Option Investor
Newsletter

Daily Newsletter, Tuesday, 4/27/2010

Table of Contents

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

Market Wrap

Portugal Catches Greek Debt Flu

by Jim Brown

Click here to email Jim Brown

Greece problems worsened today when their debt was cut to junk status and the contagion spread to Portugal with their debt cut two notches.

Market Stats Table

S&P cut Portugal's debt two notches from A+ to A- and warned that further downgrades were possible. This followed the S&P downgrade on Greece long and short-term debt to non-investment status (B and BB+) and warned that anyone who owned Greek bonds faced a dwindling chance of getting their money back. S&P said that Greece's ability to cut spending and increase austerity measures was "materially weakened by domestic political opposition." They were referring to the continued riots and nationwide strikes protesting the austerity plans. Even their air force went on strike. The odds that Greece would eventually restructure its debt are increasing. This strong language was the only excuse needed for equity investors to dump stocks and the Dow closed on its lows for the second consecutive day.

The dollar soared to a new 52-week high and the Euro fell to a new 52-week low. Even the British pound was crushed and lost more than two full points to close at 151.85. The price of gold rocketed higher to $1,173 for a +$18.80 gain at the close and a new five month high.

Foreign markets imploded with the London FTSE falling -2.61% and the CAC-40 in Paris fell -3.83%. On this side of the pond Mexico lost more than 3% and Brazil's Bovespa was down -2.7% at midday.

With the dollar soaring the price of commodities other than gold fell sharply. Prices for crude oil fell to a low of $81.70 intraday and -$3.12. There was a slight rebound at the close to end down -2.40 at $82.42. Copper prices dropped -4.6% for the day. Energy and commodity stocks also fell sharply. Stocks with large recent gains were crushed as the profit taking accelerated.

It did not help that CNBC was 100% coverage of the testimony of Goldman executives to the Senate committee. Investors and traders who wanted to know why the markets were dropping and how it impacted their various positions were greeted with eight hours of testimony with only short breaks during recesses and those breaks were used to summarize the prior hour of testimony. This was not helpful to people who wanted to know why the market was down triple digits and what was powering the decline.

On the economic front the news was excellent but it did not make the headlines given the Greece and Goldman news blanket. The Richmond Fed Manufacturing Survey exploded higher to 30.0 for April after a reading of 6.0 in March. This is the highest level on record! The shipments component rose from 5.0 to 30.0 and the highest level since March 2004. New orders rose from 31.0 to 41.0 and the highest level on record. The employment index rose to 13 and the highest level since December 1994. The Richmond Fed Survey was very bullish and suggests the economic activity at least in the Richmond area is accelerating rapidly.

Richmond Fed Survey

The Consumer Confidence reading for April rose sharply to 57.9 from 52.3 in March. After several months of erratic readings on confidence the April reading was the highest reading since September 2008. The majority of the gains came from the expectations component, which rose from 70.4 to 77.4. The present conditions component also rose from 25.2 to 28.6.

Those planning on buying an auto rose to 5.1% from 3.9% and those considering an appliance purchase rose to 27.4% from 25.5%. However, those planning on buying a home fell to 2.0% from 2.8%. Obviously the consumer is feeling more confident about the state of the economy and this is shown in their purchase plans. The decline in plans to buy a home is simply a factor of the sell forward over the last three months in order to capture the tax credit. Now that the credit expires in three days there are very few people left with purchase plans. If they had a plan they have already acted on those plans.

Despite the sharp rise in confidence the level remains at recessionary levels. As recently as late 2007 the confidence level was over 110. Today's 57.9 is barely over half the levels we saw before the crash and barely over the highs of the last 12 months.

Despite the rise in confidence over a quarter of the respondents expect the stock market to decline in 2010. The majority of respondents still expressed concerns over high unemployment, problems getting credit and higher gasoline prices.

Consumer Confidence Chart

The Case Shiller Home Price Indexes for February showed an actual gain in prices of +0.6% compared to a -0.7% decline in the prior month. Considering the rising number of repossessions and foreclosures the rebound in home prices is moving much slower than expected. This is a lagging indicator covering the February period and as such would have been ignored without the Greek news and the Goldman grilling.

Case Shiller Chart

Economic reports due out on Wednesday include the Mortgage Applications, Oil and Gas Inventories and the FOMC announcement. Obviously the biggest of those events is the FOMC. The announcement at 2:15 is not expected to produce any change in rates other than a potential for another discount rate hike. The key to the statement will be the retention or the discarding of the "extended period" language. There have been dissentions in the recent past and I am sure there will be dissentions again this week. Whether there were enough dissenting votes to change the language is the question.

I mentioned over the weekend that a statement change could actually be perceived as a positive event that would indicate the Fed is becoming more bullish on the economy. Since the bad news bulls have been buying every dip there is a growing chance that they would buy the language change as well.

It appears that the majority of analysts have shifted to a statement change position. If the Fed is aware of this fact then that increases the chance they will change the statement because it is basically a free move. If everyone thinks they are going to change then not changing could actually cause a new round of questions over what the Fed knows that analysts don't know. This should be a really interesting statement considering the chess moves leading up to it.

On the earnings front 3M (MMM) posted earnings of $1.40 per share if you exclude an 11-cent charge for the new health care program. Analysts were expecting $1.21 per share. That was a 79% increase from the year ago quarter. 3M raised its guidance for the full year to $5.40-$5.60 from $4.90-$5.10. However that guidance increase was not based on a rebounding U.S. economy. 3M CEO George Buckley said, "I don't think we should look to the U.S. for a big recovery in 2010." 3M is looking to a strong rebound in Asia and Latin America for the increased profits. 3M said the rebound in auto sales was helping their profits since they make over 1,000 products for cars including paints. Sales of films for LCD TVs, cell phones and computers improved the most. MMM closed positive for the day but significantly off it highs of $90.25.

Ford (F) reported earnings of 50-cents compared to a loss of 60-cents in the year ago quarter. Ford said it expected to be solidly profitable in 2010 and that is a year earlier than their prior guidance. Ford's market share gains took the largest jump in 33 years but analysts were afraid the company could not maintain those gains. Another factor worrying analysts was a large $528 million profit from the finance division but that is expected to decline later this year as cars financed before the recession are traded and paid off and the lack of cars sold during the recession lead to lower finance profits.

Ford's CFO took issue with analysts whining about potential pitfalls ahead and said "We would not have improved our guidance if we thought this was just a wild quarter." Ford saw $1 billion in gains from higher pricing and lower incentives. Ford expects U.S. vehicles sales in 2010 of between 11.5 and 12.5 million compared to sales of 10.4 million in 2009 and 16 million in 2005. Ford shares lost -6% after their earnings release.

Ford Chart

Lexmark (LXK) posted earnings of $1.20 per share compared to 75-cents in the year ago quarter. Analysts were expecting 89-cents. The strong earnings came on an increase in sales and continued cost cuts. Printer sales rose +20% including a 27% spike in revenue from laser printers. Lexmark upgraded guidance to 85-95 cents for Q2 compared to analyst estimates of 73-cents. Gross margins rose to 36.9%. Moody's raised their ratings outlook to stable from negative. LXK rallied to a new 52-week high but collapsed back to close only fractionally positive on market weakness.

Lexmark Chart

UPS reported earnings of 71-cents that beat analyst estimates of 57 cents. UPS said the international package segment posted an 18% jump in revenue on an 18% jump in daily volume. UPS also raised estimates for 2010 but not substantially. UPS prewarned of the earnings beat earlier in April. The positive comments about increased daily volume have been echoed by FedEx. UPS shares lost-3.4% on Tuesday.

ADP reported earnings that beat the street by two cents but offered cautious guidance. ADP said 2010 earnings would probably be little changed from 2009 due to the low levels of employment. "It is going o be a gradual upswing" according to the CFO on the conference call. ADP declined -2% on the news.

Yesterday Caterpillar (CAT) reported earnings of $233 million for Q1 and reversed a loss in the comparison quarter. Before a health care charge of $90 million their earnings were 50-cents per share. After the charge their earnings were 36-cents. The CAT CFO said, "We are in a revival. There is no doubt about it." CAT spiked to $72.83 on the news on Monday but was a significant drag on the Dow today with a -4.3% decline to $68.60.

After the close today Broadcom (BRCM) reported earnings of 57-cents compared to analyst estimates of 47-cents. Broadcom also raised guidance for revenue of $1.5b to $1.6B. Analysts were expecting $1.4B. Broadcom said sales to businesses were improving and demand is strong and improving. They are building chips for Samsung cell phones as well as those from Apple and Nokia. They said supply was tight but they were able to keep up with demand. This was similar to the Texas Instruments earnings on Monday. BRCM declined -3.3% on Tuesday and rebounded +2% in afterhours.

The best earnings for the day came from BP. The oil company reported earnings of $1.94 compared to estimates of $1.57 and year ago earnings of 82-cents. Profits rose +135% to $5.6 billion for the quarter. Were it not for the growing oil spill in the gulf I am sure the results on the stock price would have been a lot better. BP fell -2.7% today after a huge drop on Monday as the oil spill news turned for the worse.

BP has been unable to activate the valves on the blowout preventer on the ocean floor. The plan now is to lower a dome over the leak and attempt to pipe the oil to the surface to prevent a greater spill. BP says the dome should be completed in 2-4 weeks. BP said they were spending $6-10 million a day to mitigate the spill. The Development Driller III rig has been moved into position to begin drilling a relief well that will close off the first well. That is expected to cost another $100 million and could take two months. They are considering drilling a second relief well with another rig at the same time just in case the first relief well failed. That would cost an additional $100 million according to BP. The company is self-insured and will have to bear the full cost of all the mitigation efforts. The stock price has declined about $4.50 since the explosion but the majority of that has been this week. The real losses did not occur until the Coast Guard reversed their original claim that the well was not leaking. The oil slick is now 49 miles by 100 miles and continues to grow.

Chart of BP

In my comments about the bank closures over the weekend I erroneously stated that the total bank closures so far in 2010 were 140. That was the total for 2009. The total for 2010 is now 57. At this rate we will exceed the 2009 total.

The debt downgrade to Greece and Portugal was simply a perfect excuse for profit taking. The impact to the U.S. will be negligible with the dollar strengthening and a slightly larger bid for our debt at auction. The Greek bailout package may have to be increased because of the inability of Greece to sell debt in the future. Already the IMF is looking to add €10bn to the previously announced €45bn package. This is likely to continue to grow as the year progresses. Greece already has more than €300bn of euro debt in the market. The addition of Portugal and Spain to the endangered species list is likely to mean that the EU and the IMF will eventually be called upon to lend them some money as well. This story is not going away for a very long time. However, it really has little impact on the U.S. economy or markets. It was an excuse to sell and nothing more.

The Goldman Grilling was the perfect public flogging. Goldman CEO Lloyd Blankfein was beaten up for more than three hours by senators that were able to perfectly phrase their accusatory questions and then not allow an answer in any form they did not like. The eleven hours of testimony was the equivalent of a kangaroo court. The hearing had no bearing on anything except the further demonization of Goldman and big banks in general and possibly lifted the election hopes of a couple senators. Shares of Goldman closed the day with a gain of +$1.

If nothing else the Goldman grilling provided lawmakers with a high profile podium from which to lobby for passage of the financial reform bill. Some topics in the bill were repeatedly used as talking points by the Senators on the panel. Do they really think we are so stupid that we can't see though the haze and understand their underlying political motives?

The Dow lost -213 to close just under 11,000 and right on decent support. Despite all the smoke circling the markets there was no fire. Had the Goldman assassination not been televised for nearly 11 straight hours without commercials and only a minimum of voice over with market tidbits the market outcome would have been significantly different. When the markets are dropping and investors don't know why the tendency is to sell first and ask questions later.

Market volume was very heavy with 12.6 billion shares traded after a 9.2 billion share day on Monday. This was stops being hit and selling on uncertainty ahead of the FOMC announcement on Wednesday. Volume was 10:1 negative.

Ordinarily I would be suggesting we buy this dip. I believe we will see a rebound but possibly not until after the FOMC announcement. When selling accelerates on uncertainty as it did today it sometimes becomes a self-fulfilling process. Selling sometimes begets more selling. When you look at the huge losses by some or the prior high flyers it was evident that momentum traders were running scared.

I think the initial Dow support at 11,000 should hold but we know that Europe is going to trade down overnight and Asia will probably be down as well because of our decline. That could cause some follow on selling on our markets. If the Dow moves lower the next support is around 10,850. I would expect that level to be bought. Earnings are still good and the FOMC is not expected to do anything stupid otherwise all bets are off.

Dow Chart

The S&P-500 fell -2.3% and stopped right in the 1180-1185 support range where you would have expected it to stop. The next material support is 1165 and we could easily test that on an early morning intraday dip. The day's decline was the largest drop since Feb-4th and without any material change in the U.S. economy it is a dip that should be bought.

S&P-500 Chart

The Nasdaq declined -2% or -51 points but the decline halted exactly where you would have expected it to stop. Apple gave back -2.7% but that decline failed to reach even initial support at $258. Tech traders were not running for cover even on a grossly overbought stock like Apple. Now for the qualification. If the Nasdaq does decline under 2470 the next real support is well below at 2400. I think the Nasdaq has a clear line in the sand and one that will trigger additional selling if it is violated.

Nasdaq Chart

The Russell declined an equal amount in percentage terms as the big cap indexes. If the Russell had corrected more than the other indexes I would be more bearish. Instead I think this was just a news driven, actually a news blackout driven, decline that will be bought. By that I mean that the Goldman grilling blacked out all the other news in a busy market day.

The next support on the Russell is 700 and we could easily trade there without breaking the longer-term uptrend.

Russell Chart

In summary, I think the dip will be bought but possibly not until after the FOMC statement at 2:15. If the dip is not bought and the FOMC statement is neutral then we have seen a major shift in market sentiment. I had been expecting a decline prior to the FOMC announcement but today's news blackout drop exceeded my expectations.

I would be a buyer of any opening dip with a stop under the morning lows. After the FOMC announcement there will probably be additional volatility regardless of what they say. Remember, that the market historically declines the day after the FOMC meeting on a sell the news trade. Today's dip should have negated that normal decline and that is why I would be a dip buyer on Wednesday.

Jim Brown


New Plays

New Plays After FOMC Announcement

by Scott Hawes

Click here to email Scott Hawes

Editor's Note:

Editor's Note: I think it is smarter to wait until we see how the market reacts to the FOMC announcement tomorrow prior to initiating new plays. This market has been tough enough to navigate over the past week or two and initiating a new play by guessing what happens tomorrow at 2:15 PM EDT is simply that, guessing. If the quantitative easing language remains we have plenty of longs to benefit, however, if the language changes or there is a surprise rate increase we may have already seen the highs of the year. And I will be ready with biased positions for either direction in tomorrow's newsletter.

Here is a trade idea for those of you who are interested: Long JNJ – the stock has upward trend line support from November and horizontal support from a prior resistance level on February 2nd. JNJ tends to be a defensive play so it may work in a declining market and should participate in an advancing market.



In Play Updates and Reviews

EXM is a Big Winner, QQQQ is a Small Loser

by Scott Hawes

Click here to email Scott Hawes

Editor's Note:

Good evening traders. EXM hit our target this morning and we are flat for a +8.4% gain. QQQQ also gave us what we were looking for today by trading down to its 20-day SMA. We closed this position for a small loss. The question now is what will happen after the FOMC announcement tomorrow. If the language changes it could spark some serious selling, but if the language remains consistent it may give the markets an excuse to continue this rally. I am not releasing new plays tonight ahead of the announcement. Please stay nimble with any positions tomorrow as there is bound to be some volatility in the afternoon beginning at about 2:15 PM sharp. Our new long positions struggled today but I don't want to panic out of the positions just yet. I am expecting rebounds in both of them. Good luck.

Current Portfolio:


BULLISH Play Updates

Enzo Biochem, Inc. - ENZ - close 6.03 change -0.46 stop 5.74 *NEW*

ENZ sold off today closing lower -7%. The stock blew right through its 20-day SMA and ended up closing right on its 50-day SMA, putting the stock right back in the bull flag that has been intact since early March. The Accumulation/Distribution studies on ENZ remain bullish. The volume on declining days is still not as high as the volume on advancing days which tends to be a more bullish sign. After looking more closely at the recent bull flag the lows are $5.79 but our stop is $5.91. I suggest readers move their stops down to $5.74 to prevent from getting shaken out of the trade if there is more volatility in the coming days. Hopefully you have used small position size as we have been suggesting because of the more aggressive trade set-up. I suggest readers not panic out of positions. I want to see if ENZ can reverse from here and at that time we will look for new exit targets and stops, etc.

*NOTE: Please use small position size to limit risk as I consider this to be an aggressive play. The stock's average daily volume is 160,000 shares which can add to volatility.*

Current Position: Long ENZ stock @ $6.52

Entry on April 26 at $6.52
Earnings Date 6/15/10 (unconfirmed)
Average Daily Volume: 160,000
Listed on April 24, 2010


Fuel Systems, Inc. – FSYS – close 31.41 change -1.07 stop 29.39

The retracement in FSYS continued today and our position is struggling. However, I expect FSYS to bounce from here. The stock is still above its uptrend line from March 4th and it bounced nicely off of its 50-day SMA today. The stock closed well of off its lows while the overall market closed on their lows. FSYS is still in an upward trend on its daily chart and is also forming an ascending triangle that has some time to play out. I like our chances of FSYS rallying into its earnings report on May 6th, especially if we get a bounce in the market from here. The company trades at about an 11 PE and its earnings have been steadily increasing over the past year. I believe FSYS will rally to our target of $34.65 prior to its earnings report on May 6. Our second target is $37.00, but there is probably not enough time to reach this level prior to the earnings report. If FSYS reaches our target we will earn +5.8% on the trade. We will use a stop at $29.39 which is below its 50-day SMA and a recent swing low. Traders can initiate new positions now but please be prepared for a quick exit as FSYS tends to be volatile. Our time frame is about two weeks.

Current Position: Long FSYS stock @ $32.75

Entry on April 26 at $32.75
Earnings Date 05/06/10 (unconfirmed)
Average Daily Volume: 720,000
Listed on April 22, 2010


Medicis Pharmaceutical Corp. – MRX – close: $25.19 change -0.34 stop: $24.29

It appeared MRX was breaking out this morning as it traded as high $26.03, but the market got whacked and MRX was not spared. I have been suggesting traders consider tightening stops if MRX rallies into to the $25.80 area to protect profits. This makes the 7th time the stock has tested this area since April 12 before being knocked back down. Maybe the door won't open after all. I am a little concerned as MRX is now back below its uptrend line from February 11 and the candlestick that was formed today looks bearish, especially if the market continues correcting. But the market declines have been short lived recently and I expect at least another bounce prior to a bigger fall. As such, I would like to lower our target to $25.75 and will gladly take a small +3% profit at this level. MRX has support down at $24.88 and its 50-day SMA at $24.68. Our stop is $24.29 which is below the 50-day SMA. Our target is now $25.75 and we are removing our second target at $27.75 because we plan to be out prior to this level. I am not suggesting new positions at this time.

Current Position: MRX stock @ $25.00

Entry on April 14 at $25.00
Earnings Date 5/06/2010 (unconfirmed)
Average Daily Volume: 1.0 million
Listed on April 13th, 2010


BEARISH Play Updates

Moody's Corp. - MCO - close 24.85 change -1.21 stop 28.60

MCO never got close to our entry today and I do not want to chase it down at these levels. The stock closed down -4.64%. However, I would like to take advantage of any bounces so I am going to lower our trigger to enter to $25.90. There is strong resistance in the $26.00 area which I would expect to hold if MCO makes back up here. I suggest readers look to short the stock if it reaches this level. My comments from last night remain mostly the same. MCO's chart is broken and a lot of damage has been done. The stock broke out of a bear flag on its daily chart today and I believe conditions are ripe for the decline to continue. The stock was hanging on to a recent support level and its 200-day SMA, both in the $26.00 area. I think it is only a matter of time before this level is broken. I am bearish on MCO and if the market starts to pullback MCO could be a nice winner for us. I would like to place an initial wide stop at $28.60 just in case there is a spike in the stock from short covering or a news event. If that happens I am confident MCO will be sold by many who may still be holding long shares, creating additional pressure. There is plenty of resistance and congestion just overhead as well. Our target is $23.25 and our time frame is a couple of weeks.

NOTE: The ratings agencies are also under the microscope in Washington as reports have surfaced that they were overly influenced by Wall Street firms and they used outdated models for rating complex securities, i.e. mortgage-backed securities, CDO's, etc. I would be surprised if they are not regulated as part of the financial reform bill which traders will probably view as a negative for the stock.

Suggested Position: Short MCO at $25.90

Option Traders:
Suggested Position: Buy JUNE $25.00 PUT, current ask $1.23

Entry on April xx at $xx.xx
Earnings Date Over two months
Average Daily Volume: 3.5 million
Listed on April 26, 2010


CLOSED BULLISH PLAYS

Excel Maritime Carriers Ltd. – EXM – close 6.80 change -0.01 stop 6.06

EXM bucked the trend again today and ended up closing down only 1 penny on the day. However, EXM was up +6% in early trading and our target of $7.10 was hit. So we are now flat on the position for a nice gain of +8.4%. This is a perfect example of sticking with the trade set-up and not trying to squeeze out more gains. The stock reached a high of $7.22 but quickly gave back all of those gains when the market reversed. Readers who may still have positions should protect profits. EXM has support down to about $6.70 which would fill a recent gap up.

Closed Position: Long EXM stock @ $7.10, entry was at $6.55

Annotated chart:

Entry on April 20 at $6.55
Earnings Date 05/19/10 (unconfirmed)
Average Daily Volume: 1.2 million
Listed on April 19th, 2010


CLOSED BEARISH PLAYS

Powershares QQQQ Trust - QQQQ - close: 49.34 change: -1.07 stop: 50.95

We got the intraday sell-off we anticipated in the market today which allowed us to exit QQQQ for a small loss at the 20-day SMA. We are now flat the position for a small loss of -0.43%. QQQQ trading down to its 20-day SMA was way overdue as I have been expressing in my updates. Where it goes from here is anybody's guess and I would rather not be involved ahead of the FOMC announcement tomorrow. Readers who may still have positions please protect today's gains. There will inevitably be a bounce. A new protective stop could be placed at $49.93 which is just above the level where today's intraday bounce reversed back lower.

Closed Position: Short QQQQ at $49.26, entry was at $49.05

Annotated chart:

Entry on April 12th, 2010
Earnings Date Not Applicable
Average Daily Volume: 49.4 million
Listed on April 10, 2010