and I would take it step further by adding that hedge fund managers also game this process, and have their own little tricks by causing short squeezes in controversial names.  A couple examples of this just yesterday could be the 8.4% rally in JCP, the 4.5% rally in DECK and the 7.1% rally in BKS.  All of these names are in the retail /consumer space are very controversial, have massive short interest, and in the case of JCP and BKS have activist investors involved who control large stakes of the float.

-JCP: 41% short interest, top 5 holders control ~50% of the shares outstanding

-BKS: 31% short interest, top 5 holders control ~50% of the shares outstanding

-DECK: 38.5% short interest, top 5 holders control ~31% of the shares outstanding

Put another way, these activists and large holders are practically daring shorts to get in.  The flip side of this is that savvy hedge funds know how to game this and we have seen a ton of upside call buying in BKS over the last week as the stock has rallied 30%!  As an example, yesterday 13k of the Jan13 20 calls traded.

Sticking your neck out to short these sorts of stocks at this time of year can be quite dangerous.  If you have a strong fundamental view, then options can make more sense, on both the big winners and the big losers, as volatility in single name stories will probably stay high for the next couple months.


MorningWord 10/11/12:  Last night, in his Too Many Options, Enis flagged a large options trade that caught me by surprise in NOK.  Someone bought 44k of the Jan14 5 calls for .37, with a break-even in 15 months more than 100% higher than current levels.  NOK sits about 65% off of its 52 week highs, about 55% off of the 52 week, and 15 year lows made in July.   The company, and the stock for that matter, has been relegated to the once dominant but now also ran category among handset makers (see RIMM & MOT).  

Just to put things in perspective, AAPL’s Q3 revenues  alone of $35 billion will be greater than NOK’s expected full year 2012 revenues of about $29 billion.  Of AAPL’s $35 billion $25 billion can be attributed to iPhone and iPads.  Make no mistake about it, many of NOK’s woes have been self inflicted, but AAPL’s emergence to the mobile space was kind of the nail in the coffin.  In 2007 when AAPL introduced the iPhone, NOK reported record sales of $51 billion, which has steadily declined ever since.

Yesterday’s trade was interesting to me because I read a blog post from last week entitled Why Apple Should Acquire Nokia.  Here are a few of the highlights from the post:

  • A large por­tion of progress in the mobile space will be dic­tated by the avail­abil­ity and own­er­ship of patents. While Apple and Sam­sung are most famous for their spe­cific fights over patented tech­nolo­gies and approaches, Nokia has qui­etly built up a very strong and rel­a­tively young patent port­fo­lio
  • A 2011 sur­vey showed that Nokia was the largest patent holder for essen­tial tech­nolo­gies relat­ing to LTE.
  • In fact, Nokia’s patent port­fo­lio may be valu­able enough on its own to jus­tify buy­ing the com­pany. With ana­lyst putting its value at any­where between US$6 and US$10 bil­lion, one could buy a patent port­fo­lio and get a telecom­mu­ni­ca­tion and map­ping com­pany for almost free.
  • Nokia has made a num­ber of bets on loca­tion and map­ping, with the 2007 U$8 bil­lion acqui­si­tion of Navteq. This acqui­si­tion made Nokia the largest provider of map­ping ser­vices in the world. In fact, the com­pany pro­vides map­ping ser­vices to Google, UPS, Fedex, and many of the largest play­ers in the auto­mo­tive industry.
  • When looked at in con­trast to the recent release of Apple maps, it seems that this invest­ment is one that would greatly ben­e­fit Apple and allow it to quickly catch up and sur­pass Google. The com­pany could decide that it would not renew its offer­ing to Google when that con­tract expires, forc­ing the search giant to go and build out a greater capa­bil­ity in that arena if it wants to retain its lead in the space.
  • Of course, an acqui­si­tion of Nokia would have quite an impact on Microsoft as it tries to make its way back into the mobile space. With Nokia as its most impor­tant part­ner, Microsoft’s hope to become a likely con­tender for con­sumers’ hearts might be dealt some­thing pretty close to a death­blow.
  • Mean­while, the increase in the size of the patent port­fo­lio Apple would con­trol would prob­a­bly have a large impact on the company’s law­suits against Android man­u­fac­tur­ers. In a world where Android is promi­nent that you get a free Android phone when you buy a mag­a­zine, Apple’s law­suits could even­tu­ally start cut­ting into that rate of growth.

Maybe yesterday’s buyer read this opinion last week as I did and was equally intrigued by NOK’s $5 billion enterprise value and the how the sum of the parts could far outweigh the risks to their hardware business near term.  Additionally given MSFT’s reliance on NOK given their recent smart-phone partnership, any interest by a competitor such as AAPL would force MSFT into the bidding.  NOK’s Q3 is likely to be horrible, and given the stock’s recent 50% rally of the lows it may make sense to wait for the next dip to step in, but given the recent M&A activity in the wireless services space (PCS/T-Mob and this mornings report of Softbank for Sprint) traders may not be able to contain themselves as the lower dollar stock, and the low dollar premiums in NOK allow for low notional exposure with large amount of shares or contracts.




MorningWord 10/10/12:  Last night YUM reported Q3 earnings that were better than expected, while revs were a tad light, but slightly raised FY2012 eps growth forecast from at least 12% to at least 13%.  As it relates to China, where they will see much of their future growth and receive about 45% of their current revenues, the company reported comp store sales in line with consensus and suggested they will open 750 stores in China this year, up from previous target of 700.  I guess the most interesting take-away from the report, is that while most investors were focused on China being the cause for concern (me included), many had expected the U.S. to be weak after seeing disappointing results this summer in the U.S. from MCD and CMG.  U.S. comp sales were actually better than expected, up 6% vs the estimate of up 4.4%.  Could YUM’s U.S. performance be a result of one of the main tenets of hedge fund manager David Einhorn’s short thesis on CMG that he laid out nearly 2 weeks ago at the Value Investing Congress?  His view on CMG (he declined to offer and investment opinion on YUM) is that Taco Bell’s New Upscale Menu in the U.S. may eat CMG’s lunch so to speak.  Some guys are just really good at this.

The stock is up about 4.5% in the pre-market in line with the implied move, as investors’ worries about slowing sales in China are allayed for now and the U.S. is outperforming.  This is one fast food chain that appears to be bucking the trend.

Yesterday prior to the close,  I adjusted a bearish position in YUM that I have had on for 2 months, and rolled up and out a bit, my new position as of yesterday’s close is long the Nov 65/60 Put Spread after taking a loss on the Oct 62.5/55 Put Spread.  In the post I outlined 3 options for my Oct trade and how I was thinking about going forward, and they were:

1. Sell the Spread for a loss and wait for the news to come out and then make a decision about how to express the bearish view if the news confirms the thesis (albeit at lower levels).
2. Sell the spread and roll to higher strikes and possibly even out to Nov in an effort to stay in the game.
3. Leave the position on and play for an out sized move post earnings.

In hindsight, number one was the right option, but here is the thing, if I am going to trade earnings, which I do frequently, I have to go with what I feel my best trade ideas are, knowing that I will not always be right.  The prudent thing to do would have been to take a step back after 2 months in the trade, and wait for the news to come out and make my next move with the knowledge of the results.  At this point, I am just wrong on the story, or maybe my timing is wrong, but now I have had 2 losing trades in the course of 2 months in the name, and it is likely time to bail and move on.  I will officially update this trade this morning, after I see how the stock trades.

On another note, Enis nailed CMI with a Bearish play into their Q3 earnings and will get paid early after last night’s negative pre-announcement.  Whats interesting about CMI is that their exposure to China is obviously one of the main drags on the company.  Also last night, AA once again cut their demand forecast for Aluminum due to weakness in China.  Both China related warnings come on the heals of FDX and NKE’s results in the last month that also both signaled to weakness in China.