Option Investor
Newsletter

Daily Newsletter, Tuesday, 7/21/2009

Table of Contents

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

Market Wrap

Earnings Losing Their Impact

by Jim Brown

Click here to email Jim Brown

A flurry of large companies reported decent earnings today along with multiple Dow components but the positive impact on the market was muted.

Market Stats Table

Earnings were the focus of the day and that was a good thing since the economics were minimal and uninspiring. The Chicago Fed National Activity Index rose to -1.80 from last months -2.30 reading. 75% of the component categories improved in June but only 15 of the 85 indicators made positive contributions to the index. Are you excited yet?

CFNAI Chart

The Risk of Recession index came in at 37% for June. This is a forward-looking indicator and projects the percentage risk of the country being in recession within six months. Since we are in a recession and this is a lagging indicator for the June period it was and is normally ignored by the market. The highest level this indicator reached in the current economic cycle was a 60% chance back in November. In July 2008 as we headed into the recession this index only projected a 35% chance. Needless to say this is not a market mover.

Fed Chairman Bernanke told Congress today that the economy was still too weak to begin tightening monetary policy. He said inflation was not an immediate threat despite market expectations for inflation at the highest level since 2004. Bernanke reiterated his expectations for prices to remain subdued over the next couple years. Bernanke said the Fed had the tools to remove the excess liquidity once conditions improved. However, Bernanke warned about fiscal responsibility by Congress and the administration and how it could upset the economy and the Fed's plans to keep it moving forward. The Fed has taken on over a trillion in assets in an effort to reduce the impact of the economic decline. They will have to unload those assets once the economy begins to improve. They would like to do it before interest rates begin to rise.

In prior recessions the Fed began to raise rates 9-12 months after unemployment peaked. Since unemployment is not expected to peak until early 2010 that means the Fed may not begin raising rates until the middle of 2010 if they follow the previous trends. In 1982 unemployment peaked at 10.8% in November. The Fed did not begin raising rates until May 1983. The next largest unemployment was May 1975 at 9.0% and the Fed raised rates in June 1975. This shows there is a precedent for quick removal of the liquidity once unemployment peaks even though the average is 9-12 months.

Bernanke's assessment of the economy was slightly more upbeat than his previous testimony but stressed that consumer spending remained fragile and that would warrant keeping interest rates low for a "extended period." Analysts felt the Bernanke testimony was slightly upbeat but still cautious given the length of time the Fed expected the economy to remain stagnant. Bernanke will repeat the performance before a House panel on Wednesday.

That brings us to the big news of earnings. Tuesday was chock full of earnings by major companies and not all were positive. Leading the hit parade was Caterpillar (CAT) with revenue that fell -41% and profits that fell -66%. However, CAT still beat the street and CAT stock was up +12% in early trading and powered the Dow to another gain. Actually the response was muted intraday after they said on the conference call that Q3 could be very tough and they might even lose money. CAT is going to schedule rolling factory shutdowns to cut costs.

I heard from somebody familiar with business inside CAT that the workforce has been cut to skeleton crew strength. Reportedly there is only a trickle of orders for Q3/Q4 and upper management's forecast is not expecting a recovery until sometime in 2010. The number of orders in one plant could be counted on both hands according to this person. Obviously CAT does not want to portray that kind of weakness to the public and simply warning that Q3 could be "very tough" and possibly a loss is the sanitized outlook equivalent. 61% of their orders come from overseas and they did say they were seeing some improvement in China.

On the positive side CAT said they were seeing some stabilization in the credit markets. They were able to secure financing for some customers in what the CEO said was a dramatic improvement in what they had seen over the prior two quarters.

CAT Chart

United Technology (UTX) said profits fell -24% on a $2.7 billion drop in revenue. Earnings of $1.05 beat the street by a penny. However, UTX cut its revenue guidance for the year and lowered estimates for profits. UTX lowered revenue guidance by $2 billion and full year profits in a range from $4-$4.20. That is down from $4-$4.50. The CEO said they DO NOT expect a significant economic recovery next year although cost cutting will help them weather the storm. UTX already cut its guidance in March and cut 11,600 jobs. UTX shares lost $1 on the news.

UTX Chart

AMD did not match Intel's performance but nobody should have expected that to happen. AMD lost -62 cents compared to street estimates for a loss of -53 cents. AMD stock fell -12% in after hours. Gross margins slid to 37% from 43% in what AMD called a "disappointment."

AMD Chart

Merck (MRK) beat the street with earnings of 83 cents compared to estimates of 77 cents. Schering Plough (SGP) posted earnings of 45 cents and beat by a penny. SGP is being acquired by MRK and the deal should close in Q4.

The airlines also reported earnings of sorts. Southwest (LUV) beat the street by a penny with earnings of 8 cents. Continental missed estimates by a penny with a loss of -$1.36 per share. Continental said the average fare price had declined -18% and there was a -24% drop in overseas travel. United (UAUA) posted a loss after items of -$2.23 per share and beat analyst estimates for a -$2.56 loss. UAUA said business traffic had died and revenue fell -25.2%. The eight largest U.S. airlines lost a combined $1.2 billion for the quarter.

United said it was going to cut international capacity by 7% to offset falling demand. UAL has $2.8 billion in cash and the burn rate is causing analysts to predict another chapter 11 bankruptcy filing. Southwest earned $54 million for Q2 but warned it could lose money in Q3. Continental said Q3 was shaping up to be dismal and would cut additional jobs and raise fees for extra services. CAL said it was going to add a fee for telephone reservations and for bags checked at the curb like Delta did recently. They are hoping to raise $100 million through their new fee schedule.

After the bell Apple Inc (AAPL) posted earnings of $1.35 that blew past analyst estimates of $1.18. Revenue was inline at $8.3 billion. Apple said it sold 2.6 million Macs, up +4%. Apple also said it sold 5.2 million iPhones including the new 3GS version for $99. The company said that almost 20% of the Fortune 500 companies had purchased at least 10,000 iPhones and demand was so strong that they could not make enough 3GS phones to fill orders. Several analysts had worried that the $99 iPhone would be a drag on margins as would the 40% rise in flash memory costs. However margins came in at 36.3% and above the 34% analysts expected.

Apple issued another downbeat forecast for Q3 with an earnings range from $1.18 to $1.23 that was below the analyst estimate for $1.30. Nobody really pays attention to Apple guidance because they always talk down estimates significantly. Apple sold 10.2 million iPods and the CFO said he expected iPod sales to decline as the iPhone cannibalized iPod demand. Apple shares rose to $158 in after hours trading and up from the close of $151.56.

Apple Chart

Yahoo (YHOO) crumbled after the close despite earning a small profit. Ad sales worsened for Yahoo with Google continuing to take market share and now Microsoft Bing is also stealing share. CEO Carol Bartz implied that ad sales for the second half "might" improve but stopped short of saying it. Bartz said there was just too much conflicting information in the market to make an accurate call. Yahoo earned 10 cents and analysts expected 8 cents. Revenue fell -13% to $1.57 billion for the biggest decline in the last three years. By contrast Google's revenue rose +3% to $5.5 billion. Bartz did not mention a potential search partnership with Microsoft that is still being discussed. YHOO declined to $16.23 in afterhours.

Yahoo Chart

With 150 S&P companies reporting earnings this week we are blazing right through the heart of the earnings cycle. So far 71% of companies reporting have beaten estimates, 22% missed and 8% reported inline. We have seen numerous companies report a beat of a penny or two on accelerated cost cutting and then warn that Q3 was going to be "very tough." This downbeat guidance has yet to phase the market but eventually the markets are going to catch this guidance virus.

Need a hotel cheap? The Watergate Hotel in Washington was auctioned off to bidders today after GE Capital foreclosed on the $40 million mortgage. The opening bid was $25 million and that turned out to be the only bid for the historic 250 room riverside hotel. The hotel was purchased for $45 million in 2004 and has been vacant since 2007. It appears there is a small matter of $100 million in needed renovations. GE Capital was the bidder at $25 million and said it will attempt to sell the property.

In a corresponding article an analyst said hotel room revenue in general has declined -20% since last year and operating cash flows have declined -35%. Commercial mortgage delinquencies are running 2.55% and 13 major loans defaulted in June. Three of those loans were for more than $100 million.

Crude futures for August expired today at just under $65. This was the lowest price for the coming months as the contango in crude continues. For instance the December Z9 price today was $69. However, that same contract was trading over $76.50 last month. This is a factor of a lack of hurricanes and a continued rise in global inventory levels. Some refined products are now at a 25-year high.

Future Months Table

Oil Futures Chart

The two storms I pointed out last week have failed to materialize into anything but rain and the weather service claims each have less than a 30% chance of strengthening. One noted forecaster lowered his estimate today for the number of storms in 2009.

Atlantic Storms

The Nasdaq inched higher for a +6 point gain and stretched its string of consecutive gains to ten days. This is the first time in 11 years that the Nasdaq has accomplished this feat. You would think that a blowout by Apple and a +7 point gain in after hours would guarantee another Nasdaq gain tomorrow. I would not hold my breath. The Nasdaq futures were up strongly immediately after the Apple report but have since declined into negative territory. S&P futures have also declined into negative territory. Beating the street by a penny on cost cutting and then lowering guidance for Q3 is not conducive to continued gains.

Obviously no index can continue to post gains day after day and eventually the Nasdaq will have to take profits. The 1900-1905 level was decent resistance and that was cracked this week but not very convincingly. This could still come back to bite the index as the summer doldrums replace the Q2 earnings excitement.

Nasdaq Chart

The Dow has moved over prior resistance at 8800 although not very convincingly. It is nearing stronger resistance at 9000 and after gaining nine of the last ten days it is very over extended. Like the Nasdaq it can't continue to rally without some profit taking eventually taking place. The Dow would have been negative today were it not for the major gains by Caterpillar. CAT, MRK and XOM provided over 50 Dow points. Boeing contributed another 8 points and IBM 6 points. Basically it was a five stock rally for the Dow thanks to earnings reports.

With the Dow very extended with a +800 point bounce off its 7/10 lows at 8100 I can't help but believe this string is about to end.

Dow Chart

The S&P-500 has strong resistance at 950 and after two days of trading this week it could only muster a +4 point move over that level. Sellers are camped out on 950 and even the strong gains by the big Dow components could not move the S&P higher. 954 is not really a convincing break of 950 and with S&P futures down tonight it does not appear we are going to have a positive open although anything is possible. The S&P was negative for much of the day and only broke into the green at the close.

S&P Chart

The Russell-2000 is less bullish than the big cap indexes. The Russell is still below the comparison resistance levels and actually closed down on Tuesday despite the late day rally in the other indexes. As the mutual fund manager sentiment indicator it is warning us that there is little conviction in the market.

Russell Chart

I remain in watch mode on market direction. I am amazed that the markets have continued to gain ground this week but I believe their four-leaf clover is about to wilt. The S&P can't move over 950 with conviction and the Russell is lagging. If the Nasdaq can't rally on Wednesday on the strength of the blowout Apple earnings then the markets may take a needed break. I would be cautiously short on any failure at the S&P 950 level. On Sunday I said go long over 8800/950 and while the Dow did move over 8800 on Monday the S&P closed right at that level. I don't believe a +4 point close today has enough conviction to carry the rally forward but we have to respect that level in either direction. For Wednesday I would be cautiously long over 950 and short below that level.

Jim Brown


New Plays

Gazing Through the Crystal Ball

by James Brown

Click here to email James Brown
Editor's Note:

I am suggesting the average trader step to the sidelines. The markets remain very extended. This is not a great place to be launching new positions. The NASDAQ is likely to gap higher at the open tomorrow thanks to AAPL's earnings but where it goes from there is anyone's guess. Will the NASDAQ stretch its gains to 11 in a row? Maybe. But what about day 12? or day 13? Are you willing to bet on new bullish positions with the market looking this extended? Our new play on the QID is very aggressive and only nimble traders should give it a shot.


NEW BULLISH Plays

UltraShort QQQ - QID - close: 28.77 change: -0.37 stop: *see details*

Why We Like It:
The QID is the ultra-short ETF on the NASDAQ-100 index (NDX) and tries to simulate twice the inverse of the NDX's performance. The NASDAQ is up about 10 days in a row and looking very short-term overbought and due for a correction. I believe the AAPL earnings tonight will push the NDX higher on Wednesday morning but I expect the rally to fail. Imagine a blow-off top formation. Our challenge is entry point and stop loss. The NDX and the QID will like gap open with the NDX gapping higher and the QID gapping lower.

Here's the plan. Buy the QID at the open or shortly after the opening bell. It could see a big move in the first 15 to 30 minutes of trading. We'll set our stop loss at $2.00 below whatever our entry point is. We need to use a wide stop because the QID will see twice as much volatility as the NDX. We are essentially trying to call a short-term top in the market before it's even created. This is very, very aggressive and I suggest traders only use a very small position size (about 25% of normal). If we do see a reversal we can add to the position later. If you don't like trading through a crystal ball then don't make this trade. I'm trying to anticipate what might happen based on the market's extended rally and the AAPL earnings.

Annotated chart:

Entry on      July xx at $xx.xx <-- see TRIGGER  
Change since picked:     + 0.00   			
Earnings Date          00/00/00 
Average Daily Volume:        19 million 
Listed on  July 21, 2009    



In Play Updates and Reviews

Not The Whole Story

by James Brown

Click here to email James Brown


BULLISH Play Updates

Alcoa - AA - close: 10.14 change: -0.46 stop: 9.35

Uh-oh! We were expecting a little correction in shares of AA. That's not the problem. The problem is that AA just produced a very clear bearish engulfing candlestick pattern, which can be interpreted as a bearish reversal signal. We still want to get long AA but I'm moving our entry point from $9.75 down to $9.15 and I'm moving the stop loss to $8.94. If the stock only pulls back toward $9.50 and begins to bounce again we'll reconsider. Our first target is $10.90. Our second target is $12.25. FYI: The Point & Figure chart is very bullish with a $19.50 target.

chart:

Entry on      July xx at $xx.xx <-- TRIGGER @ 9.15
Change since picked:     + 0.00   			
Earnings Date          07/08/09 (confirmed)    
Average Daily Volume:        41 million 
Listed on  July 16, 2009    


Ameron Intl. - AMN - close: 71.56 change: -0.02 stop: 65.95 *new*

AMN tested support in the $69.50-70.00 zone and bounced but volume remains very light. I'm upping our stop loss to $65.95. I'm not suggesting new positions at this time. Our target is $79.50. My time frame is six to eight weeks. I do consider this somewhat aggressive because AMN does not trade with a lot of volume.

Entry on      July 16 at $70.50 *triggered       
Change since picked:     + 1.36   			
Earnings Date          09/21/09 (unconfirmed)    
Average Daily Volume:       150 thousand
Listed on  July 15, 2009    


Aegean Marine Petrol. - ANW - close: 17.46 change: -0.14 stop: 14.95

This is the second time in three days that ANW has produced a failed rally near $18.00 and its exponential 200-dma. I really expect a deeper correction soon.

I am adjusting our entry point zone to the $16.25-16.00 zone. We'll start the play with a stop loss at $14.95. More conservative traders might be able to get away with a stop in the 15.50-16.00 region. If triggered at $16.25 our first target to take profits is at $18.25. Our second target is $19.75.

Entry on      July xx at $xx.xx <-- TRIGGER  16.25
Change since picked:     + 0.00   			
Earnings Date          08/12/09 (unconfirmed)    
Average Daily Volume:       284 thousand
Listed on  July 18, 2009    


Diana Shipping - DSX - close: 14.46 change: -0.11 stop: 12.70

The action today looks like a failed rally pattern. The plan is to buy a dip in the $13.50-13.00 zone. Our first target is $16.40.

Entry on      July xx at $xx.xx <-- see TRIGGER  
Change since picked:     + 0.00   			
Earnings Date          08/06/09 (unconfirmed)    
Average Daily Volume:      1.27 million 
Listed on  July 15, 2009    


Hormel Foods - HRL - close: 35.11 change: -0.14 stop: 34.20

I don't see any changes from my Monday night comments on HRL. Shares continue to look like a bullish candidate here. More aggressive traders may want to put their stop under $34.00 or under the July low of $33.73. My first target is $37.90. My second target is $39.90. My time frame is mid to late August because we need to exit in front of earnings. FYI: The Point & Figure chart is very bullish with a $50 target.

Entry on      July 20 at $35.40 /gap higher entry
                              /originally listed at $35.25
Change since picked:     - 0.29   			
Earnings Date          08/20/09 (unconfirmed)    
Average Daily Volume:       486 thousand
Listed on  July 20, 2009    


J.P.Morgan Chase - JPM - close: 36.94 change: -0.04 stop: 33.90

The banking sector was one of the worst performers today yet shares of JPM out performed its peers. The stock is churning sideways near $37.00. Momentum indicators are beginning to falter. We want to buy a dip at $35.25. Our first target is 38.75.

Entry on      July xx at $xx.xx <-- see TRIGGER  
Change since picked:     + 0.00   			
Earnings Date          07/16/09 (confirmed)    
Average Daily Volume:        55 million 
Listed on  July 18, 2009    


NATCO Group - NTG - close: 35.78 change: +0.52 stop: 31.49 *new*

I am pleasantly surprised by NTG's relative strength. The stock notched another gain (+1.4%) and closed at new three-week highs. I'm raising our stop loss to $31.49. Our exit target is $37.50. We do not want to hold over the early August earnings report.

Entry on      July 15 at $32.56 *triggered/gap higher entry
Change since picked:     + 3.22   			
Earnings Date          08/03/09 (unconfirmed)    
Average Daily Volume:       270 thousand
Listed on  July 14, 2009    


Ross Stores - ROST - close: 43.42 change: -0.29 stop: 39.95

The rally in ROST has paused but the trend is still up. I'm not suggesting new bullish positions at this time. Our first target is $45.75. Our second target is $49.45. My time frame is about six weeks.

Entry on      July 13 at $41.60 
Change since picked:     + 2.11   			
Earnings Date          08/20/09 (unconfirmed)    
Average Daily Volume:       2.4 million 
Listed on  July 13, 2009    


BEARISH Play Updates

Gen-Probe - GPRO - close: 39.52 change: +0.03 stop: 42.01

Nothing has changed. GPRO is still consolidating under resistance at $40.00. Our first target is $38.05. Our second target is $35.25. FYI: The P&F chart is bearish with a $32.00 target.

Entry on      June 23 at $42.03 /gap higher entry
                             /originally listed at $41.64
Change since picked:     - 1.92   			
Earnings Date          07/30/09 (unconfirmed)    
Average Daily Volume:       449 thousand
Listed on  June 23, 2009    


Humana Inc. - HUM - close: 29.44 change: +0.39 stop: 31.05

HUM has offered us another entry point in the $29.50-30.00 zone. More conservative traders may want to consider a stop loss closer to $30.00. Our target is $25.25.

Entry on      July 16 at $29.50 *triggered       
Change since picked:     - 0.06   			
Earnings Date          08/03/09 (confirmed)    
Average Daily Volume:       3.1 million 
Listed on  July 14, 2009    


Intl. Speedway - ISCA - close: 24.49 chg: -0.51 stop: 27.05

It looks like ISCA's true colors are beginning to show. The stock lost 2% today. I would use this move as a new entry point for bearish positions. More conservative traders may want to lower their stop loss to $26.15. Our first target is $22.10. Our second target is $20.25. My time frame is six to eight weeks.

Entry on      July 09 at $24.75 *triggered       
Change since picked:     - 0.26   			
Earnings Date          07/07/09 (confirmed)    
Average Daily Volume:       342 thousand
Listed on  July 08, 2009    


Usana Health Sciences - USNA - close: 24.84 chg: -0.21 stop: 28.21

The stock gapped open higher only to slip to $23.58 before trimming its losses. Shares almost look short-term oversold and I wouldn't be surprised to see a bounce back toward $26.00 before rolling over again. If you're patient we might get a better entry point on a bounce near $26.00-27.00.

Please note that I consider this an aggressive, higher-risk trade because shares have very, very low daily volume (54,000) and the stock has above average short interest (about 12%). That's not a great combination should a short squeeze appear. I am suggesting traders only use very small position sizes (at least half or less than your normal trade size). My first target to take profits is $21.00.

Entry on      July 20 at $25.29 /gap higher entry
                              /originally listed at $25.05
Change since picked:     - 0.45   			
Earnings Date          07/23/09 (unconfirmed)    
Average Daily Volume:        54 thousand
Listed on  July 20, 2009    


CLOSED BULLISH PLAYS

Morgan Stanley - MS - close: 27.56 change: -0.78 stop: 27.25

It was our plan to exit today at the closing bell but MS beat us to it by hitting our new stop loss at $27.25. It seems that investors were taking a little money off the table before the company reports earnings.

chart:

--New Trade, buy dip @ 25.25 --
Entry on      July 08 at $25.25 *triggered       
Change since picked:     + 2.00<-- stopped @ 27.25 (+7.9%)
                              /1st target hit @ 27.75 (+9.9%)
Earnings Date          07/22/09 (unconfirmed)    
Average Daily Volume:      29.4 million 
Listed on  June 23, 2009    


CLOSED BEARISH PLAYS

Medtronic Inc. - MDT - close: 34.75 change: +0.08 stop: 35.35

Curses! Rival Boston Scientific (BSX) reported earnings last night and the company's revenues were better than expected. Shares of BSX gapped higher this morning and MDT followed suit. MDT spiked to $35.35, which was just enough to hit our stop loss before the stock reversed lower. Our play is closed. I would keep MDT on your watch list for a new decline under $34.00 and its 50-dma.

chart:

Entry on      July 11 at $32.80 
Change since picked:     + 2.55 <-- stopped @ 35.35 (+7.7%)
Earnings Date          08/18/09 (unconfirmed)    
Average Daily Volume:       6.3 million 
Listed on  July 11, 2009    


Walgreen Co. - WAG - close: 29.96 change: -0.11 stop: 30.31

The early morning rally in shares of WAG failed but the rise was enough to hit our stop loss at $30.31. Our play is closed.

chart:

Entry on      July 11 at $28.84 
Change since picked:     + 1.47<-- stopped out @ 30.31 (+5.0%)
Earnings Date          09/21/09 (unconfirmed)    
Average Daily Volume:       8.4 million 
Listed on  July 11, 2009