Since trading as high as $107 following China’s surprise rate cut on November 21st, shares of Caterpillar (CAT) have declined 17% to fresh 11 month lows, in clear correction territory down 20% from the 52 week highs:
CAT share volatility in 2014 has been a clear example of the push and pull between the earlier hope of growth in emerging markets to match some of the sparks in the U.S. vs the reality of recent signs of slowing in Europe, Russia, Brazil and China. This has all been made apparent buy the crash in oil prices.
Over the past week we have seen some very downbeat commentary from industrial companies Joy Global (JOY) and Navistar (NAV) with shares of both stock’s round-tripping all of their prior 2014 gains making new 52 week lows.
These stocks clearly reflect what is likely to be a challenging first half of 2015, especially if we continue to see the bifurcation between the strengthening U.S. and a weakening globe. The worst case scenario is that the U.S. does NOT de-couple from the global malaise and falls back into a sub 2% gdp (or worse) environment. If that happens 2015 turns into an all out deflationary disaster.
I don’t have a clue what happens from here but I will tell you that the likelihood of a dramatic rebound in EM in the first half of 2015 is NOT high and looking for stocks that don’t reflect a downbeat first half (yet) could present a trading opportunity.
One such company is Deere (DE) which gets about a third of their sales outside North America (vs CAT which gets about 60% of their sales outside North America) DE, like CAT buys back a ton of stock, which in this environment is all they can do to offset what has been a fairly dramatic earnings and sales decline over the last couple years (last Dec company announced an $8 billion buyback program).
DE trades at 10x trailing earnings and about 16x fiscal 2015 earnings that are expected to decline 36% year over year on a expected sales declines of 11%. On a P/E basis, DE is trading near its lowest levels since the end of the financial crisis reflecting a stagnant stock price and the dramatically decreased earnings. If earnings and sales were to somehow pick up, the stock would see a fairly quick move back to the all time highs of about $100 back in 2011. While a continued malaise could mean a re-test of key support at $80:
The stock is kind of in “No Mans Land.” It sits just about the middle of the range. But recently, options prices (30 day at the money implied vol) have seen a healthy uptick, nearly doubling off of the 52 week lows:
[caption id="attachment_49110" align="aligncenter" width="600"]
DE 1yr chart of 30 day at the money IV from Bloomberg[/caption]
The stock nearly traded 90 yesterday and we wish we had seen it then to take a shot from the short side. We’d love to get a chance a little higher and would likely look to a put spread in March. Right now with the stock at $88, the March 87.5/82.5 put spread is around $2. The March 87.5/80 is about 2.60.
Because vol is pumped, timing on an out-of-the-money put spread like that is crucial and that’s why we’re not doing a trade right now. If we could catch the stock above $89 we’d feel pretty good about one of those two put spreads (cheaper than they are now) despite implied vol over 20. Stay tuned.