Option Investor
Newsletter

Daily Newsletter, Tuesday, 8/24/2010

Table of Contents

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

Market Wrap

Existing Home Sales Fall -27%

by Jim Brown

Click here to email Jim Brown

That is not the kind of headline the stock market wants to see and the knee jerk reaction was a drop below Dow 10,000.

Market Stats Table

Existing Home Sales fell -27.2% in July according to data from the National Association of Realtors report this morning. Sales fell to an annualized rate of 3.83 million homes from the June rate of 5.37 million. Analysts had expected a decline but only to 4.83 million. The drop of a million home sales more than expected was a serious shock to the market. Months of supply soared to 12.5 and a new record high. The pace of home fell to a level not seen since 1995.

The homebuyer tax credit produced the first spike in October and then sales declined after that credit ended. The credit was eventually reinstated with even better metrics that included additional buyers but the resulting sales spike was lower. Once the second credit period expired the pace of sales fell off a cliff. This is a clear example of how stimulus programs pull sales forward leaving a void of activity in future periods.

All four census regions showed month over month sales declines of 20% to 30% so the lack of activity was nationwide and not region specific. The number of single-family homes for sale fell to an 11.9-month supply and the lowest level since 1985. Homes for sale increased in July while sales declined. Record low interest rates have been unable to draw buyers back into the market. The unavailability of credit and the strict requirements for home loans is hurting the market. The homebuyer tax credit was an addictive drug for homebuyers and the removal of the tax credit has put the housing sector into withdrawal.

The downside risks to the economy are huge. Home sales should continue to decline until spring. This will hurt new home sales as well and cause another round of layoffs in the construction sector. Home prices will fall again and foreclosures will increase. This is a major problem for the U.S. economy.

Home Sales Chart with Tax Credit Spikes

Homebuilders imploded at the open but many rebounded to close in positive territory after several brokers reiterated buy ratings. Citigroup said the "Risk-reward profile is more favorably skewed." JP Morgan said homebuilders offer a "Compelling risk/reward" and Barclays "We remain positive on the builders." Obviously those brokers must have a considerably longer time horizon than most readers.

Toll Brothers (TOL) will report earnings n Wednesday and it will be interesting to hear how they are dealing with the downturn and more importantly hear their guidance for the next six months. I do believe that the current cutback in housing starts will eventually lead to a shortage of homes and a rapid spike in prices and profitability. The only question is when that will happen. 2011 or 2012?

While Citigroup was reiterating its buy on the homebuilders it was cutting its outlook on building supply companies like CRH and MLM. I am guessing it is a case of different analysts with different views. One firm, CRH Plc (CRH), warned today that earnings would decline sharply due to a faltering U.S. economic recovery. CRH is based in Ireland but 50% of its sales are to U.S. clients. The company said conditions in the U.S. had declined significantly since mid July.

Earnings fell -20% and they guided sharply lower for the next six months. Citigroup cut CRH to a hold and share prices declined by -16%. Other suppliers including CX, EXP, VMC and MLM all declined sharply as well.

The other major economic report today was the Richmond Fed Manufacturing Survey. The headline number fell from 16.0 to 11.0 but remained in positive territory unlike the Philly Fed report last week. The components declined at a slower rate than those in the Philly Fed. The two that stood out to me were the unfilled orders at zero from 16.0 just three months ago and the capital expenditure plans that were cut in half from last month. The shipments component (not shown) dropped from 22 to 11 after peaking at 32 in May.

Richmond Fed Components

Reports due out on Wednesday include Mortgage Applications, Durable Goods, Home Price Index and New Home Sales. The new home sales numbers should not be quite as bad as existing home sales but I seriously doubt it will be good news.

We knew the home sales numbers were going to be bad but nobody expected the severity of the actual decline. After the drop in the Philly Fed last week and the monster drop in the home sales this week you can bet the sentiment numbers over the next month are going to be very ugly. Friday's sentiment report cutoff 10 days ago so it won't reflect the bad news. The next one will be the really ugly number.

The GDP revision on Friday is now expected to decline from 2.4% to 1.2% and many analysts are expecting it to fall under 1% on the next revision. Analyst David Rosenberg from Gluskin Sheff said on Tuesday the economy is not in a double dip recession but already in a 1930s style depression.

Rosenberg wrote in a note to clients that even in the Great Depression there were high points with a series of positive GDP reports and stock market gains. Then as now those signs of recovery were unsustainable and only provided a false sense of stability. The 1929-33 recession saw six quarterly bounces in GDP with an average gain of +8% and causing the stock market to rally +50%. This time around there have been four quarterly GDP advances and the average is only +3%. Rosenberg pointed out that the current economic decline has come after two years of a Fed interest rate at record lows and after an increase in the Fed balance sheet of more than $2 trillion plus the largest stimulus program in history. He said, "This is not your garden variety double dip recession." He also believes we could see another 4-5 million lost jobs. He pointed out that historically the home construction sector employed three workers for every housing start. Today that number is closer to 10 and continued weakness in housing will force a return to historical norms. This is also true with all the industries that supply goods and services to the housing sector.

Gluskin Sheff Chart

Quite a few analysts disagree with Rosenberg but those that agree are growing in numbers. This kind of talk from a highly respected analyst is very detrimental to market sentiment.

Chicago Federal Reserve President Charles Evans said in a speech on Tuesday that the risk of a double dip recession has escalated. "I am increasingly uncomfortable with the lack of noticeable improvement in the labor market." Despite the current problems he believes the economy will escape a double dip and he believes the current Fed policy is the correct one. However, he said today's numbers would force him to lower his estimates for the recovery and he would probably support move Fed stimulus. He is worried that foreclosures could reach three million in 2010 with one million homes owned by lenders. That is drastically over the existing estimates by analysts.

The housing data and the comments by Evans are focusing the spotlight even more on the Ben Bernanke speech at 10:ET on Friday. This speech at Jackson Hole is not normally a revelation of policy but more of an informal luncheon talk. With the recent downturn of economics there is a growing hope that Bernanke will say something substantive to calm economic fears. While on the subject of the Fed there is a growing belief that the Fed is going to announce another stimulus move of some kind over the next 3-5 days.

Dollar Index Chart

Ten-Year Note Yield Chart

In a remarkable burst of speed two people were charged with insider trading on the announcement of the BHP bid for Potash. The head of a research arm at Banco Santander was one of the two people charged. Banco Santander is one of the banks advising BHP on the bid. The SEC said two of the bankers traded on inside information they obtained about the deal. The idiots bought $61,000 of out of the money call options and sold them for $1.1 million after the deal was announced. Let's see, professional bankers buying large quantities of OTM call options in a U.S. trading account just before the deal was announced and they did not expect anyone to notice? After the sale they immediately tried to move the money offshore.

Potash has more suitors than customers today. Rio Tinto said it may join with a Chinese partner like China National Offshore Oil Company (CEO) to breakup the BHP bid. Rio Tinto is probably the 4th or 5th company to express a desire to make a competing bid. The price on POT could go to the moon if this bidding war continues to heat up. Since China has a national imperative to corner the market on fertilizer I would bet that the eventual winner will have Chinese backing.

McAfee and Intel were sued by an irate shareholder claiming Intel paid too little for McAfee. You may remember Intel is paying a 60% premium at $48 for the software company and the stock was headed lower before the offer. McAfee has not been close to $48 since March of 1999. I would bet that suit is a colossal waste of money.

The banking sector may be the only sector with worse charts than homebuilders. The financial sector is losing ground fast and there appears to be no relief in sight. Fears of a double dip are weighing on the major banks because nobody wants to be caught owning the next Lehman or Bear Stearns if the double dip turns out worse than the initial dip. The flurry of eight bank closures last Friday is also weighing on banking sentiment. Among banks hitting new 52-week lows today were BAC, BK and USB.

Banking Index Chart

The markets had been down for the prior three days and that did not prevent them from stretching that string to four. Oversold can always become more oversold and we are seeing that in action. The Dow dropped -183 points at the open and recovered somewhat to trade down only -100 early in the afternoon but the "sell on close" strategy is alive and well. There are no bulls after 2:PM. Fear of darkness has become a powerful motivator again. Triple digit declines at the open convince traders they do not want to be long at the close.

Internals were severely negative with new 52-week lows hitting 467 and the highest level in nearly a year. That is even higher than the levels seen on the early July dip to 9,614 on the Dow. Sentiment is declining very rapidly.

The S&P declined -15 points and hit a low of 1046. This is very close to the 1040-1044 support dating back to February but I seriously doubt it will hold. I am sure there is a rebound rally in our future but I think the trend will remain lower at least until after Labor Day. Resistance is now 1060 and 1075.

S&P Chart

The Dow broke below 10,000 at the open and quickly rebounded to just over 10,100 but it was a short trip. The Dow was handicapped by huge losses in BA, CAT, IBM, UTX and CHV. Boeing lost -2.37 or nearly -4% on news the FAA was going to step up inspections of 737s.

The Dow is going to be under pressure as long as the economics continue to worsen. The double whammy is the large tech stocks added over the last few years that are also providing a major drag. A major market cycle analyst, Charles Nenner, has predicted quite a few of the major Dow moves in the past and he has been right on more often than not. In 2006 he predicted the initial housing crisis, the recession and now he is predicting a return to Dow 5,000 as the country falls into a depression. He was showcased on CNBC today and regardless of whether you believe him or not the existence of the high profile prediction is strongly bearish.

The support on the Dow is now 10,000 but it is more psychological than technical. The Dow has already declined -700 points since the August highs on August 9th. The 10K level may slow that already oversold decline but I don't think it will be the low for August. I believe we will retest the 9800 closing low from June. Resistance is now 10,100.

Dow Chart

I have nothing positive to say about the Nasdaq. The big cap techs are being sold hard on worries consumer PC sales as well as the corporate upgrade cycle has broken. Chip stocks have been warning on guidance and analysts are cutting their PC sales estimates. There are no positives for techs.

The decline below strong support on Tuesday clearly targets the 50% retracement level at 2063. I would be very surprised and suspicious of any tech rebound. Prior support at 2140 is now resistance.

Nasdaq Chart

The Russell tested critical support at 590 today and the initial test was a success. However, I think we will see that level tested again. If it fails we could see a stutter step at 580 but 550 becomes the next target. We need to focus on small caps over the next month to see when fund managers start buying stocks again. Until the Russell shows some strength the market will remain under pressure.

Russell Chart

In summary I believe the market will continue lower until after Labor Day but we could see oversold rebounds thanks to short covering at any time. The economics are simply too negative and worsening. Fear of a double dip is growing and this is not the climate for fund managers to suddenly start buying stocks. We also have the decline in the financial sector. The markets are not going to rally as long as the outlook for financials is worsening.

Over the weekend we experienced a hardware failure on one of our servers. This caused the newsletter emails to be delayed until Sunday night. When the process was restarted thousands of aborted emails from the failed process were sent to readers. We apologize for the extra emails and the delayed newsletter. Thank you for your continued support of Option Investor.

Jim Brown


New Plays

Short Candidate

by Scott Hawes

Click here to email Scott Hawes


NEW BEARISH Plays

HNSI, Inc - HNSI - close 26.58 change -1.49 stop 29.11

Company Description:
HSN, Inc. (HSNi) is an interactive multi-channel retailer offering retail experiences on television (TV), online, in catalogs and in retail and outlet stores through its two operating segments, HSN and Cornerstone. HSN is a retailer and interactive lifestyle network offering an assortment of products through television home shopping programming on the HSN television network and through its business-to-consumer Internet commerce site HSN.com. Cornerstone comprises home and lifestyle brands, including Frontgate, Ballard Designs, Garnet Hill, Smith+Noble, The Territory Ahead, TravelSmith and Improvements. Cornerstone distributes over 200 million catalogs annually, operates seven separate Internet sites, and operates 23 retail and outlet stores.

Target(s): 25.05, 23.50, 22.25
Key Support/Resistance Areas: 28.90, 27.25, 25.80, 200-SMA, 23.50, 22.00
Time Frame: 1 to 2 weeks

Comments:
Retailers are weak and HSNI looks like it is headed to test its 200-day SMA and possibly its recent swing lows. The stock has made a great comeback off of its 2009 lows but the selling has picked back up in recent weeks. The stock lost -5.3% today on strong volume and I expect it to continue if the broader market cooperates. I would like to see a retracement of some of today's gains to initiate short positions but if the stock breaks down I also suggest initiating short positions. Let's use triggers on a bounce to $27.20 or a breakdown to $25.69. More nimble traders can initiate positions now. We'll keep a tight stop at $29.11 which is above the downtrend line and Monday's high. If we get filled at $27.20 our first target is nearly 8% lower and above the 200-day SMA. HSNI closed below its 20, 50, and 100 day SMA's today.

Suggested Position: Short HSNI stock, if it trades to $27.20 or $25.69

Options Traders: Buy September $25.00 PUTS, current ask $1.65

Annotated chart:

Entry on August xx
Earnings: 11/11/2010 (unconfirmed)
Average Daily Volume: 495,000
Listed on August24, 2010


In Play Updates and Reviews

Two Short Positions Triggered

by Scott Hawes

Click here to email Scott Hawes
Current Portfolio:


BULLISH Play Updates

Athenahealth, Inc. - ATHN - close 27.86 change -0.85 stop 26.90

Target(s): 28.75, 29.50, 31.50 (hit), 32.95, 34.00
Key Support/Resistance Areas: 34.25, 31.75, 30.00, 28.25, 25.75
Current Gain/Loss: -7.90%
Time Frame: 1 to 2 weeks
New Positions: No

Comments:
8/24: The sell-off in ATHN continued today and we are getting very close to being stopped out. The stock closed below its upward trend line from the 7/22 lows today, while also closing below its 20-day and 100-day SMA's. The 50-day SMA is below our stop and it appears ATHN may visit this level near $26.00. The stock has retraced just about 50% of its gains from the 7/22 low and there is support at current levels, so this is a logical place for ATHN to bounce. However, the broader market is weak so readers may want to consider looking for an exit. $28.75 and 29.50 are intraday resistance levels and should be considered as areas to selling positions or tightening stops to protect capital.

Current Position: Long ATHN stock, entry was at $30.25

Options Traders: Long September $31.00 CALL

Entry on August 16, 2010
Earnings 10/28/2010 (unconfirmed)
Average Daily Volume: 767,000
Listed on August 14, 2010


The Andersons, Inc - ANDE - close 36.95 change +1.23 stop 34.45 *NEW*

Target(s): 38.90, 40.50, 41.50
Key Support/Resistance Areas: 41.50, 40.50, 39.20, 38.00, 35.50
Current Gain/Loss: -0.19%
Time Frame: 1 to 3 weeks
New Positions: Yes

Comments:
8/24: ANDE surged +3.44% higher today on a very weak tape in the broader market. We are just about break-even on this trade but I urge readers to be cautious as ANDE can't buck the broader market trend forever. However, if the market bounces from here ANDE should head towards our first target of $38.90 (lowered 25 cents). I want to raise the stop up to $34.45 which is below the 50-day SMA and well below the recent congestion area and key resistance level of $35.50. This should protect us from a head fake lower and protect against a hard reversal.

Current Position: Long ANDE stock, entry was at $37.02

Options Traders: Buy December $40.00 Calls, current ask $2.10

Entry on August 19, 2010
Earnings 10/28/2010 (unconfirmed)
Average Daily Volume: 180,000
Listed on August 18, 2010


Newmont Mining Corp - NEM - close 57.12 change -0.46 stop 56.40

Target(s): 59.30 (hit), 59.85, 61.50
Key Support/Resistance Areas: 62.00, 59.50, 58.16, 55.00, 54.30, 52.30
Current Gain/Loss: +0.65%
Time Frame: Several weeks
New Positions: Yes

Comments:
8/18: NEM gapped lower but was immediately bought and closed well off of its lows. This is more of a defensive play that can do well in broader market weakness. I've adjusted the 2nd target and suggest we take profits this time if they are reached. $59.30 was hit last week and still remains a valid target.

Current Position: Long NEM stock, entry was at $56.75

Entry on August 13, 2010
Earnings 11/3/2010 (unconfirmed)
Average Daily Volume: 7.7 million
Listed on August 10, 2010


Oceaneering International - OII - close 49.03 change -0.75 stop 46.60

Target(s): 50.75, 51.75, 53.00, 54.40
Key Support/Resistance Areas: 57.50, 54.50, 53.40, 49.00
Current Gain/Loss: -0.35%
Time Frame: 1 to 2 weeks
New Positions: Yes

Comments:
8/18: OII is hanging tough and is maintaining its upward trend line from the 6/1 lows. Let's stick with the set-up and see if the stock bounces from here. I've added a lower target of $50.75 which will produce a small +3% gain if reached. Readers should consider tightening stops or taking profits as they targets are reached.

Current Position: Long OII stock, entry was at $49.20

Options Traders: Long September $50.00 CALL

Entry on August 16, 2010
Earnings 10/28/10 (unconfirmed)
Average Daily Volume: 807,000
Listed on August 14, 2010


UltraShort Semiconductor ETF - SSG - close: 18.18 change: -0.08 stop: 18.40

Target(s): 22.00
Key Support/Resistance Areas: 22.00, 20.00, 19.00, 17.00
Current Gain/Loss: N/A
Time Frame: 4 to 6 weeks
New Positions: Yes, See Entry Point Below

Comments:
NOTE: This is a bearish trade using a long position in an inverse ETF. Since we are bullish on the inverse ETF it is listed as a bullish trade.

8/24: SSG looks on the verge of breaking out and hitting our trigger to buy positions at $19.65. I think pullbacks in SSG can be bought as well so I would like to add a trigger of $17.80 to buy positions which is just above the 200-day SMA and upward trend line from the 7/27 lows. If triggered at $17.80 we'll use a stop loss at $16.45.

8/21: Semiconductor companies that supply materials to the smart phone market have been doing better than their peers that provide chips for the PC market. Yet the chip sector in general has been underperforming. The SOX index broke down under significant support a few days ago and looks ready to begin a new leg lower. I am suggesting we take advantage of this weakness with a bullish position on the SSG.

The plan is to buy the SSG when it breaks out past the July high and hits $19.65. Our multi-week target is $22.00. More nimble traders may want to cross their fingers and hope for a pull back toward $17.25-16.75 as an alternative entry point but if you do buy the dip I would use a relatively tight stop loss. FYI: This is a double, inverse ETF. Expect volatility!

Suggested Position: Long SSG stock/ETF if trades to $19.65 or $17.80

Entry on August XX
Earnings Date: N/A
Average Daily Volume: 178,000
Listed on August 21, 2010


BEARISH Play Updates

Automatic Data Processing - ADP - close: 38.81 change: -0.24 stop: 41.26

Target(s): 37.25, 36.50, 34.00
Key Support/Resistance Areas: 41.00, 39.00, 37.30
Current Gain/Loss: -0.15%
Time Frame: Several weeks
New Positions: Yes

Comments:
8/24: We were triggered on our short entry in ADP at $38.75. This is the lowest close since 10/8 and the stock looks vulnerable. I've added $37.25 as a first target because it is near a long term upward trend line and prior swing low from 9/3/09.

8/21: Our new bearish play on ADP was almost triggered Friday. Shares dipped to $39.10. I am suggesting readers use a trigger to open bearish positions at $38.75. There are no changes from my Thursday comments.

Is it possible that businesses are cutting back on bookkeeping as they reduce the number of employees? For whatever reason shares of ADP are losing ground. In late July, at the company's latest earnings report, management lowered their guidance. Now the stock is trading near the bottom of its $39-42 range. If you check out the weekly chart you can see ADP's bearish H&S pattern.

I am suggesting a trigger to open bearish positions at $38.75. If triggered our first target is $36.00. Our second target is $34.00. Use a stop at $41.26.

Current Positions: Short ADP stock, entry was at $38.75

Option Traders: Long November $37.00 puts

Entry on August 24, 2010
Earnings Date 10/28/10 (unconfirmed)
Average Daily Volume: 3.2 million
Listed on August 19, 2010


Chesapeake Energy - CHK - close 20.23 change -0.35 stop 22.10 *NEW*

Target(s): 19.70, 18.80, 18.05
Key Support/Resistance Areas: 22.50, 21.60, 20.30, 19.65, 18.75, 18.00
Current Gain/Loss: +2.79% Time Frame: 1 to 2 weeks
New Positions: Yes

Comments:
8/18: CHK lost -1.70% and today and is close to printing new 52-week. Our first target is just above those 52-week lows at $19.70. If CHK get there we will have +5% gains in the trade. I suggest taking profits at this level or tightening stops to protect them.

Current Position: Short CHK stock, entry was at $20.81

Options Traders: Long October $20.00 PUTS

Entry on August 16, 2010
Earnings: 11/2/2010 (unconfirmed)
Average Daily Volume: 10 million
Listed on August 14, 2010


Con-way Inc. - CNW - close: 27.95 change: +0.41 stop: 31.55

Target(s): 28.25, 26.75, 25.50
Key Support/Resistance Areas: 25.00, 28.00, 32.00
Current Gain/Loss: N/A
Time Frame: Several Weeks
New Positions: Yes, trigger 29.20

Comments:
8/24: CNW managed to gain +1.33% to close at $27.52. This stock is shortable on strength but we are still waiting on our trigger. The plan is to initiate bearish positions if CNW can bounce to $29.20. The stock is still very oversold with its recent decline from $35.00. A normal 38.2% Fibonacci retracement and the declining 20-day SMA are near $29.80. If the stock can manage to bounce to $29.20 I would be short seller.

Suggested Position: Short CNW stock if it trades to $29.20

Entry on August xx
Earnings Date 11/03/10 (unconfirmed)
Average Daily Volume: 1.0 million
Listed on August 7, 2010


Starbucks Corp. - SBUX - close: 24.04 change: -0.46 stop: 25.05

Target(s): 22.10, 21.30, 20.00
Key Support/Resistance Areas: 25.00, 23.50, 22.00, 21.00, 20.00
Current Gain/Loss: +2.06%
Time Frame: Several weeks
New Positions: Yes

Comments:
8/24: We were triggered in SBUX at the open this morning and the stock sold off the remainder of the day. I've adjusted our targets and suggest readers begin to tighten stops or take profits as they are reached.

8/21: There is no change from my Thursday comments. SBUX is still consolidating sideways but the path of least resistance is down. Entry point to open bearish positions is at $23.40.

The rally in shares of SBUX appears to have cooled off. It isn't surprising with more and more signs of the economy slowing down, consumers cutting back and saving more. SBUX's latest earnings report was ho-hum. Profits were inline but what impressed was the better than expected revenues. Unfortunately, management guided 2010 inline with prior estimates and guided 2011 lower.

Shares of SBUX are now testing support near $23.50 and its 200-dma. It looks like the stock is ready to break. The weekly chart shows a bearish head-and-shoulders pattern. I am suggesting we wait for a drop under the early July lows. Therefore our entry point to open bearish positions is $23.40. Our target is the $21.00 and 20.00 levels. More nimble traders could try an alternative entry point with another failed rally near $25.00.

Current Position: Short SBUX stock, entry was at $23.30

Options Traders: Long October $23.00 puts

Entry on August 24, 2010
Earnings Date 11/04/10 (unconfirmed)
Average Daily Volume: 8.0 million
Listed on August 19, 2010


SPDR Retail ETF - XRT - close 37.91 change +0.47 stop 38.62 *NEW*

Target(s): 36.00, 35.25, 34.65
Key Support/Resistance Areas: 39.00, 38.00, 37.60, 36.50, 35.80, 35.00
Current Gain/Loss: +3.07%
Time Frame: 1 to 2 weeks
New Positions: Yes

Comments:
8/24: XRT hit our first target of $36.00 this morning and bounced. I see no reason the ETF won't trade down to its July lows which are just below our second target of $35.25. Let's move our stop down to $38.62.

Current Position: Short XRT stock, entry was at $37.52

Options Traders: Long September $36.00 PUTS

Entry on August 17, 2010
Earnings: 11/2/2010 (unconfirmed)
Average Daily Volume: 12 million
Listed on August 16, 2010