The bond market is closed today for Columbus Day, but the TLT (iShares 20 year Treasury bond etf) is down a little less than 1%, suggesting that yields would be up a bit. The etf today is trading at its 200 day moving average for the first time since early January, and is now down about 7.5% from its all time highs made in early July when U.S. Treasury yields made an all time low (the 10 year traded nearly 1.3%). Given the confidence in the Fed Fund futures market of a Dec rate increase (at a high of 65%), the TLT could be trading in the high $120s soon:
If that were to happen, I suspect we will see a continuation of the recent rotation out of high yielding equities like Utilities, U.S. Telco, Pharma and Consumer Staples. Much like utilities, staples have gotten expensive relative to their historic values (and the broad market) as investors have sought yield in sectors deemed to be defensive. The etf that tracks Consumer Staples is down about 6.5% from its July all time high and sitting right above technical support at $52:
The top 5 holdings in the XLP make up about 40% of its weight, with the largest components Procter & Gamble (PG) at 13% , with Coca-Cola (KO) nearly 9%, followed by Philip Morris (PM) and Altria (MO) at a combined 14% and Walmart (WMT) at 5.7%. Shares of PG and WMT have massively outperformed the S&P 500 (SPX up 6%) in 2016, up 12 & 11% respectively, with the cigarette guys up 9 & 6% respectively, and KO down 3%.
The point here is that investors have pushed stock’s like PG to valuations unseen in a very long time due to its 3% dividend yield, coupled with their $8.2 billion in shares bought back in fiscal 2016, equlaing $15.6 billion (150% of their adjusted net earnings) in capital return in that period, or nearly 7% of their $237 billion market cap. The stock’s P/E on expected fiscal 2017 eps of $3.88 is about 23, a 10 year high:
In fiscal 2016, 56% of PG’s sales came from outside the U.S., which is one reason you also want to keep an eye on the U.S. dollar. I know, I know, it has been range-bound for the last year, with the DXY (the U.S.dollar index) spending most of the last 12 months between $94 on the downside and $100 on the upside. But one question you have to ask yourself if you own staples (with lots of overseas exposure) right now is whether or not the DXY near $97 is set to make a run back towards the 52 week highs near $100:
And if so, what sort of headwind will that be for a company like PG where current estimates are only calling for 6% eps growth on 1% sales growth (would be first increase in 4 years) in fiscal year 2017 (current year).
The stock has been a monster, making a new 52 week high today, on a slow grind back towards the prior all time high made just below $95 in late 2014:
Near term though, the stock has been trading in slightly wider volatility bands with realized vol (white below) hitting its highest levels since February, and implied vol (the price of options, blue below) also increasing in lock step:
The one year chart shows obvious technical support at the July breakout near $83.50, just above the stock’s 200 day moving average (yellow), which could be an attractive near term target into earnings, and the potential for rates to continue to raise into the Fed’s Dec 14th FOMC meeting:
So What’s the Trade?
There are two events in the next few months that will determine what’s next in PG. The first is earnings 10/25 before the open, then of course the Fed meeting in December (and to a much lesser extent the one in November). Therefore, any directional bet for a pullback needs to catch the Dec Fed meeting. The stock has also been in a grind for quite some time and there’s nothing stopping it from continuing that lack of volatility, especially if it goes sideways for now. So any directional bet with long premium must be as protective as possible with decay:
*PG (89.25) Buy the Dec 90/82.5/75 put butterfly for 1.95
- Buy 1 Dec 90 put for 3.20
- Sell 2 Dec 82.5 puts at .75 (1.50 total)
- Buy 1 Dec 75 put for .25
Break-even on Dec expiration:
Losses of up to 1.95 above 88.05 with total loss of 1.95 above 90
Gains of up to 5.55 below 88.05 and above 76.95 with max gain of 5.55 at 82.50.
Rationale – this trade targets a wide area below for a pullback in shares with a max gain target near the 200 day moving average. It starts already .75 in the money so the break-even just below at 88.05 is not a ton of extrinsic premium to be long to start. The main risk of this trade is that the stock goes higher on earnings and the fly is too far out of the money after.