MorningWord 5/9/13: Bull in a China Shop

by Dan May 9, 2013 9:13 am • Commentary

MorningWord 5/9/13:  Every small dip in the market is being bought. It’s just that simple.  Over at RiskReversal HQ we have a little snarky saying every time we see a 5 handle sell off in the SPX, “that was your opportunity to get in!”  While we say to each-other in jest, every single dip this year has been the “Buy of 2013”.  I read the other day that the The Dow Jones Industrial Average has had the longest streak without 3 consecutive down days since the the mid 1950s, WOW!  Money flows into U.S. equities show no apparent signs of letting up, despite some fairly stark under-performance in emerging markets equity indices in  China, Brazil and Mexico (all down on the year).  My fear of committing new capital to U.S. equities above 1550 in the SPX for the last few months is that we are either going to see the economies in Emerging Markets pick up which would likely cause money to flow out of perceived safe havens like the U.S., or we will see a continued slowdown in growth that causes a re-set to earnings expectations for U.S. multi-nationals, which eventually cause a 5-10% pull back.

I am no economist or macro trader, but there seems to be a fairly stark disconnect bwtn investor expectations for growth in the developed world vs EM and my assumption is that something has to give.  The 10 year chart of the SPX (white line: the largest equity index of the largest economy in the world) and the Shanghai Comp (yellow line: the largest equity index of the 2nd largest economy in the world) shows 2 periods of massive relative under-performance, 2003-2006 and 2010- 2013.  IN my little mind, either China is the Buy of the Century or the SPX setting up for a doozie of a sell off.  Just sayin.

SPX vs Shanghai Comp 10 year chart from Bloomberg
SPX vs Shanghai Comp 10 year chart from Bloomberg


In single stock land, stocks have really been moving. IN just the last 24 hours I have seen more 10% moves than I can remember in a while (TSLA up 23%, GMCR up 15%, GRPN up 15%, MNST down 10%, FIO down 18%, AOL -9%, Z -10%, WFM up 10% & EA up 17%, ) to name just a few.  I am obviously a little biased, but I don’t see this sort of price action as bullish at all time highs, seems speculative on the upside and nervous on the downside.




MorningWord 5/8/13:  As U.S. equities continue to chug along and make new highs almost every day, there has been a lot of talk about sector rotations and how new leadership will likely drive the next leg of the rally, if it is too continue.   This logic makes perfect sense and only time will tell, but one mini phenomenon of late has been the resilience of  stocks with unusually high short interest, and the question that I would pose is this bullish or bearish at new highs after such a long bull run?  Again I have no clue, but I would obviously fall into the camp that thinks the price action of stocks like TSLA, FSLR, GMCR & HLD of late is a last ditch effort to chase performance by hedge funds who have wildly under-performed year to date.  Per Cullen Roche who writes the Pragmatic Capitalism blog,  “HFRX Global Hedge Fund Index: +3.77%….vs the SPX up 14%” enough said…. he goes on to say.

“The reality is that being an active manager is incredibly difficult in an environment where the market seems to never go down.  If you’re not leveraged, strategically differentiated, lucky or unusually skilled the odds are heavily against an active manager outperforming a market like the one we’ve seen in 2013 where stocks just don’t go down.”

Which leads me back to the aforementioned stocks, which all have short interest north of 27%, all of which have a significant concentration of shares outstanding among a handful of holders and all have had eye-popping gains ytd (data below from Bloomberg):

% Ownership
 Top 5 Holders 55% 60% 54% 59%
Short Interest 46% 30% 27% 38%
YTD Gains 63% 40% 41% 30%

That combination in a market where hedge fund managers need to justify their highs fees in a period of under-performance, makes for an explosive cocktail for those looking to cause short squeezes and garner out-sized returns, even if only in a few small positions.

As Traders you will often hear and read on the site our desire to fade certain moves, either direction or vol (with defined risk), in the case of these super-freaks, we wouldn’t short them with your money, but will continue to look for opportunities around events to sell vol.  Fundamentals will eventually determine the direction, but from where??  For those of us who lived through the dot com bubble and burst the notion that the market, or an individual security can remain irrational longer than one can stay solvent is ingrained in our brains, and while this sort of price action routinely draws in shorts, it is the exact set up for those looking to cause squeezes are looking for.



MorningWord 5/7/13:    If you were too look at this chart without knowing the stock ticker, it would be logical to deduce that the underlying company was doing a lot of things very right, and after a period of under-performance, some piece of positive news just catalyzed a nearly 20% rally to 5 year highs.

1 yr chart of MSFT from Bloomberg
MSFT 1 yr chart from Bloomberg

But of course you can see the ticker, and it is MSFT and the only reason I can come up with for the performance is a fairly lame one, rotation out of defensive stocks into cyclicals/laggards blah blah blah.  I guess it makes sense to me if you believe the economy is slowing improving, or will ultimately improve given the continued rate of asset purchases by Central Banks, so why not look to play for a bit of catch up in names/sectors that have yet to participate.

The five year chart below of MSFT shows the fairly tight range the stock has traded in over that period, despite continued failures to vastly improve their core Windows and Office products, and woefully disappoint in anything mobile.

MSFT 5 year chart from Bloomberg
MSFT 5 year chart from Bloomberg

To look at the stock’s chart since inception it is easily to see the period of what must have been rapid growth and innovation (well maybe not innovation, it is MSFT, lets say mass adoption), and then a long period of just status quo.  Back to my initial comment up top, if you didn’t know the ticker, and the underlying company, than you would think this company was about to be doing some really big things based on the recent price action.

MSFT chart since IPO
MSFT chart since IPO

SO after the stock’s fairly epic recent run, why does it not come as a surprise that MSFT is about to do an about-face on their core Windows product that was supposed to be an end to the ridicule of one crappy offering after another since Windows 2000.

This morning’s Financial Times is reporting (here) that MSFT:

Microsoft is preparing to reverse course over key elements of its Windows 8 operating system, marking one of the most prominent admissions of failure for a new mass-market consumer product since Coca-Cola’s New Coke fiasco nearly 30 years ago.

“Key aspects” of how the software is used will be changed when Microsoft releases an updated version of the operating system this year, Tami Reller, head of marketing and finance for the Windows business

Microsoft has also admitted to a range of other slips with the launch of Windows 8, including failing to do enough to train retail staff and educate potential customers about the new software, as well as not focusing all of its financial incentives behind the touchscreen PCs that show off Windows 8 to best advantage.

Despite the slips, she said that Microsoft continued to view the software as suitable for both PCs and tablets and that “customer satisfaction with Windows 8 with touch is strong”

A few weeks back prior to MSFT’s fiscal Q3 earnings, the stock saw a rash of downgrades and estimate cuts from the likes of BAC, GS and Nomura, all by very high profile analysts.  Could it be that their reasons for their new found pessimism that the company is accelerating market-share losses as pc shipments continue to get decimated by tablets was just wrong?  I doubt it, and I would suggest the recent rally has little to do with fundamentals and all to do with money flows.  I was a tad early in calling the rally’s demise back in early April, but the recent move could present a near term opportunity on the short side, I will be looking to fade a portion of  this move after possibly one more push higher and then a failure and will likely look to do so via short call spreads.

Enis’ quick take is slightly different (and it’s not often we agree 100%):  MSFT is slated to earn $3 in calendar year 2013 vs. earning $1.80 in 2007, the last time the stock was at these levels.  A near-term fade likely makes sense soon given how quickly the stock has moved.  But in the longer-term, the heavey buying we’ve seen recently seems to indicate investors don’t seem to care whether the real number is $2.70 or $3.30.  They just want the safety of a big balance sheet and reliable dividend, growth be damned.



MorningWord 5/6/13:  Not sure about you guys but since Friday evening, when Berkshire Hathaway reported Q1 results that handily beat Wall Street expectations and CEO Warren Buffett hosted the company’s annual shareholder meeting, I need a little Buffer from the Oracle of Omaha.  To attempt to knock at this routine and long term investment success is just ridiculous – there are probably few that have ever been better.  But at this point, after all these years, my sense is that the real “alpha” generated in his vast portfolio of corporate and equity holdings has a ton to do with the sweetheart deals he gets during crisis.  While the rest of the financial world was melting btwn 2008 and 2011, from the U.S. to Europe, Buffett sat back in his humble surroundings and waited for the phone to ring from the C-Level suite of almost every major financial institution looking to get the “Buffett Bump” in the form of a crisis deal that would likely be the floor in the stock.  You know whose call he didn’t pick up? Alan Schwartz (Bear Stearns) or Dick Fuld (Lehman Brothers). But he most certainly picked up Lloyd Blankefien (GS), Jeff Immelt (GE), and Brian Moynihan’s (BAC) calls!  And he is very glad he did as the deals he struck earned far greater profits than if he had just bought the stock at the time!

It’s just amazing to me that the guy who was the investor of last resort for some of the largest financial institutions in the world during the worst financial crisis since the Great Depression still had holdings in companies like Dairy Queen, Sees Candies & Fruit of the Loom all under the same umbrella.

Despite the massive Berkshire Love-Fest over the last 72 hours, my Options Action friend Carter Worth of Oppenheimer, attempted to rain on the Buffet parade Friday evening, with his bearish technical view on the stock:

Carter thinks that in the case of BRK/B  “Price is  Discounting the Facts”.  I don’t have a view on the stock other than as long as the market keeps chugging along, so will Berkshire as the stock has essentially traded in lock step with the SPX since the 2009 bottom sporting an almost identical gain off of the lows.

Carter thinks the stock could have met an inflection point given certain technical divergences.  The producers of Options Action asked me to construct a trade structure that would be inline with Carter’s near term bearish view and give a good defined risk, risk/reward structure.  Again I have no position in BRK/B and never have, but if you wanted to try to “Fade the Oracle” btwn now and Sept this is one way to do it (the stock is up 2.50 in the pre-market, so this was based off of Friday’s close of $108.65):

Theoretical Bearish Trade: BRK/B ($108.65) Buy Sept 105/100 Put Spread for 1.20

-Buy 1 Sept 105 Put for 2.60

-Sell 1 Sept 100 Put at 1.40

Break-Even on Sept Expiration:

-Profits btwn 103.80 and 100 of up to 3.80, max gain of 3.80 at 100 or below.

-Losses of up to 1.20 btwn 103.80 and 105 and max loss of 1.20 above 105.

Trade Rationale:  Frankly if you wanted to be short BRK/B I don’t think you have to worry a whole heck of a lot about this stock adding another 20% any time soon at all time highs and up 21% on the year already, but if you are looking to trade it, risking ~1% over the next 4 months to play for an ~8.5% sell off that pays 3 to 1 with defined risk seems like a decent way to do it.

I guess in sum, it doesn’t make a lot of sense to bet against Buffett, just like it didn’t make a lot of sense to bet against Steve Jobs at AAPL.  But all good things come to an end as was brutally evidenced by AAPL’s rise and fall since Jobs death. But in the case with AAPL, the aftershocks of  departure (for the company and the stock) were not felt for almost a year.  Shorting stocks because of key man risk isn’t smart, but when you have a company where the founder and leader of the company is the “special sauce” so to speak, investors have to remain vigilant.  This warning is probably more directed at new investors in the stock who expect another 30 years of performance similar to the last 30.  My sense is you probably won’t get it.