Option Investor
Newsletter

Daily Newsletter, Tuesday, 1/12/2010

Table of Contents

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

Market Wrap

Where Did the Earnings Go?

by Jim Brown

Click here to email Jim Brown

This is supposed to be the start of a bullish earnings cycle but instead we are seeing earnings misses and earnings warnings. If this week is a preview of this cycle the bulls are going to be very disappointed.

Market Stats Table

This earnings cycle has started off with a thud instead of a bang. Alcoa missed estimates of six-cents and posted only a penny profit saying higher costs for power and raw materials were a factor as well as continued weakness in aerospace and construction. Alcoa shares fell over 10% on the news.

Chevron warned that Q4 results would be sharply lower than previously forecast due to pressures in the refining sector. KB Homes reported a profit but shares dropped nearly 5% after they said sales of homes came in much lower than expected. The also said profits would be flat in Q1.

Aetna (AET) fell more than 5% after warning 2010 earnings were "likely to be modestly lower." The SEC filing said earnings would be below the $2.76 estimate for 2009. Analysts were already expecting 2010 earnings to be in the range of $3.09 so the expected drop "modestly lower" than $2.76 was a major change.

Amgen (AMGN) warned today that earnings would be at the low end of their prior forecast of $4.90 to $5.05 per share. Analysts were expecting $5.04 per share. A Sanford Bernstein analyst said it looked like AMGN accelerated some expenses into 2009 so they could show some profit growth in 2010. In other words they decided to take the haircut in share price this year by forcing lower earnings so they could show better earnings in 2010 despite higher costs. This is legal book cooking. AMGN lost -2% on the news.

Electronic Arts (ERTS) slashed its earnings forecast after the close on Monday saying there was no increase in sales over the holidays. ERTS said sales were down as much as 15% in some countries. They cut full year profit estimates from $0.70-1.00 per share to 40-55 cents. The cut Q4 estimates to 31-cents and analysts were expecting 56-cents. ERTS shares fell 8% on the news.

The ERTS news crushed the semiconductor sector because investors decided the sales of video game cds are related to sales of PCs, Xboxes and PlayStations. The Semiconductor Index fell a whopping -4%.

It is not so much that traders are afraid of weak earnings from Intel or the other chips but the market was priced to perfection with everyone expecting blowout numbers. With the first couple reports negative and a sudden burst of negative pre-announcements those expectations are not being met.

News that President Obama may try to levy a new $120 billion levy on banks to pay for TARP losses to companies like AIG and GM was another drag on the market. Several of the banks did not want the TARP funds but were forced to take the money with instructions to boost lending. Then they had to pay it back in full and buy back the preferred shares. Now the president wants to tax the banks for bailing out the banking system as a way to boost the 2011 budget he will present in February. This is on top of the strong increase in fees from the FDIC. The banking index was down -2% on the news.

In my opinion this is ridiculous. The government forces tarp loans on the top 20 banks to disguise the bailouts to the banks that really needed them. Everyone was then forced to raise additional billions in capital before they were allowed to pay back the TARP loans. They had to use some of that new capital to buyback the preferred shares giving the Treasury a strong profit on the deal. The government told them to lend the remaining money to stimulate the economy. Last week regulators again warned banks not to hoard money but loan it out. This week the president wants to impose a levy on banks for another $120 billion to pay for "administrative expenses" and to recover TARP losses to companies like AIG and GM. The banks will pass that tax on to consumers and we will pay to repay the losses that we the taxpayer incurred in the TARP to start with.

Chain store sales fell -3% last week after four weeks of gains. Consumer wallets slammed shut after the holidays. Also dragging on sales was a limited amount of clearance inventory left over from holiday sales. Retailers had ordered less and discounted it heavily so there was little left for the post holiday sales.

Job openings declined for the second month and separations increased according to the Job Openings and Labor Turnover Survey (JOLTS) released today. This is a lagging report for the November period but it clearly showed the stress that led to the drop in payrolls in December. Job openings declined from 2.571 million to 2.415 million. This was the second month of decline. Separations increased to 4.34 million from 4.223 million. The number of people who quit their jobs increased to 1.96 million and the highest rate since January 2009. Layoffs fell to 2.05 million and the lowest level since September 2008. Layoffs peaked in Q1.

JOLTS Chart

The Trade Deficit for November widened more than expected to -$36.4 billion. Exports increased +0.9% and imports increased +2.6% and both to their highest levels for 2009. In order to return to pre-crash highs in July 2008 exports would need to increase another +19% and imports another +31%. The continued rebound of trade is proof that the U.S. and the global economy are in recovery mode.

The big report due out on Wednesday is the Fed Beige Book at 2:PM.

So where do we go from here? Earnings misses and negative pre announcements seem to be the trend for the week but will this trend continue? I believe today was a sample but a very small sample of what is to come. I believe the vast majority of earnings reports will be positive and the market has already priced this into equities. If we do get further negative surprises it will be very negative to the market as investors adjust their expectations.

It would be nearly impossible for 2009-Q4 earnings not to improve since 2008-Q4 posted a 10-cent per share loss for the S&P-500. That was the first earnings loss ever for the S&P. Earnings for the current cycle are expected to increase +34% to +37%. We may not be off to a flying start but at least we are in motion.

The Intel earnings on Thursday should be very bullish. We have seen the beginning of the corporate upgrade cycle and PC demand in China is exploding. Reportedly there are chip shortages everywhere and the recent CES show in Vegas highlighted the reason why. Computer usage is exploding but not specifically to desktops. The variety of computing products expands daily and every one has dozens of chips of every flavor.

I believe Intel should knock the cover off the ball and post some of its best gross margins ever at 61%. Intel declined to $20.50 on Tuesday in response to the ERTS warning but it was a sector day not an Intel day. I don't normally recommend holding long positions over an earnings report but I would on Intel this quarter.

The downside risk is the sector in general. The Semiconductor Index has risen +50% in the last six months on expectations the chips will lead us out of the recession. The -4% drop intraday was only light profit taking and with a couple more earnings challenges we could see it decline sharply. I would be a buyer of the dip today but only for a short-term trade of a couple weeks.

I believe the Alcoa earnings were much ado about nothing. Alcoa attracts attention because it is the first Dow component to report but is it really relative. When you compare it to other Dow components like IBM, MMM, HD, MSFT, INTC, HPQ, CSCO and WMT, AA is a sector specific $15 billion lightweight compared to those others with market caps in the hundreds of billions. Those other stocks give us a much better read on the global economy than Alcoa. When the ledger is closed on Q4 earnings six weeks from now Alcoa won't even rate a footnote.

To be fair the hysteria today wasn't just about Alcoa. Chevron tanked the energy sector because of refining margin declines due to lack of demand. Nobody focused on their +9% production increase for the quarter. That is huge for a major oil company where increases are measured in low single digits. Exxon had a -1.2% production loss and nobody noticed.

These companies were pilloried today because there was nothing else to talk about. This time next week and there will be dozens of companies reporting every day. Once the big cap reporting is over in about two weeks we will have something to worry about if the market turns negative.

Not every earnings announcement on Tuesday was negative. Infosys (INFY) posted better than expected earnings and raised estimates for the entire year. The CEO said the "global economic recovery seems to be led by the U.S. and the financial services sector. He also said INFY was having to hire internationally because they could not get enough qualified people to handle their new projects. INFY rose +5% on the news to $57.67.

INFY Chart

Tiffany (TIF) reported that sales surged in November by +16% and December by +10%. This was coming on top of some lousy comps where sales fell -35% in the same period in 2008 but still good news. In Q4 sales rose +15% in the Americas, +11% in Asia Pacific and +30% in Europe. Tiffany now expects Q4 earnings to be in the range of $2.07 to $2.12 and up from earlier forecasts of $1.88 to $1.98 per share. Analysts were expecting $1.92 per share.

Hartford (HIG) raised earnings estimates to nearly double prior estimates and shares rallied nearly 7% at the open. Hartford said earnings were now expected in the range of $1.45 to $1.60 for Q4 compared to prior estimates of $.65 to $.80 per share. Analysts were expecting 82-cents. Shares ended up only +3.6% because Hartford was already up +15% for the last week.

Oil prices finally broke with a dip to $79.91 after hitting $83.95 early Monday. Analysts blamed it on news from China that banks would have to set aside a larger proportion of deposits as reserves. This was the first increase since 2008 and is supposed to suppress new loans and keep the economy from overheating. The rise in warmer weather was also blamed on the decline in oil prices. I believe oil declined like the market because of the decline in year-end retirement funds as we approach the middle of January. The threat of an inventory gain on Wednesday's EIA report was also to blame as is the approaching futures expiration next week.

Crude Oil Chart

The CFTC is meeting on Thursday to decide on placing position limits on energy futures. This is a very controversial topic and it will be webcast at www.cftc.gov. Considering the recent buying frenzy by commodity funds that pushed prices to nearly $84 it appears nobody expects those limits to be imposed. In the most recent CFTC data contracts held by large speculators are at all time highs in oil, gasoline and heating oil. The Dow Jones Commodity Index will be rebalanced on Wednesday and managers are adding to natural gas holdings and trimming positions in oil and gasoline.

While on commodities the corn futures plunged limit down today after the government announced there was 13.5 billion bushels of corn being planted for the 2010 season. This a a record amount and should mean a record harvest assuming the dust bowl drought does not return in 2010. A record harvest means lower prices and that was reflected in the futures. It was also reflected in the fab five fertilizer stocks with a -4% or greater decline. If farmers expect a record harvest is going to lower prices then they won't lay out the extra money for a big fertilizer application.

Fitch ratings said 9.2% of prime jumbo mortgage loans were delinquent in December. That is almost 300% higher than the 3.2% delinquency rate in December 2008. Florida led the nation with a 16% delinquency rate followed by California at 10.8%. Fitch says more than one-third of prime jumbo borrowers that were still current on their loans are underwater and owe more than their house is worth but are still making payments.

The Mortgage Bankers Association said they expect the number of mortgages written in 2010 will decline -40%. Originations in 2010 are expected to be around $1.28 trillion and well below the $2.11 trillion in 2009. If this comes true it will be the lowest volume since $1.14 trillion in 2000. The MBA is expecting mortgage rates to rise sharply when the Fed gets out of the mortgage market in February. With more than 30% of homeowners currently underwater in their mortgage it makes moving to a new home really difficult without paying off that underwater premium.

Can you believe it is almost time for the Super Bowl? The recession has depressed prices for Super Bowl ads for only the second time in history. Media Intelligence said 30-second spots are selling this year between $2.5 and $2.8 million. That is a drop from last year's average of $3 million. Prior big spenders Pepsi and GM are opting out this year and smaller companies are bidding lower for the spots. This will be Pepsi's first absence in 23 years. As of Friday only four of the 62 commercial spots remained unsold. A newcomer this year will be Homeaway.com a vacation rental website. They are bringing back Chevy Chase ad Beverly D'Angelo as the Griswold family to star in the commercials.

For the rest of the week I think our fate is still tied to the Intel earning. Intel is the heartbeat of the tech sector and Thursday's EKG had better not show any signs of a heart attack in the making. I think traders will buy today's dip in anticipation of a good report by Intel. There are no material earnings due out on Wednesday and only the Fed Beige Book in the way of economic events.

The Dow to 10676 on Monday and dipped to 10568 intraday today. That dip was anemic at best and no real change in the trend. The Dow has resistance at 10750 and initial support at 10550. I do not expect that support to be tested without some new headline to disrupt sentiment.

Dow Chart

The S&P declined nearly three times as much as the Dow in percentage terms at -0.94% compared to -0.34%. I know that is splitting hairs but I have a point. Remember last week when I pointed out that the S&P and Russell were up much stronger than the Dow because the year-end retirement funds were primarily headed for index funds tracking the S&P and Russell. That year-end inflow of cash is fading and what we saw today was the result of that fade with stimulation by the earnings events. I don't think there was any real damage to the S&P with support at 1130 and again at 1115. A break under 1130 would have me start to worry.

S&P Chart

The Nasdaq dropped sharply with a =1.3% decline. Support at 2280 was tested all day and it was only because of an end of day buy program that the Nasdaq did not close under that level. This is critical support followed by even more critical support at 2250. A break of these levels would be very negative and produce dozens of sell programs as funds take profits from the 2009 rally.

Nasdaq Chart

The Russell declined to test very long term downtrend resistance, which was crossed back on Jan-4th and is now support. The Russell lost -1.3% but without some new market disaster it should not crack the 625-630 threshold. A more under 625 would be very bearish.

Russell 2000 Chart

As I said earlier, it is all about Intel this week. They are going to report earnings in a new format that is expected to unlock additional value in the stock by showing income from different operations. Let's hope this new structure is not cobbled together with chewing gum and bailing wire.

I would be a buyer of this dip as long as those support areas mentioned above are not violated.

Jim Brown


New Plays

Transportation Sector

by James Brown

Click here to email James Brown


NEW BULLISH Plays

CSX Corp. - CSX - close: 50.71 change: -1.15 stop: 48.90

Why We Like It:
Railroad stocks have shown a lot of strength in January. Most of the group broke through significant resistance late last week. CSX rallied to new 52-week highs on Friday. This two day pull back is a good opportunity to hop on board. Broken resistance near $50.00 is holding up as support. I am suggesting bullish positions now. We'll use a stop loss at $48.90 but more conservative traders might be able to get away with a stop loss closer to $50.00.

This is going to be a very short-term play. Earnings are coming up on January 19th. While I am tempted to hold over the report we will exit ahead of the announcement. There are just too many unknown variables that can turn an earnings report into a painful lesson in risk management. Our first target is $53.95.

Annotated chart:

Entry on   January 12 at $50.71 
Change since picked:     + 0.00   			
Earnings Date          01/19/10 (confirmed)    
Average Daily Volume:       2.6 million 
Listed on   January 12, 2009    



In Play Updates and Reviews

First Decline of the Year

by James Brown

Click here to email James Brown

The S&P 500 index was up six days in a row. We were due for some profit taking.


BULLISH Play Updates

Bank of Hawaii - BOH - close: 48.64 change: -0.11 stop: 46.49

Banks were caught in the market's widespread decline on Tuesday. Shares of BOH held up pretty well and just drifted sideways. More conservative traders might want to consider raising their stops. Broken resistance near $48.00 is acting as short-term support. I am not suggesting new positions. Our target to exit is $49.85. More aggressive traders may want to aim higher but I would avoid holding over earnings.

Entry on  November 18 at $46.20     
Change since picked: + 2.44
Earnings Date 01/25/10 (unconfirmed)
Average Daily Volume: 424 thousand
Listed on November 17, 2009


Cisco Systems Inc. - CSCO - close: 24.20 change: -0.39 stop: 23.95

CSCO is dipping toward short-term support near $24.00. This area should be bolstered by the rising 50-dma. More aggressive traders may want to consider buying a bounce from here with a tight stop. I'm suggesting readers wait for a breakout and use a trigger to buy CSCO at $25.05. If triggered our first target is $27.40, which is a little optimistic but we will plan to exit ahead of the early February earnings report. The plan is to keep our positions small to reduce risk.

Entry on   January xx at $xx.xx <-- TRIGGER @ 25.05     
Change since picked: + 0.00 (small positions)
Earnings Date 02/03/10 (confirmed)
Average Daily Volume: 34 million
Listed on January 09, 2009


Diana Shipping Inc. - DSX - close: 16.04 change: -0.23 stop: 14.95

I am surprised that DSX didn't see stronger profit taking. The stock is up a good chunk in the last two weeks. Shares gapped down this morning but spent most of the day consolidating sideways. At this time I'd still prefer to launch new positions on a dip or a bounce near $15.50. This sector and this stock can be volatile. I do consider this an aggressive, higher-risk trade. We want to keep positions small. Our first target is $17.90.

Entry on   January 09 at $16.44 /gap higher entry   
Change since picked: - 0.40 (small positions)
Earnings Date 02/18/10 (unconfirmed)
Average Daily Volume: 1.5 million
Listed on January 09, 2009


Home Depot - HD - close: 27.98 change: -0.18 stop: 27.80

Uh-oh! HD has broken support near $28.00. I think the only thing that saved us was technical support at the 50-dma. The low today was $27.89. If there is any follow through lower tomorrow odds are we will be stopped out. I'm not suggesting new positions at this time.

Our first target is $30.60. Our second target is $32.45. We'll plan to exit ahead of the February earnings report. FYI: The P&F chart is very bullish with a $44 target.

Entry on  December 14 at $28.82 *gap higher entry       
Change since picked: - 0.84
Earnings Date 02/23/10 (unconfirmed)
Average Daily Volume: 15.7 million
Listed on December 12, 2009


Hologic Inc. - HOLX - close: 14.92 change: -0.02 stop: 14.40

HOLX continues to churn sideways. The range has narrowed to the $14.75-15.05 zone. There is no change from my prior comments. We're waiting for a breakout higher. I am suggesting a trigger to buy HOLX at $15.15. If triggered our first target is $16.45 although we'll have to keep a cautious eye on the 100-dma, which could be resistance. I would keep positions small. There is still a chance for the market to correct in January.

Entry on   January xx at $xx.xx <-- TRIGGER @ 15.15  (small positions)     
Change since picked: + 0.00
Earnings Date 02/01/10 (unconfirmed)
Average Daily Volume: 2.7 million
Listed on January 04, 2009


Potlatch Corp. - PCH - close: 32.17 change: -0.28 stop: 31.49

Short-term technical indicators in PCH are starting to take on a more bearish tone. I am not suggesting new positions at this time. Our first target to take profits is at $33.60. Our second target is $35.75.

Entry on  November 16 at $30.30     
Change since picked: + 1.87
Earnings Date 02/11/10 (unconfirmed)
Average Daily Volume: 503 thousand
Listed on November 11, 2009


Renolds American - RAI - close: 53.15 change: -0.24 stop: 52.45

RAI pretty much erased yesterday's bounce. The stock has been trading sideways since mid December. A real breakout past $54.00 could re-ignite the rally. I am suggesting that we sell half our position now (if you haven't done so already). I'm not suggesting new bullish positions at this time. Our target to exit is $55.90.

Entry on  November 14 at $50.32      
Change since picked: + 2.83
/sell half @ 53.15 (+5.6%)
Earnings Date 02/11/10 (unconfirmed)
Average Daily Volume: 1.6 million
Listed on November 14, 2009


Starbucks Corp. - SBUX - close: 22.82 change: -0.39 stop: 21.95

We need to stay defensive on SBUX. The stock has broken down from its $23-24 trading range. I am expecting a dip toward the $22.00 level, which should be support. I'm not suggesting new bullish positions at this time. Our target to exit is $24.90.

Entry on  December 10 at $22.25     
Change since picked: + 0.57
Earnings Date 01/28/10 (unconfirmed)
Average Daily Volume: 10.9 million
Listed on November 30, 2009


Sigma Designs - SIGM - close: 11.80 change: -0.12 stop: 10.95

SIGM almost hit our trigger midday. The low was $11.60. Given today's market weakness I'm going to adjust our entry point on SIGM. Our new trigger to buy the dip is $11.35. We'll move the stop loss down to $10.95. I would still keep positions small as I remain cautious on the market. Our first target to take profits is at $12.95.

Entry on   January xx at $xx.xx <-- TRIGGER @ 11.35  
Change since picked: + 0.00
Earnings Date 03/04/10 (unconfirmed)
Average Daily Volume: 392 thousand
Listed on January 09, 2009


Sonoco Products - SON - close: 30.25 change: -0.24 stop: 29.20

Tuesday ended up a quiet session for SON with the stock trading in a narrow range. Given the market's weakness on Tuesday I would hesitate to launch new positions in SON right here. Our plan was to use small positions. Our first target is $34.50.

Entry on  December 26 at $30.31      
Change since picked: - 0.06 (small positions)
Earnings Date 02/04/10 (unconfirmed)
Average Daily Volume: 343 thousand
Listed on December 26, 2009


Steel Dynamics - STLD - close: 19.08 change: -0.48 stop: 18.45

Last night's earnings report from Alcoa sparked widespread profit taking for all the metal-related stocks. Yesterday's bearish reversal pattern coupled with today's decline is a warning sign. More conservative traders will want to consider an early exit. I'm watching the $18.50 level for support. No new positions at this time.

STLD has already hit our first target at $19.95. Our second and final target is $21.95.

Entry on   January 06 at $18.75 (small positions)     
Change since picked: + 0.33
1st target hit @ 19.95 (+6.4%)
Earnings Date 01/26/10 (unconfirmed)
Average Daily Volume: 5.7 million
Listed on January 04, 2009


Seagate Technology - STX - close: 17.72 change: -0.63 stop: 17.45

STX is dipping back toward recent support near $17.50. Some of the technical indicators are starting to grow more bearish. More conservative traders will want to consider an early exit right here! I'm not suggesting new positions.

Remember, we plan to exit ahead of the January 20th earnings report. Our target to exit is $19.75. The plan was to keep positions small to limit our risk.

Entry on  December 19 at $17.83 /gap open higher (small positions)     
Change since picked: - 0.11
Earnings Date 01/20/10 (confirmed)
Average Daily Volume: 8.2 million
Listed on December 19, 2009


Vishay Intertechnology - VSH - close: 8.71 change: -0.26 stop: 8.20

VSH displayed relative weakness with a 2.8% decline. The stock broke down under a couple of levels of short-term support. Traders did buy the dip at $8.45 and the stock delivered a decent afternoon bounce from its lows. More conservative traders may want to up their stops toward today's low. I'm not suggesting new bullish positions at this time. Our target is $9.95. The plan was to keep positions small to limit our risk.

Entry on   January 08 at $ 8.85 (small positions)
Change since picked: - 0.14
Earnings Date 02/09/10 (unconfirmed)
Average Daily Volume: 1.1 million
Listed on January 05, 2009


Wright Express Corp. - WXS - close: 31.91 change: -0.35 stop: 30.95

WXS is still consolidating sideways. I don't see any changes from my previous comments. Cautious traders might want to adjust their stops toward $31.50ish.

Our target is $35.90. I'm setting a longer-term target at $39.50 but we want to sell the majority of our position at $35.90. We will plan to exit ahead of the February earnings report.

Entry on  December 21 at $32.30     
Change since picked: - 0.39
Earnings Date 02/10/10 (unconfirmed)
Average Daily Volume: 209 thousand
Listed on December 19, 2009


Wyndham Worldwide - WYN - close: 20.44 change: -0.25 stop: 19.90

We had a close call on WYN. The stock briefly traded under support near $20.00 and hit $19.94. The strong afternoon bounce from its lows is encouraging but it looks like momentum is definitely waning for WYN. Readers may just want to call it quits and exit now. I'm not suggesting new positions at this time. Our first target has already been hit at $21.00. We're currently aiming for $22.40. The plan was to use small positions (1/2 a position).

Entry on  November 10 at $18.88 (1/2 position) /gap open higher     
Change since picked: + 1.56
/1st target hit @ 21.00 (+11.2%)
Earnings Date 02/11/10 (unconfirmed)
Average Daily Volume: 3.5 million
Listed on November 10, 2009


BEARISH Play Updates

Best Buy - BBY - close: 39.26 change: +0.03 stop: 41.26

After two days of declines BBY eked our a small gain. The trend is still down. It is worth noting that shares spiked lower this morning and hit $38.71. Our trigger to open bearish positions was hit at $38.95 so the play is open. Keep an eye on the rising 200-dma, where BBY will probably see a bounce but we expect the bounce to be temporary. There is no need to rush into positions now. We'll probably get a new entry point in the next couple of days.

Our first target is $35.25.

chart:

Entry on   January 12 at $38.95 (small positions)       
Change since picked: + 0.31
Earnings Date 03/25/10 (unconfirmed)
Average Daily Volume: 8.0 million
Listed on January 02, 2009