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Newsletter

Daily Newsletter, Saturday, 7/12/2014

Table of Contents

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

Market Wrap

A Rocky Week For Stocks

by James Brown

Click here to email James Brown

The U.S. stock market started the third quarter on an up note. Momentum faded and equities experienced a rocky week thanks to some troubling headlines out of Europe. Believe it or not but after last week's choppiness and widespread declines the S&P 500 index is still less than one percent from its all-time high set on July 3rd - just five trading days ago.

Market Statistics:

Stocks just delivered their worst weekly performance in three months. The small cap Russell 2000 index led the way with a -3.99% plunge. The NASDAQ composite fell -1.6% for the week. Both the Dow Industrials and the large cap S&P 500 managed to pare their weekly losses to less than 1%.

Tuesday and Thursday were pretty ugly considering the low-volatility environment. Yet traders are still in a buy-the-dip mood. The main stories fueling the market weakness was disappointing economic data out of Asia and Europe. Plus, a shocking revelation out of Portugal that resurrected all the worries about a financial meltdown in Europe but we'll talk more about that in a minute.

Money was searching for safety and U.S. bonds rallied. The yield on the 10-year note pierced 2.5% on Thursday and closed at 2.52% on Friday. Gold was also in rally mode and the GLD broke out to three-month highs. Gold is currently up six weeks in a row, which makes it the best streak since August 2011. Gold prices are up +6% in the last six weeks and up +10.9% for the year. Meanwhile gold miners are really outperforming. The GDX gold miner ETF is also up six weeks in a row. It has been a very volatile year for the GDX but it's currently up +29% year to date.

Weekly chart of the Gold Miner ETF (GDX)

In contrast oil is down sharply. West Texas intermediate crude oil futures fell -2% to close at $100.83 a barrel. Oil is now down 9 out of the last 10 days and just marked its fourth weekly loss in a row. The International Energy Agency said Iraqi oil production fell -260,000 barrels a day last week but the difference was made up by other OPEC nations. Fighting continues in Iraq but the headlines are not making front page news so its impact is not having an effect on investor sentiment.

Economic Data

It was a quiet week for economic data in the United States. The only real event was the FOMC minutes from the June meeting. The message the market got from the minutes was that the Fed is likely to end its current QE program and reduce the stimulus by the last $15 billion in October. You could choose to interpret that as confidence that the U.S. economy is improving. Analyst are now looking beyond the end of QE and speculating on when the Federal Reserve will start to raise rates again.

Bloomberg noted some good news in consumer sentiment hitting the highest levels in six years. The Bloomberg Consumer Comfort Index rose +1.2 to 37.6 the week ending July 6th. The component that measures consumer outlook on the U.S. economy reached levels not seen since January 2008.

With little economic news in the U.S. the markets looked overseas and what they saw was disappointing. Germany said their industrial production fell -1.8% for the month. That's down from a -0.3% reading the month before. Italy reported a -1.2% drop in their industrial production and Great Britain saw a -0.7% drop.

Japanese machinery orders plunged -19.5% for the month, which doesn't bode well. China said their exports rose +7.2% in June. That looks like good news but economists were expecting a +10% gain. Meanwhile Germany said their exports actually dropped -1.1% in May. That was worse than the -0.4% estimate.

The real story of the week was in Portugal. With a GDP of $212.5 billion and a population of less than 11 million people, Portugal is not a very big player on the world stage. Yet the European banking system is so interconnected that if Portugal were to see a dramatic failure the shockwave could affect the entire region. Espirito Santo International failed to make a short-term debt payment. ESI happens to own Espirito Santo Financial Group SA and Banco Espirito Santo. Suddenly the creditworthiness of both financial companies were in question. The two stocks plunged -9% and -14%, respectively, before the exchanges halted trading.

This news fueled a serious case of nervousness for the European financial system and European banks were hammered lowered. The Portuguese stock market fell -4.2% on Thursday while the country's bond yields soared. Portugal's central bank was trying to soothe investors' fears on Friday and the major European indices (Germany, France, and Britain) all bounced.

American banking giant Wells Fargo & Co (WFC) was making headlines on Friday. The company reported Q2 earnings before the opening bell. Wall Street was looking for a profit of $1.01 per share with revenues in the $20.7-20.8 billion range. WFC met expectations with a profit of $1.01 on revenues of $21.1 billion. Net income was $5.7 billion. That's up from $5.5 billion a year ago.

Shares of WFC were down every day last week and gapped down on Friday morning as traders sold the earnings news. Analysts are a little concerned about WFC's net interest margin. A year ago WFC's net interest margin was 3.40%. The first quarter it was 3.20%. Last quarter this fell to 3.15%. WFC is one of the biggest mortgage lenders in the country. The bank said its mortgage originations hit $47 billion in the second quarter. That's down from $112 billion a year ago but up from $36 billion in the first quarter.

Weekly chart of the Wells Fargo (WFC)





Major Indices:

The S&P 500 lost -0.9% for the week. The index pierced short-term support near 1960 and its 20-dma on Thursday. On a short-term basis the index looks like it wants to rally. Yet looking at the weekly chart you can see how over extended the index really is. The S&P 500 has gone more than 1,000 days without a -10% correction. In a normal market it would see a correction about once or twice a year.

I don't see any changes from my prior comments on the S&P 500. If the 1960 level fails then there might be support at 1940 and 1920. The real level to watch is most likely the 1900 area, which would coincide with the bottom of its long-term bullish channel on the weekly chart.

chart of the S&P 500 index:

Intraday chart of the S&P 500 index

The NASDAQ composite posted a -1.6% loss for the week. The good news is that this index managed to bounce near its prior highs. There is no guarantee that "support" near 4370 is going to hold.

If the NASDAQ breaks down below the March peak then 4300 is the next likely level of support. A really ugly drop could pull the NASDAQ down to its long-term trend line of higher lows on the weekly chart.

chart of the NASDAQ Composite index:

Weekly chart of the NASDAQ Composite index

Right now there is a lot of focus on the small cap Russell 2000 index. This index just delivered its worst weekly performance in two years with a -4% plunge. The $RUT has clearly reversed at resistance near its March highs. This is starting to look like a bearish double top. One of the fast money guys on CNBC called it an "epic" double top.

There is still potential support in the 1140-1150 zone. Below that the 1080-1100 area is probably decent support. The six-week up trend from the May lows is clearly broken.

The current sell-off in the $RUT has 39% of the Russell 2000 stocks trading in bear market territory.

chart of the Russell 2000 index

Weekly chart of the Russell 2000 index

This week will see an increase in economic reports. We'll get two Fed surveys with the New York and Philadelphia reports. Plus, the wholesale look at inflation in the PPI.

The pace of Q2 earnings announcements will pick up speed.

Economic and Event Calendar

- Monday, July 14 -
Q2 earnings season announcements pick up speed.
Citigroup (C) reports earnings

- Tuesday, July 15 -
New York Empire State manufacturing data
Retail sales for June
Import/Export prices
JPM, GS, INTC, and JNJ reports earnings

- Wednesday, July 16 -
Producer Price Index (PPI)
U.S. Industrial Production data
Federal Reserve's Beige Book
BAC and EBAY report earnings

- Thursday, July 17 -
Weekly Initial Jobless Claims
Housing Starts & Building Permits
Philadelphia Federal Reserve survey
MS, IBM, and GOOG report earnings

- Friday, July 18 -
University of Michigan Consumer Sentiment
G20 Meetings
GE, HON, and KSU report earnings

Looking ahead the market still faces potential geopolitical risks. The situation in Israel is slowly escalating. Hamas terrorists fired over 800 rockets and more than 60 mortars into Israel last week. The Israelis responded with airstrikes that hit more than 1,000 targets. On Friday Israeli commandos traded fire with Hamas fighters but it does not appear to be part of a full scale invasion. Israel has not ruled anything out and continues to build up its forces on the Gaza border. Israeli Prime Minster Netanyahu said he has spoken with several world leaders in the past week including U.S. President Obama and several European leaders. If the Israeli army does march into Gaza it might be negative for investor sentiment.

The situation in Ukraine is not improving either. On Friday the pro-Russian rebels killed almost two dozen Ukraine forces. This time they were using "heavy" weapons including what appear to be Russian rockets. Ukraine President Petro Poroshenko had declared that, "For every life of one of our soldiers, the militants will pay with dozens and hundreds of theirs." U.S. Vice President Biden spoke with Poroshenko on Saturday saying the U.S. would continue to pressure Russia to do more to stop the violence and remind them of the consequences if they do not. There will be an EU summit in the July 16-18 time frame and one of the main topics will be Russia and if the country has done enough to counter the rebels that Ukraine claims are being supplied by the Russians.

With the exception of the small cap Russell 2000 index the U.S. market seems to be hovering near its highs. Investors are waiting for more data and earnings results from the Q2 earnings season. The real focus will be guidance.

James







New Plays

Healthcare & Shoes

by James Brown

Click here to email James Brown


NEW BULLISH Plays

Steris Corp. - STE - close: 54.38 change: +0.87

Stop Loss: 52.65
Target(s): To Be Determined
Current Gain/Loss: unopened

Entry on July -- at $--.--
Listed on July 12, 2014
Time Frame: 8 to 12 weeks
Average Daily Volume = 246 thousand
New Positions: Yes, see below

Company Description

Why We Like It:
The company website describes STERIS as a global leader in infection prevention, contamination control, surgical and critical care technologies, and more. STERIS is the world's pre-eminent infection prevention, decontamination, and surgical and critical care company, with a long list of first-to-market products and industry-leading service innovations and thousands of customers in more than 60 countries.

While the corporation was founded as Innovative Medical Technologies in 1985 and renamed STERIS in 1987, our history dates back to 1894 with the founding of American Sterilizer Company, a long-time, global leading innovator of sterilization products. Today, through a series of strategic acquisitions and continual innovation of new products, STERIS holds one of the broadest portfolios of products in the industry. It stands at the forefront of efforts to prevent infection and contamination in healthcare and pharmaceutical environments, and is broadening its reach with products to meet the needs of defense and industrial markets (source: www.Steris.com).

The infection prevention industry is expected to hit global sales of $109 billion in 2017. This area of healthcare is growing at more than 5% a year. STE is growing three times faster than the industry due to acquisitions and strong organic growth.

STE recently purchased Integrated Medical Systems International, Inc. (IMS) for $165 million. IMS has sales of $150 million a year in the sterile processing, surgical instrument management, and endoscope repair. This particular industry is fragmented and STE believes they can grab market share as well as capitalize on synergies with IMS.

STE's recent earnings report in May was very encouraging. Analysts were looking for a profit of $0.86 a share on revenues of $455.9 million. STE beat estimates with a profit of 91 cents on revenues of $465.3 million.

Revenues were up 9% for the quarter with 7% of that as organic growth. STE saw strong revenue growth in consumables (+17%) and its service business (+23%). Even with the Obama administration's new medical device excise tax STE managed to grow its gross margins 30 basis points to 41.5%. Its healthcare sterilization business saw margins jump 410 basis points. STE also reported growth in its backlog of business.

They expect double-digit top and bottom line growth in 2015 and boosted their revenue estimates into the +15% to 17% range.

Technically shares have been consolidating sideways the last few weeks. That's not surprising after the big spike higher following its earnings report in May. Now STE appears to be almost done with this consolidation phase. Shares look poised to breakout past resistance near $55.00 and hit new record highs.

The May 12th high was $55.36. Tonight I am suggesting a trigger to open bullish positions at $55.50 with a stop loss at $52.65, just under last Thursday's low. We are not setting an exit target tonight but I will point out that the Point & Figure chart is bullish and suggesting at $74.00 long-term target.

Trigger @ $55.50

Suggested Position: buy STE stock @ (trigger)

Annotated chart:

Weekly chart:



NEW BEARISH Plays

DSW Inc. - DSW - close: 27.61 change: +0.05

Stop Loss: 29.15
Target(s): To Be Determined
Current Gain/Loss: unopened

Entry on July -- at $--.--
Listed on July 12, 2014
Time Frame: 8 to 12 weeks
Average Daily Volume = 1.5 million
New Positions: Yes, see below

Company Description

Why We Like It:
DSW Designer Shoe Warehouse runs over 400 company-owned stores. They also participate in hundreds of other shoe departments in regional department stores through their Affiliated Business Group.

There appears to be a bear market in designer shoes. At least that is the picture if you're looking at shares of DSW Inc. The stock has actually been a big winner for investors if you have owned it the past few years. On a post 2-for-1 split adjusted basis DSW traded down to $3.33 in 2009. It peaked in 2013 with a close at $47.22 in November last year. That's a huge run (more than 1,400%). Unfortunately last November was indeed the peak. DSW has been stuck in a bearish trend of lower highs and lower lows since then.

DSW lowered its earnings guidance back in February 2014. Of course back then just about all of the retail companies were warning about lack of sales and blaming it on the extremely cold winter weather. That was after weeks of worry over the 2013 holiday shopping season.

The U.S. economy is slowly recovering but consumer spending has not. There are still large chunks of the consumer who continue to struggle. The sharp rise in food prices this year combined with elevated gasoline prices has not helped. There seems to be a bifurcation in the consumer spending. There has been strong demand for big ticket items like housing and cars. Yet smaller discretionary spending is just not there.

The overall retail industry saw some improvement in May. There was hope that June same-store sales would come in better than expected. Analysts and investors were a bit disappointed when the retail industry delivered June numbers that were only in-line with estimates.

Meanwhile DSW continues to struggle. The company reported earnings on May 28th. Wall Street was expecting a profit of $0.48 per share on revenues of $622.9 million. DSW announced earnings of 42 cents on revenues of $599 million. A miss on both counts. Management then lowered their 2015 guidance. The company blamed the weather (again) and said they were facing an intense promotional retail environment. The Container Store (TCS) has a completely different product mix but recently mirrored DSW's troubles and said they were experiencing a retail "funk" (i.e. lack of sales).

Shares of DSW dropped from $32.50 to $23.60 on its earnings miss and earnings warning late May. Since then the stock has bounced but it has found new resistance in the $28.50 area. Now DSW looks like it is rolling over again.

Friday's low was $27.20. I am suggesting a trigger to open bearish positions at $26.90. If triggered I'm expecting DSW to at least test its May lows if not breakdown to new lows.

We will plan on exiting prior to DSW's late August earnings report.

Trigger @ $26.90

Suggested Position: short DSW stock @ (trigger)

- (or for more adventurous traders, try this option) -

Buy the OCT $25 PUT (DSW141018P25) current ask $0.90

Option Format: symbol-year-month-day-call-strike

Annotated chart:

Weekly chart:




In Play Updates and Reviews

Outperforming The Major Indices

by James Brown

Click here to email James Brown

Editor's Note:
Our bullish candidates were outperforming the major indices on Friday.


Current Portfolio:


BULLISH Play Updates

Microsoft Corp. - MSFT - close: 42.09 change: +0.41

Stop Loss: 39.90
Target(s): To Be Determined
Current Gain/Loss: + 0.6%

Entry on June 17 at $41.85
Listed on June 14, 2014
Time Frame: 10 to 12 weeks
Average Daily Volume = 23 million
New Positions: see below

Comments:
07/12/14: MSFT made another acquisition on Friday. The company purchased business continuity specialist InMage. This is essentially a cloud-storage and back up type of service to protect a corporation's key systems and data in case of disaster.

Meanwhile shares of MSFT continued to bounce and are once again challenging resistance near $42.00. The June 27th high was $42.29. Traders may want to wait for a rally past $42.30 before considering new positions. Keep in mind that MSFT is due to report earnings on July 22nd.

I'm leaning towards holding over MSFT's announcement but we'll make that decision as the date approaches.

Earlier Comments: June 14, 2014:
It's back to the future with old-tech heavyweights making progress on Friday. Semiconductor giant Intel (INTC) surprised the market with an announcement Thursday night. INTC raised their revenue guidance due to stronger PC sales. That's right, they said stronger PC sales. Intel chips are in about 80% of the world's PCs. Unfortunately the PC has been declared dead for years due to the explosion of laptops, smartphones, and tablets. It is true that PC shipments have been falling for the last eight quarters in a row. IDC expects PC shipments to fall another -6% in 2014. If that's true then what's the story behind Intel's positive guidance? It might be Microsoft.

Microsoft ended support for its Windows XP operating system in April this year. No more support means they would no longer provide patches or virus updates to protect your system from hackers. With credit card data being stolen a constant threat for businesses the lack of support for XP has sparked an upgrade cycle, especially among corporations.

There does seem to be some disagreement on just how long and how big of an effect this upgrade cycle will last. Was it a one quarter bump or will it last throughout the rest of 2014? An FBR analyst estimates that 25% of the PCs connected to the Internet still run Windows XP. That is a very large number so the upgrade cycle for Microsoft could last a while. It could be bigger than expected too.

Not only are consumers and businesses going to upgrade their operating system from Windows XP to Windows 8 but they will most likely buy an upgraded copy of Microsoft Office. MSFT will likely sell a few more copies of SQL server as well.

The MSFT story is not just about software either. The company seems to be making in-roads into the healthcare sector with their Surface Pro 3 tablets. MSFT is also slugging it out with Sony in the game console wars. Consumers bought $3.6 billion in video games in the first quarter of 2014. MSFT's line up of games for its Xbox One looks pretty good following the annual E3 conference last week.

Technically shares of MSFT are in a long-term up trend and hitting 14-year highs. As an investor would you rather buy a 10-year bond with a 2.6% yield or MSFT with a 2.7% yield and good chance for price appreciation?

More conservative investors may want to wait for a rally past $42.00 before initiating positions.

current Position: long MSFT stock @ $41.85

- (or for more adventurous traders, try this option) -

Long 2015 Jan $45 call (MSFT150117c45) entry $1.16

06/30/14 new stop @ 39.90
06/17/14 triggered @ 41.85
Option Format: symbol-year-month-day-call-strike

chart:



SoftBank Corp. - SFTBY - close: 37.10 change: +0.56

Stop Loss: 35.35
Target(s): To Be Determined
Current Gain/Loss: +1.1%

Entry on June 17 at $36.68
Listed on June 16, 2014
Time Frame: 8 to 12 weeks
Average Daily Volume = 499 thousand
New Positions: see below

Comments:
07/12/14: The big headlines for SFTBY on Friday was a story the company had reached a deal to buy T-Mobile US from Germany's Deutsche Telecom. If this story is true then it opens up the possibility of SFTBY merging T-Mobile with its Sprint subsidiary.

Currently Sprint is a distant third behind AT&T and Verizon Wireless in the U.S. market. By adding T-Mobile's 100 million U.S. customers it would boost Sprint closer to its rivals. Any potential merger would need to be approved by U.S. regulators.

Shares of SFTBY outperformed the U.S. indices with a +1.5% gain on Friday but remains inside its recent trading range.

Keep in mind that Alibaba is still expected to IPO this summer. There has been some speculation it could happen later this month. Others believe Alibaba wants to IPO on the "lucky" date of August 8th. The number eight is considered a lucky number is Chinese culture.

I am not suggesting new positions at this time. Resistance remains overhead near $38.50.

Earlier Comments: June 16, 2014:
SoftBank Corp. has been referred to as the Warren Buffet of Technology although a better comparison is probably to Buffet's Berkshire Hathaway. They are a holding company with hundreds of businesses. According to the company website SFTBY has 235 subsidiaries and 108 affiliates (including 150 consolidated subsidiaries and 83 equity method companies). SoftBank Group possesses both advanced infrastructure and diverse services and content, and invests in promising companies working in the Internet field.

SFTBY owns 80.2% of Sprint Corp., 33.3% of eAccess Ltd., 100% of WILLCOM, Inc., 33.3% of Wireless City Planning Inc., 58.5% of GungHo Online Entertainment, and 42.5% of Yahoo Japan Corp. They also own 34% of Renren Inc., which is considered the Chinese version of Facebook. They also own 36.7% of Alibaba Corp., which is a much larger and more profitable version of Amazon.com. That's on top of owning SoftBank Telecom, SoftBank BB Corp. and SoftBank Mobile.

SFTBY's combined telecom assets makes the company one of the largest telecom/wireless players in Japan. In 2013 they added 4.1 million new subscribers and more than double the 1.19 million subscriber gain by NTT DoCoMo and 2.8 million for AU, which is owned by KDDI. Softbank added 47% of the Android phones activated in Japan and 39% of the iPhone 4s and 5c models. Both metrics are the largest in Japan and shows how Softbank is gaining market share.

Their Renren investment could be a big. China already has the largest Internet audience on the planet and it's only going to get bigger. Currently Renren has about 200 million users. This will grow. Like Facebook, Renren is developing its mobile platform. Renren is currently valued at about $8 per user but this seems extremely low considering what Facebook paid for WhatsApp.

SFTBY's majority stake in Sprint is starting to pay off. Sprint has had a rough few years working through its merger with Nextel. Sprint later acquired Clearwire. It looks like Sprint is now in recovery mode after adding +477,000 subscribers in Q4 2013 versus losing -337,000 in Q4 2012. SFTBY wants to acquire T-Mobile and combine it with Sprint. Currently 75% of U.S. customers are on AT&T or Verizon. SFTBY calls them an American duopoly but they believe by combining Sprint, the third largest carrier, with T-Mobile, the fourth largest, the combined company could compete with AT&T and Verizon, which would be good for competition and ultimately consumers.

Today the real allure of SFTBY is its 37% ownership of Alibaba. Amazon.com (AMZN) is an Internet powerhouse with sales of $86 billion in 2013 and a net profit of $274 million. Alibaba dwarfs AMZN with 2013 sales of $160 billion and a profit of $2.16 billion. Right now it looks like Alibaba will IPO this summer. Analysts have been estimating they could be the biggest IPO in history with a value of $160 to 185 billion.

There were new numbers out on Alibaba today with the company stating that its Q4 revenues only rose +39% to $1.9 billion. That's down from 62% growth in Q3. Margins retreated from 51.3% to 45.3% on higher marketing costs. This spooked investors today into thinking that maybe the valuation may not be in the $160-185 billion range.

We believe that SFTBY's shares are very undervalued and when the Alibaba IPO does hit this stock could soar. Tonight we're suggesting investors launch positions tomorrow morning at current levels. Depending on your trading style this could be an aggressive entry point. Technically SFTBY still has resistance in the $38-39 zone. More conservative investors may want to wait for SFTBY to close above $39.00 before initiating new positions. The risk of not launching positions now is that we do not know when Alibaba is going to announce its IPO. It could be any day and likely in the next few weeks. We will plan on exiting after Alibaba's first day of trading.

Current Position: Long SFTBY stock @ $36.68

07/11/14 News hits that SFTBY might buy T-Mobile soon.
06/30/14 new stop $ 35.35
06/17/14 trade opens. SFTBY gapped down at $36.68
note: SFTBY does not have options.

chart: