Option Investor
Newsletter

Daily Newsletter, Thursday, 12/29/2016

Table of Contents

  1. Market Wrap
  2. New Option Plays
  3. In Play Updates and Reviews

Market Wrap

The Market Waits

by Thomas Hughes

Click here to email Thomas Hughes

Introduction

The markets continue to consolidate within near term trading ranges, waiting on the start of the New Year. What will the New Year bring? By all accounts growth in earnings and the economy, how much growth is the question weighing on everyone's mind. Next week's raft of monthly macro-data may help answer important questions. Regardless, GDP and earnings growth expectations for next year are positive, expansionary and bullish for equities.

Trading action was light around the world as post-holiday trading volumes persist. Asian indices were mixed following the US sell-off, led by the Nikkei and a loss of -1.30%. European indices did not fare much better, closing with minimal losses and basically flat for the day.

The news of the day turned out to be political in nature. President Obama evicted more than 2 dozen Russian diplomats and shut down 2 of their compounds in retaliation for the election tampering and hacking attacks. Russia has responded saying the move is illegal and will be countered. For those of us who can remember the Cold War years, here we go again.

Market Statistics

Futures trading was light in the early electronic session, indicating a flat to mildly positive open all morning. There was little in the way of economic data and nothing in the way of earnings or business news to move the market. The open was calm, the indices began the day in positive territory, just above the bottoms of near term trading ranges, and were able to make some gains within the first half hour of trading. Gains were small, about 0.15% for the SPX, and did not last. By 11AM most indices had fallen into negative territory where they remained for the better part of the day.

Economic Calendar

The Economy

Jobless claims data was as expected, consistent with seasonal trends and long term labor market health. Initial claims came in at 265,000, up 10,000 from last week's not revised data, while the 4 week moving average of claims fell -750 to 263,000. This is the 95th week of claims under 300,000, the longest streak since 1970. On a not adjusted basis claims rose 7.9 versus an expected gain of 12% and are down -1.8% year over year. There has been some volatility in the numbers lately but based on the historical data remain consistent with seasonal trends. Increases in initial claims should peak out in early January and then fall off into the spring and summer. The state with the largest increase in claims is Ohio with +2,625, the state with the largest decrease in claims is Pennsylvania with -1,521.


Continuing claims increased by 63,000, on top of a +3,000 revision to last week's data, to hit 2.102 million. The 4 week moving average of continuing claims rose 4,500 to hit 2.042 million. This is the highest level of continuing claims in 4 months but within seasonal expectations and still near the long term low. Despite the gains over the past few weeks continuing claims remain consistent with labor market health. Continuing claims should peak in the next few weeks and then subside going into the spring and summer.

The total number of Americans claiming unemployment benefits jumped 102,430, in line with expectations, to hit 2.140 million. The jump in claims is well within seasonal expectations and remains consistent with long term labor market improvements. We can expect to see total claims hit its peak in the next 2 to 3 weeks, near 2.75 million, and then fall off into the spring and summer. Next week we'll get the latest round of ADP, Challenger and NFP. The only thing on tap tomorrow, economically, is the Chicago PMI.


The Dollar Index

The Dollar Index fell in today's action. The index lost a little more than -0.5% on an absence of news but remains within the near term trading range. Despite today's loss the dollar remains within a near term consolidation range just below long term highs. It is supported by economic trends, FOMC outlook and expected economic strength that has put upward pressure on FOMC expectations. In the near term the indicators are consistent with a test of support within an uptrend but are also showing divergences that indicate a deeper correction is possible. Near term support is just below today's closing price at the $102.50 level, a break below that level would be bearish and could take the index down to the short term moving average, near $102.00, or to the next target at the recently broken previous long term high near $100.50. A move higher, in line with the prevailing trend, may find resistance at the $103 level, a break above this would be bullish.


The Oil Index

Oil prices wavered near the recently set high as US crude stockpiles unexpectedly build. The build, +600,000 barrels, comes in the face of the expected OPEC production cuts that has WTI and Brent trading near 18 month highs. If, and it is a big if, OPEC actually follows through on production cuts, enough to actually affect the supply/demand imbalance, prices could continue higher. The risk is that bullish outlook relies on OPEC, it's members (who don't like each other) and the non-members who have also agreed to cuts. If, and I think this is a more likely scenario, production does not decline noticeably in January oil prices could see a big correction.


The Oil Index continues to consolidate within the near term trading range, just below recently set long term highs. The index has been supported on the recent rise in oil prices and, more importantly, the forward earnings growth outlook for 2017. The energy sector, in aggregate, is expected to post year over year earnings growth of 343%, reversing this years earnings decline of -75%. This, regardless of oil prices (provided they don't tank), is the likely driver of the sector in the near to short term. The index gained about 0.05% today but price action has been nearly flat over the past 9 trading sessions. The indicators are consistent with a consolidation/test of support within an uptrend and setting up for another leg higher. The current MACD peak is convergent with the latest high suggesting strength in the market and more new highs on the way. Resistance is at 1,300, a break above this level would be bullish.


The Gold Index

Gold rebound in today's session, up nearly 1.5%, to close above $1,150 for the first time in two weeks. The gains were driven by today's dollar weakness and did not snap the short term down trend in gold. Long term outlook for the dollar is bullish, today's action has not altered that, and that is bearish for gold plain and simple. Today's move in gold barely retraces the 6 month bear market and faces tough resistance at the $1,200 level, if it is able to sustain the move above $1,150. Next weeks data is a big risk for the dollar and gold; strong data and signs of inflation could put pressure on the Fed to hike more often, or more aggressively, than the market now expects and that could send the dollar higher and gold lower.

The gold miners got a lift from gold prices but not enough to break the short term down trend. The Gold Miners ETF GDX gained nearly 7.5% in a move that appears to have strength but likely to be short lived. The ETF is moving up toward resistance and a retest of the 50% retracement level at a point that coincides with the short term down trend line, near $22.00, and resistance is likely to be strong. This will be the 4th time this trend line has been tested since the August market reversal/September confirmation and a likely point of entry for bearish positions. The indicators are bullish in the near term, moving higher, but remain consistent with bear market conditions in the short to long term. Upside target for resistance is $22.00 in the very near term with a possible retest of recent lows near $18.50 in the near to short term. Longer term, provided the dollar continues to rise, a full retracement to $12.25 remains a possibility.


In The News, Story Stocks and Earnings

Disney. Star Wars Rogue 1. I saw it and I liked it and what I noticed, aside from how much richer the Star Wars universe is, is that the theater was still full even weeks after the opening. My point is that this movie is a winner, far beyond expectations, and has firmly cemented the future of Star Wars and Disney. All they need to do now is fix ESPN and avoid new pitfalls. Shares of the stock held steady in today's session, just above yesterday's close, and within a recent consolidation range. Prices are holding just below the one year high of $106.75 which is the current resistance target. A break above this level would be bullish


Amazon was awarded a patent today for a flying warehouse. That's right. A Jetson's-like flying fulfillment center that would hover in high altitude, be serviced by shuttle flights for crews and product, and send drones out on delivery as order come in. The design included with the patent application use a blimp to support a large warehouse structure, so far no news about plans to build it. Other innovations Mr. Bezos has in store for us are drone delivery, the first was completed this month, and personally tailored shopping experiences powered by AI. Shares of the stock fell -1.20% in today's session but are flat over the past 3 weeks, near the middle of the post-earnings trading range.


The Indices

Trading was basically flat for the day. The indices opened with small gains, gave them up and in exchange for small losses, held those most of the day and then climbed back to near break-even by the close. No move was large, the day's top loser shedding only -0.12% at the close. The tech heavy NASDAQ Composite created a small spinning top doji and set a new two week low. Despite the new low today's close is above the previous all time high, a critical support target that is confirmed at this time by the short term moving average. The indicators are consistent with a test so support, near 5,400, within an up trend and do yet indicate more. A break below 5,400 would be bearish in the near term, a bounce from this level bullish and trend following.


The Dow Jones Industrial Average posted the next largest decline, -0.07%, and created a similar doji spinning top. This candle is at the bottom of a near term consolidation range, a range that has formed following a strong rally and may indicate continuation. The indicators are consistent with a test of support within an up trend with targets at 19,800 and 19,500. A break below 19,800 would be bearish in the near term only, a break below 19,500 could be more serious.


The Dow Jones Transportation lost only -0.04%, reclaiming nearly all of the intraday losses before the closing bell. The index created a small doji candle after trading in a range of only 1%. The candle is sitting on short term support at the 30 day moving average with bearish indicators. The index has corrected after a strong rally and is now at a critical juncture. If the rally is to continue in the near to short term support at the moving average needs to hold. Based on the MACD peaks and specifically the strong peak associated with the onset of the Trump Rally, market participation was fairly strong leading up to these levels and suggests support will hold and a retest of the recent high is likely.


The S&P 500 brings up the rear in today's lineup with a loss of -0.03%. The broad market index created a small doji spinning top and set a new 3 week low. Despite setting a new low the index remains above support and near the all time high. Divergences in the indicators suggested a pull back to support could happen, now that it is it does not appear to be very strong, at least not yet. First target for support is just below today's close at an up trend line that is confirmed by the short term moving average. The indicators are consistent with a test of support within an up trend and so far reveal one that is very weak. Should support fail, near 2,230, a move down to the previous all time high near 2,200 is likely.


The markets have been consolidating near all time highs with indications of potential correction. Now it looks like that correction is happening and it doesn't look like it is very strong. The thing to remember is that this is the holiday week, the final week of the year, volumes are low, market participation is thin and anything that happens now is just as like to be a whipsaw as a real move. Next week is when the rubber hits the road in terms of the the Trump Rally. There may be selling at the start of the year, I can understand if folks want to start the year with profits, and it may lead to more than just a dip despite an expected quarter of positive earnings growth.

If near term support fails we could see as much as a 3 to 5% correction before strong support along long term up trend lines and moving averages are reached. Short to long term however, the outlook remains bullish; earnings growth is back and expanding with positive forward outlook. Risk at this time lay in next weeks data bundle. Too hot and the market could get bent on FOMC expectations, too cold expectations for the 1st and 2nd quarter could take a hit. This makes me a bull long term, hoping for the big dip, cautious in the near term waiting to see what happens next.

Until then, remember the trend!

Thomas Hughes


 

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New Option Plays

Year End Festivities

by Jim Brown

Click here to email Jim Brown

Editors Note:

Traders will be looking forward to the yearend festivities but dreading the potential volatility at the close. With the quarter end pension fund rebalancing on Friday there is likely to be a sharp decline at the close. While nobody can guarantee any particular market event the odds are still very good.

There is no reason to add more positions because we are already heavily weighted to the downside. Take it easy and enjoy the weekend. Next week could be a roller coaster.

If you are just dying for something else to play, buy February calls on the $VIX. The $15 call is now $2.55 and a spike to the $20 level would be a decent payday. I am not recommending it because we already have five shorts in anticipation of a January decline.



NEW DIRECTIONAL CALL PLAYS

No New Bullish Plays


NEW DIRECTIONAL PUT PLAYS

No New Bearish Plays



In Play Updates and Reviews

Friday Could be Exciting

by Jim Brown

Click here to email Jim Brown

Editors Note:

If the pension fund rebalance occurs as Credit Suisse expects, Friday could be a bad day. CS expects between $38 and $58 billion in stock to be sold on Friday. In a low volume market, this could produce a sharp decline. Most of the selling would happen at the close but there are probably a lot of traders that will try to initiate some shorts in front of the move.

We have not seen any material increase in downside volume so it remains to be seen if the market is actually going to react as expected. However, starting on Tuesday, it is a new tax year and that could also be a challenge for the bulls.

I would strongly recommend investors remain very flat with your account in cash until we get into January.



Current Portfolio


Stop Loss Updates

Check the graphic below for any new stop losses in bright yellow. We need to always be prepared for an unexpected decline.


Profit Targets

Check the graphic below for any profit stops in green. We need to always be prepared for a profit exit at resistance.




Current Position Changes


MAT - Mattel Inc

The long put position was entered at the open.



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BULLISH Play Updates


ADP - Automatic Data Processing - Company Profile

Comments:

No specific news. New historic high in a weak market.

Original Trade Description: December 5th.

Automatic Data Processing, Inc., together with its subsidiaries, provides business process outsourcing services worldwide. The company operates through two segments, Employer Services and Professional Employer Organization (PEO) Services. The Employer Services segment offers a range of business outsourcing and technology-enabled human capital management (HCM) solutions, including payroll services, benefits administration services, talent management, human resources management solutions, time and attendance management solutions, insurance services, retirement services, and tax and compliance solutions. This segment's integrated HCM solutions include RUN Powered by ADP, ADP Workforce Now, ADP Vantage HCM, and ADP GlobalView, which assist employers of all sizes in all stages of the employment cycle from recruitment to retirement; and ADP SmartCompliance and ADP Health Compliance. The PEO Services segment provides a human resources (HR) outsourcing solution through a co-employment model to small and mid-sized businesses. This segment offers ADP TotalSource that provides various HR management services and employee benefits functions, such as HR administration, employee benefits, and employer liability management into a single-source solution. Company description from FinViz.com.

ADP reported a 26.5% rise in earnings to 86 cents that beat estimates by 9 cents. Revenues rose 7.5% to $2.92 billion and beat estimates for $1.91 billion. The number of employees on client payrolls rose 2.7%. They ended the quarter with $2.82 billion in cash and long-term debt of $2 billion. The announced the sale of their CHSA and COBRA business to WageWorks for $235 million. The sale will be completed in Q2 2017.

The company guided for 2017 revenue growth of 7% to 8% and 15% to 17% earnings growth. The PEO Services segment revenues are expected to rise 14% to 16%.

The company just declared a 57-cent quarterly dividend to raise the annual dividend to $2.28.

Earnings Feb 1st.

ADP holds a dominant position in the payroll processing sector. With employment expected to rise again in 2017 this could be an attractive investment for funds that are tired of chasing industrials and bank stocks in the current rally.

Shares took profits last week from a very nice climb and could be ready to try for a new high.

There is resistance at $97 but given the time of year and the overbought conditions in the rest of the market, we could see a breakout. Options are relatively cheap.

Position 12/6/16:

Long Feb $97.50 call @ $2.10, see portfolio graphic for stop loss.



BEARISH Play Updates (Alpha by Symbol)

CAT - Caterpillar - Company Profile

Comments:

No specific news. No material gain after Wednesday's decline.

Original Trade Description: December 17th

Caterpillar Inc. manufactures and sells construction and mining equipment, diesel and natural gas engines, industrial gas turbines, and diesel-electric locomotives worldwide. The company's Construction Industries segment offers backhoe, small wheel, skid steer, multi-terrain, compact track, medium and compact wheel, and track-type loaders; mini, wheel, and track excavators; track-type tractors; and select work tools, motor graders, telehandlers, soil compactors, and pipelayers, as well as its related parts for the heavy and general construction, rental, mining and quarry, and aggregates markets. Its Resource Industries segment provides electric rope and hydraulic shovels; draglines; drills; highwall and longwall miners; hard rock vehicles; articulated, large mining, and off-highway trucks; large wheel loaders; wheel tractor scrapers; wheel dozers; machinery components; hard rock continuous mining systems; electronics and control systems; and select work tools for use in mining and quarry applications. The company's Energy & Transportation segment offers reciprocating engines, generator sets, marine propulsion systems, gas turbines and turbine-related services, diesel-electric locomotives, and other rail-related products and services. Its Financial Products segment provides retail and wholesale financing for Caterpillar equipment, machinery, and engines; offers property, casualty, life, accident, and health insurance; insurance brokerage services; and purchases short-term trade receivables. The company's All Other segments remanufactures Cat engines and components, and provides remanufacturing services for other companies; offers business strategy, and development, management, manufacturing, marketing, and support primarily for paving, forestry, industrial, waste, and Cat products. Company description from FinViz.com.

Caterpillar's business has been in decline for several years as the energy sector went into hibernation and Asia's economic growth appeared to slow. For some reason, the stock bottomed on January at $58 and rallied to almost $100 despite a weak outlook in every earnings cycle. The $18 post election bounce was just another example of irrational exuberance. The election did not sell more tractors overnight and a pickup in their business could be several quarters away.

The best thing Caterpillar has in its favor is OPEC's decision to cut production. That means a year from now oil prices may have recovered slightly and energy companies may begin to buy more tractors. That is a long time off for an $18 spike.

Earnings in 2014 were $6.38, 2015 $4.64, 2016 they are estimated to be $3.26 and for 2018 analysts expect $3.15. However, CAT said last week that the estimates were overly optimistic. While Asian sales may have quit declining there is no material rebound at present.

Earnings Jan 24th.

This is a play on the retracement of that $18 bounce. When the company says analyst expectations are overly optimistic you can bet analysts will begin to lower their numbers. That should produce an extra weight on the stock in addition to any normal decline with the Dow in January.

The earnings are Jan 24th and the February options are expensive. Since this is a short-term position, I am recommending the January options. I believe any material decline will happen in the first two weeks of January.

Position 12/19/16:

Long Jan $90 put @ $1.89, see portfolio graphic for stop loss.


DIA Dow ETF - ETF Profile

Comments:

No material news. No rebound but no material decline either. Just passing time.

Original Trade Description: December 7th

The SPDR Dow Jones® Industrial Average ETF Trust seeks to provide investment results that, before expenses, correspond generally to the price and yield performance of the Dow Jones Industrial Average.

Remember Dow 10,000? Traders talked about it for weeks. When it was finally hit, they were passing out Dow 10,000 hats on the floor of the NYSE for a week. That was December 11th 2003. It was a big milestone for the market.

Now 13 years later we are about to double that with Dow 20,000. Given the place on the calendar, the massive post election rally and the potential for normal profit taking in January, the Dow 20,000 touch could be a massive sell on the news event.

However, we are only 386 points way and it could happen as soon as next week. The Fed rate announcement on Wednesday could either cripple that potential or accelerate it if the Fed maintains a dovish posture on future rate hikes. I believe we will hit Dow 20K before the end of December. When that happens I want to be short the DIA ETF and plan on holding it through January.

I am choosing the Dow because it is the most overbought and could produce the biggest percentage move. Just look at Goldman's chart and the profit that needs to be removed there.

Because there will be plenty of other traders thinking along the same lines I want to enter the put position at 19,900 or $199 on the DIA ETF. I know I am jumping in front of a speeding train to enter a short position on a runaway market but the potential is very high for a good trade.

Position 12/12/16:

12/12 - 1/2 position: Long Feb $195 put @ $3.40, no initial stop loss.

12/13 - 1/2 position: Long Feb $195 put @ $3.15, no initial stop loss.


DRI - Darden Restaurants - Company Profile

Comments:

No specific news. Just waiting on January correction.

Original Trade Description: December 20th

Darden Restaurants, Inc., through its subsidiaries, owns and operates full-service restaurants in the United States and Canada. As of May 29, 2016, it owned and operated 1,536 restaurants, which included 843 Olive Garden, 481 LongHorn Steakhouse, 54 The Capital Grille, 65 Yard House, 40 Seasons 52, 37 Bahama Breeze, and 16 Eddie V's restaurants. Company description from FinViz.com.

Darden Restaurants (DRI) reported earnings on Tuesday of 64 cents that beat estimates by a penny. Revenue of $1.64 billion missed estimates for $1.65 billion. They guided for the full year 2017 to earnings of $3.87-$3.97 per share. Same store sales growth was choppy. Olive Garden saw +2.6%, Longhorn Steakhouse +0.1%, Capital Grille+1.2%, Eddie V's +2.7%, Yard House +0.7%, Seasons 52 -0.3% and Bahama Breeze +2.6%. Shares spiked $2 on the news but faded in the afternoon to close negative. Darden had rallied 23% since the election.

The idea behind the rally was the end of the push for a $15 per hour minimum wage. When Clinton lost, that effort turned into wishful thinking because republicans have held the view that a lower wage offers entry level workers an opportunity and they can move up in the organization if they are qualified and work hard. Was that worth a 23% rally in Darden shares? I find it hard to believe.

Now that Darden earnings are over, we should expect a couple weeks of post earnigns depression and given the recent rally and the chance for a market decline in early January, the Darden drop could be significant.

Position 12/21/16:

Long Feb $72.50 put @ $1.55, see portfolio graphic for stop loss.


GATX - GATX Corporation - Company Profile

Comments:

No specific news. Shares closed at a two week low.

Original Trade Description: December 15th

GATX Corporation leases, operates, manages, and remarkets assets in the rail and marine markets in North America and internationally. The company operates in four segments: Rail North America, Rail International, American Steamship Company (ASC), and Portfolio Management. The Rail North America segment primarily leases railcars and locomotive, as well as other ancillary services. This segment also offers repair, maintenance, modification, and regulatory compliance services on the railcar fleet. The Rail International segment leases railcars, as well as offers repair, regulatory compliance, and modernization work for railcars. The ASC segment operates a fleet of vessels that provide waterborne transportation of dry bulk commodities, such as iron ore, coal, limestone aggregates, and metallurgical limestone for steel makers, automobile manufacturing, electricity generation, and non-residential construction markets. The Portfolio Management segment is involved in leasing, asset remarketing, and marine operations, as well as manages portfolios of assets for third parties. As of December 31, 2015, it operated a fleet of 17 vessels; a fleet of approximately 106,100 cars; a fleet of 18,400 boxcars; and a fleet of 611 older four-axle and 26 six-axle locomotives. Company description from FinViz.com.

There has been no news since the company announced a 40 cent dividend on Oct 28th. The dividend is payable on Dec 31st to holders on Dec 15th. That is today. That means nobody else is going to be buying the shares to get the dividend.

Earnings Jan 19th.

GATX has rallied 69% since the election. I can only assume it was because of the rally in the Dow Transports in anticipation of a better economy in 2017. There is no current fundamental reason for a 69% rally and odds are good once the stock begins to roll over with the market it could fall very hard. Apparently other investors believe the same way since the only put strike with any volume is the January 60 puts. There is more volume in that one strike than all the other strikes combined.

Position 12/16/15:

Long Jan $60 put @ $2.35, no initial stop loss to avoid any volatility spikes.


MAT - Mattel - Company Profile

Comments:

No specific news. No decline but we are just getting started.

Original Trade Description: December 28th

Mattel, Inc. designs, manufactures, and markets a range of toy products worldwide. The company operates in three segments: North America, International, and American Girl. It offers dolls and accessories, vehicles and play sets, and games and puzzles under the Mattel Girls & Boys brands, including Barbie, Monster High, Disney Classics, Ever After High, Little Mommy, Polly Pocket, Hot Wheels, Matchbox, CARS, Disney Planes, BOOMco, Radica, Toy Story, Max Steel, WWE Wrestling, and DC Comics. The company also provides its products under the Fisher-Price brands, such as Fisher-Price, Little People, BabyGear, Laugh & Learn, Imaginext, Thomas & Friends, Dora the Explorer, Mickey Mouse Clubhouse, Disney Jake, the Never Land Pirates, and Power Wheels. In addition, it offers its products under the American Girl brands comprising Truly Me, BeForever, and Bitty Baby; and construction, and arts and crafts brands, such as MEGA BLOKS, RoseArt, and Board Dudes, as well as publishes the American Girl magazine. Mattel, Inc. sells its products directly to consumers via its catalog, Website, and proprietary retail stores, as well as directly to retailers, including discount and free-standing toy stores, chain stores, department stores, and other retail outlets; to wholesalers; and through agents and distributors. Company description from FinViz.com.

Retail surveys showed a 9% decline in toy sales over the holiday shopping season. Several of the high profile toys that did sell, suffered serious glitches that have buyers burning up the phone lines wanting refunds and/or replacements.

Zacks downgraded Mattel to a sell saying earnings growth at Mattel, even before the holiday disaster, was only 3.1% compared to the industry average of 21.2%. For the current year Mattel is only expecting 1.2% growth and that was before the holiday news. The company has already projected sales for 2016 to decline -1.9% and that forecast is sure to be revised lower. Analyst earnings estimates were already moving lower and the holiday sales news should accelerate that trend.

Toymakers are facing something called "age compression." Previously the age range for Barbie toys was 3 to 9 years. Now that has compressed to 3 to 6 years. Electronic games are making kids smarter and taking up a large percentage of their playtime. Toys are being left in the toy box. This is good news for companies like ATVI and EA but bad news for Mattel.

The company is also vulnerable to the strong dollar because of sales overseas. The dollar is at 14 year highs and Q4 earnings are going to be impacted.

Earnings January 18th.

This is going to be a short play. With earnings on the 18th, we are going to use a February option and we will exit before the earnings report. The expected market decline in early January should accelerate any drop in Mattel shares.

Position 12/29/16:

Long Feb $27 put @ $1.30, see portfolio graphic for stop loss.




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