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Daily Newsletter, Tuesday, 04/22/2008

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Table of Contents

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

Market Wrap

Stirring the Earnings Stew

Take a few winners like MCD, WYE, T, JEC and VMW mix with a few losers like TXN, UNH, CME, UAUA and UNH and season to taste. For seasoning you could use $120 oil, a new low on the dollar to the Euro and massive write-downs by UBS. Be careful what you include or you may end up with a witches brew instead of an earnings stew.

The economics were flat and added little bias to the market direction. The Existing Home Sales for March declined to an annual rate of 4.93 million from 5.03 million in February. That is a year over year decline of -19%. Inventories increased slightly to 9.9 months and the median home price fell -8% over the year ago period. The report was still negative but appeared to indicate that the worst may be over. The efforts to halt foreclosures appear to be slowing the rate. May and June are still expected to have the most mortgage resets and then that problem will begin to recede. The lower interest rates are helping reduce the reset problem but it is still a problem given the lower house values.

The weekly chain store sales fell -0.7% and this may seem like a minor amount but the pressures are building. $120 oil is going to translate into $3.75 gasoline and consumers are getting crushed. The retail chain Linen and Things is expected to file bankruptcy over the next couple weeks. Bank America pulled the financing for Sears ($1 billion) and Talbots leaving those stores in dire need of operational cash. Retail analysts expect 6,500 retail stores to close over the coming months. That will reduce some of the retail glut but will be a major impact to employment and consumer sentiment.

The Richmond Fed Manufacturing Survey dropped to zero in April from +6 in March. Considering the survey was in negative territory for the three months ending in February this is still not a bad report. Zero shows an even split between those manufacturers showing increases and those showing declines. It is not bullish but it is far from bearish. The biggest problem is the rising inputs costs and expectations for pricing conditions to deteriorate further over the next six months. Raw materials prices rose at an annualized rate of +4.63% in April while output prices rose only 2.55%. The current spread between input and output prices is 208 basis points. That is expected to expand to 237 basis points six months from now.

There are no material economic reports on Wednesday. Earnings will continue to be hogging all the news. Earnings today were very mixed with big losses and big winners.

United Airlines (UAUA) reported a loss of $4.45 per share, a dollar worse than analysts expected. UAL said it lost $537 million on soaring fuel costs and said it is cutting flights and 1,100 jobs. The CEO said airlines needed to raise ticket prices 15-20% just to cover the soaring fuel prices. Unfortunately as long as there are dozens of airlines starving for cash and competing for flyers nobody can make a price hike stick. At $120 per barrel the top 11 airlines could lose $33 billion in 2008. The entire airline sector was crushed on the UAL news. UAUA lost 35% or -7.67, AMR -1.17, CAL -3.36 and DAL -1.31.

United Airlines Chart - Daily

McDonald's (MCD) reported earnings of 81 cents compared to 62 cents in the year ago quarter. A nickel of that gain was due to favorable currency translation. Analysts were expecting 69 cents making that a sizeable beat. The +24% jump in earnings came from an additional 2.5 million customers per day compared to the same quarter in 2007. That number boggles my mind, an extra 2.5 million per day. How many companies in the world can grow their business that strongly? The street ignored their amazing results with a -32 cent loss.

Dupont (DD) saw profits rise a better than expected by 26% and affirmed its earnings estimate for the year but the stock was crushed for a -4.5% loss. The agriculture segment continued to outperform but Dupont's coatings and materials business continued to face challenges in a weakened U.S. economy.

The Royal Bank of Scotland (RBS) said it had $11.8 billion of potential additional write-downs and would need to sell shares to raise a whopping $23.7 billion in new capital. They are going to sell 11 new shares for every 18 existing shares in order to raise the money. The need for additional capital for nearly every large bank is not news to anyone. However, the news of nearly $12 billion in new write-downs is just one more domino to fall in a long line of dominoes. This put pressure on the major U.S. banks on fears that the write-downs may not be as close to over as traders had expected.

Texas Instruments (TXN) fell -6% after disappointing earnings Monday after the close. TXN said it expects Q2 earnings to be lower than analyst's expectations. Profits rose +28% but the warning took its toll on the stock and the sector.

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Other earnings winners included Wyeth (WYE), AT&T (T), Jacobs Engineering (JEC), Coach (COH), Vmware (VMW) and Peabody Energy (BTU). Not all advanced on their good news. Notable earnings losers were United Health (UNH) and the Chicago Mercantile Exchange (CME).

After the close Yahoo (YHOO) reported earnings of 11 cents, only a penny above the comparison quarter. The earnings were 2-cents over analyst's reduced estimates. After subtracting commissions to advertising partners the total revenue was only $30 million over analyst projections. This lackluster performance did not do them any good in the Microsoft battle. YHOO stock fell -20 cents in after hours to $28.35. This should help in the Microsoft bid as investors become frustrated with Yahoo's performance.

Broadcom (BRCM) reported earnings that rose +22% on strong broadband chip sales. The CEO said the quarter was much stronger than expected and allowed Broadcom to achieve record revenues and strong cash flow. BRCM was up over $2 in after hours.

Earnings on the calendar for tomorrow include AFL, BA, AMZN, AAPL, CLB, EMC, WLP, GD, TSCO, QCOM, SGP and UPS.

So far this quarter 62% of S&P reporters have beaten the street. 15% have reported inline and 24% have missed estimates. The consolidated S&P earnings are now showing slightly more than a -15% decline. 38 of the 54 banks in the S&P have reported with a combined earnings drop of -68%. Energy is still the biggest winner with a gain of +28%.

May Crude Futures Chart - Daily

Oil prices hit $119.90 intraday on the expiring May futures contract. That contract expired at the close today. Anyone still short at the close should be prepared to actually deliver oil. This was a monster short squeeze as traders still short this contract were forced to buy them back at increasingly higher prices. I have heard several people claim this was not the case and then gave any one of a dozen reasons for spiking oil prices. I offer the following graphics in support of my position.

In the first table you can see the difference between the open interest in the various contracts from Friday's close to Monday's close. The May contract declined 35,057 in open interest of roughly 35%. In the second table you can see that that May dropped another 36,422 contracts before Tuesday's close or roughly 56% of the open interest. I wish I had captured the open interest all last week to show you the dramatic decline as shorts covered. The only way to create open interest is by selling short a contract either naked as speculation or to hedge and lock in a price for delivery of your crude. The only way for open interest to shrink is for those shorts to buy back their contract to close their position if they are not going to actually deliver oil. Just since Friday's close 71,479 of the 99,364 open short contracts were closed or roughly 72%. For anyone to claim that this was not a short squeeze they just don't have the facts.

Crude Futures Open Interest

While I have those tables listed I think it is also important to note the actual volume on the individual contracts. On Monday there was volume of 117,763 in the May contract when there was only 99,364 open contracts. Day traders were definitely juicing the tape and playing the momentum market. They claim the spikes in oil are due to various events around the world. I agree that the news provides the sparks to start the move but the traders are providing the volatility. Check out the daily volume on the June contracts. There is well more than 50% of the open interest trading each day. I will track this all week and report back on Sunday so we can see how the open interest changes now that June is the current month. Odds are pretty good that open interest is going to spike if the shorts playing in May decide to reinstate positions in the June contract.

The newscasters were pounding the weak dollar-higher oil mantra again and it simply does not add up. The dollar has been roughly in the same range since late March. During that period oil rose +21% from $99 to $120. The dollar fell only -1.5% in that same period if you use the top of the April resistance range of 72.50 as your starting point and today's 71.19 close as the end. Blaming the entire $21 rise in oil since March 25th on a 1.5% decline in the dollar just does not make sense.

USD Dollar Chart

The Dow transports (TRAN) retreated from last week's breakout high to 5100 with a decline to 4921 intraday. It is nearly impossible to believe that transports can make any gains with oil near $120. Add in the airline factor and the daily declines in that sector and I am amazed the transports are not hitting new lows. However, even with the day's decline the recent uptrend is still in place.

Dow Transports chart - Daily

The Dow gave up -105 points for the day but that was well off the lows. Dupont, AXP, CAT and AIG were the biggest losers. Even though Dupont (DD) had decent earnings it lost more than $2. Dow component Boeing (BA) will report tomorrow. The Dow rallied over 500 points last week and has only given back roughly 130 points from Friday's close. Given the strength of the rally this is a very acceptable decline even after some of those high profile earnings misses. The Dow only declined to support and showed a decent rebound into the close. I see nothing to worry about yet.

Dow Chart - Daily

The Nasdaq gave back -1.3% or -31 points and was weaker than the Dow. The big worries for the Nasdaq will be the Apple/Amazon earnings due out tomorrow after the close. The Nasdaq is trying to remain within attack range of that 2400 resistance and it did that today.

Nasdaq Chart

S&P-500 Chart - Daily

The S&P-500 only declined -0.8% and is well above rising support between 1350-1360. Overhead resistance remains 1395-1400 but well within range. I am using 1350 as my market indicator. I believe traders will buy dips above 1350 but under that level I would turn bearish.

Besides earnings to move the market we are now on Fed watch ahead of the next FOMC meeting next Tuesday. The Fed speakers are already talking about reducing their rate cuts if not eliminating them completely. There are signs the economy may be starting to recover so the Fed will immediately go back to inflation watch if the recovery continues. This could weigh on the markets ahead of that meeting.

Volume has been very light for the entire month of April but Monday was especially light at 5.59 billion shares. Tuesday's was slightly higher at 6.6 billion but still weak. There is simply no conviction on either side and it appears investors are just waiting on the sidelines for the earnings story to complete before they decide to take a position. There are simply too many clouds on the horizon and investors want to avoid the potential lightning strike. In about another 8 days the majority of earnings will be over, the Fed behind us and hopefully oil prices in decline. We will have a better view of the economy and investors will be ready to make that buy/sell decision. Until then I suggest buying a dip to SPX 1350 and turning negative under 1350.

Jim Brown
 

New Plays

Most Recent Plays

Click here to email James
New Plays
Long Plays
Short Plays
None None

New Long Plays

None today.
 

New Short Plays

None today.
 

Play Updates

Updates On Latest Picks

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Long Play Updates

Citigroup - C - close: 25.12 change: +0.09 stop: 22.89

Citigroup continues to inch higher. The CEO said they have no plans to change their dividend policy at this time. The stock continues to look poised for more gains. Our target is the $27.50-28.00 zone.

Picked on April 21 at $24.50 *triggered
Change since picked: + 0.62
Earnings Date 04/24/08 (unconfirmed)
Average Daily Volume: 104 million

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FreeSeas Inc. - FREE - close: 7.30 chg: +0.16 stop: 6.45

FREE continues to out perform to the upside. Unfortunately, we're still on the sidelines waiting to buy a dip. We are adjusting our suggested entry point to buy FREE to $6.85-6.70. We're also raising the stop loss to $6.45. Our target is the $7.50-8.00 range. The inverse head-and-shoulders pattern is forecasting an $8.25 target.

Picked on April xx at $xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 03/28/08 (confirmed)
Average Daily Volume: 134 thousand

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Gerdau S.A. - GGB - close: 38.44 chg: +0.22 stop: 35.19 *new*

GGB hit new highs today. The stock traded to $38.97 and traders were buying the afternoon dip near $38.00. We are moving our stop loss to $35.19. We have two targets. Our first target is the $39.75-40.00 zone. Our second, more aggressive target is the $42.00 mark. The P&F chart is bullish with a $57 target. We do not want to hold over the early May earnings report (unconfirmed).

Picked on April 10 at $36.84
Change since picked: + 1.60
Earnings Date 05/03/08 (unconfirmed)
Average Daily Volume: 3.1 million

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iShares Telecom - IYZ - close: 23.87 chg: -0.12 stop: 22.99

We don't see any changes from our previous comments although we're thinking about moving the stop loss to $23.35 just to reduce our risk. We have two targets. Our 1st target is the $25.85-26.00 range. Our second target is the $27.85-28.00 zone.

Picked on March 25 at $23.50 *triggered
Change since picked: + 0.37
Earnings Date 00/00/00
Average Daily Volume: 429 thousand

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Starbucks - SBUX - close: 17.70 chg: -0.35 stop: 17.32

Shares of SBUX encountered some profit taking but traders bought the dip at $17.43. The stock pared its losses to close down 1.7%. If traders wanted to buy this dip you could but use a tight stop loss under today's low. Our target is the $18.45-18.50 zone. We do not want to hold over the late April earnings.

Picked on April 15 at $17.32
Change since picked: + 0.38
Earnings Date 04/30/08 (unconfirmed)
Average Daily Volume: 13.6 million

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Teleflex Inc. - TFX - close: 51.57 chg: -0.81 stop: 49.85

We are not suggesting new bullish positions in TFX at this time. Our short-term target is the $54.75-55.00 range, which should intersect with the stock's longer-term trendline of lower highs. The long-term trend is still bearish. We're just trying to play the oversold bounce. We do not want to hold over the late April earnings report.

Picked on April 16 at $51.05 *triggered
Change since picked: + 0.52
Earnings Date 04/29/08 (confirmed)
Average Daily Volume: 319 thousand
 

Short Play Updates

Longs Drug Stores - LDG - cls: 38.29 chg: -0.51 stop: 40.05*new*

LDG continues to sink. The path of least resistance is definitely lower. We are cinching the stop loss down to $40.05. LDG has already hit our target at $38.25. Our second target is the $35.25-35.00 zone. The P&F chart is bearish with a $29.00 target.

Picked on March 30 at $41.30 /1st target hit 38.25
Change since picked: - 3.01
Earnings Date 05/15/08 (unconfirmed)
Average Daily Volume: 596 thousand
 

Closed Long Plays

Chevron - CVX - close: 94.03 chg: +1.33 stop: 89.45

Almost made it! Crude oil surged toward $120 a barrel and CVX rallied to $94.50 intraday. Our target was the $94.75 mark so CVX didn't quite make it. It was our plan to exit today at the close to avoid any sell-off in oil that might occur following futures expiration.

Picked on April 15 at $90.17
Change since picked: + 3.86
Earnings Date 05/02/08 (confirmed)
Average Daily Volume: 12.7 million

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Quanex - NX - close: 55.27 chg: +0.65 stop: 51.99

We are dropping NX as a bullish candidate. The company's shareholders just approved the $1.6 billion merger with GGB. We already have GGB as a bullish candidate. Our strategy was to buy a dip in NX but it has not yet occurred.

Picked on April xx at $xx.xx *never opened
Change since picked: + 0.00
Earnings Date 05/29/08 (unconfirmed)
Average Daily Volume: 370 thousand
 

Closed Short Plays

None
 

Today's Newsletter Notes: Market Wrap by Jim Brown and all other plays and content by the Option Investor staff.

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