Option Investor
Newsletter

Daily Newsletter, Tuesday, 5/31/2016

Table of Contents

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

Market Wrap

Brexit is Back

by Jim Brown

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In just a week, the tide has turned again with the Leave camp now beating the Remain camp 52-48% according to new Guardian survey.

Market Statistics

The tide has turned multiple times and only a week ago a different survey showed a 55 to 42% result in favor of remaining in the EU. That survey covered conservative voter while the most recent survey was randomly conducted by phone. The actual phone results were 45% leave, 42% remain and 13% did not know. By removing the undecided category, the numbers jump to 52-48% in favor of leaving. Another online survey found 47% favor leaving, 44% remaining and 9% undecided. If you remove the undecided, you get the same 52-48% in favor of leaving. The same poll was conducted in mid May and the Remain camp was ahead 55% to 45%. The trend is definitely changing. Source

The market did not like the increased uncertainty along with some negative economics and the Dow and S&P declined while the biotech sector continued to hold up the Nasdaq.

The Chicago ISM (formerly Chicago PMI) fell -1.1 to 49.3 in May from 50.4 in April. This is the sixth time it has been in contraction in the last 12 months. The production component declined -6.6 with new orders also falling into contraction under 50. Inventories fell -11.7 to 37.9 and the seventh consecutive month in contraction. Order backlogs rebounded +9 but remained in contraction for the 16th consecutive month.

This suggests the national ISM could also fall into contraction when it is reported on Wednesday.


Consumer Confidence for May fell from 94.7 to 92.6 and the lowest reading since July. The present conditions component fell from 117.1 to 112.9 and a 6-month low while the expectations component declined from 79.7 to 79.0 and the lowest level since February 2014. Those consumers planning on buying a car rose from 11.8% to 12.6%, homes up from 5.3% to 6.0%. Appliance buying plans declined from 51.6% to 50.3%. The high dollar purchase plans were strengthening while the common consumer items were fading. Consumer pessimism appears to be rising, which is common in an election cycle.


Personal income for April rose +0.4% to duplicate the rise in March. On a trailing 12-month basis income is up +4.4%. Personal spending rose +0.6% after zero gain in March. This was the fastest growth since May of 2015. Spending was concentrated on cars and parts at 5.4% compared to nondurable goods like clothing, gasoline and food at +0.7%. As consumers, we have not learned out lessons and spending growth is always higher than income growth.

The PCE (personal consumption expenditures) deflator rose +0.3% for April. This is the Fed's preferred inflation indicator. Gasoline was the biggest increase at +0.7%. The core rate was +0.2%. Over the trailing 12 months the headline PCE is +1.1% and the Core PCE is +1.6%. The Fed would like to see it at 2.0%.

The Case Shiller home price index rose +5.4% in March after the same reading in February. This is a lagging report and the data was ignored. The recent home sales reports have provided data that is more current.

The Texas Manufacturing Survey for April declined from -13.9 to -20.8. The production component declined from +5.8 to -13.1. New orders declined from +6.2 to -14.9. Inventories declined from 0.0 to -6.8. Backorders declined from -8.8 to -9.3. Employment fell from -3.7 to -6.7 and the average workweek fell from -1.0 to -11.8. This was an ugly report and corresponds with other regional reports over the last month. I do not see how the fed can raise rates in this environment.

On the calendar for Wednesday is the national ISM Manufacturing and the official estimate is for a decline to 50.6 but odds are increasing that it could be below 50 and in contraction territory. The Fed Beige book will be out in the afternoon and it should show some decreasing activity in some of the Fed regions because of reports like the Texas Survey and the Chicago PMI that I reported above.

The first payroll report is delayed until Thursday and the ADP is expected to show 180,000 jobs but the whisper numbers Tuesday afternoon were 160,000 to 175,000.


In stock news, Medtronic (MDT) reported earnings of $1.27 that rose +9.5% and beat estimates by a penny. Revenues of $7.567 billion rose +6% and beat estimates for $7.482 billion. Foreign currency problems reduced revenue by -$179 million. However, the company guided for the full year to earnings of $4.60-$4.70 and analysts were expecting $4.70. That would imply EPS growth of 12-16% after currency impacts. Shares declined slightly after the news.


Marketing software maker Marketo (MKTO) agreed to be acquired by private equity firm Vista Equity Partners for $1.79 billion or $35.25 per share. That was a 64% premium to the early May share price before rumors began to circulate. The Marketo CEO said this would allow the company to focus on customer success and to remain the independent category leader.


Great Plains Energy (GXP) agreed to buy rival Westar Energy (WR) for $12.2 billion including debt. This is the third major energy deal of the year with Dominion Resources agreeing to buy Questar for $4.4 billion and Exelon acquiring Pepco Holdings for $6.8 billion. Utility companies are seeing demand decline due to higher energy efficiency, increased solar and a weak economy. By consolidating in the sector, they can reduce costs and broaden their base. The Great Plains deal will increase its customer base from 850,000 customers to 1.5 million and its generation capacity from 6,400 megawatts to 13,000 megawatts.


Jaxx Pharmaceuticals (JAZZ) agreed to buy Celator Pharmaceuticals (CPXX) for $30.25 per share or $1.5 billion in cash to gain access to the company's developmental product for treating acute myeloid leukemia. That was a 76% premium to Celator's closing price on Friday. The drug is Vyxeos and is a combination of cytarabine and daunorubicn and it extended patient survival in the latest trials. The acquisition price was more than four times the anticipated annual sales of the drug. Celator cancelled its analyst meeting and shareholder meeting.


Monsanto (MON) shares gained another $3 on news that Bayer may be considering raising their prior $122 per share offer. Monsanto said the proposal was "incomplete and financially inadequate" but they would be willing to talk to Bayer if they were willing to pay a fair price. Analysts believe that would be in the $135 range.


Amazon (AMZN) shares hit a new historic high at $724 on no news in a weak market. Shares have recovered from the post earnings depression and appear to be headed for $800. They earned a whopping $1.25 for last year and that gives them a PE of 577. It would be tough to try and explain that to any Amazon bull. I think buyers believe it is going to $1,000 regardless of earnings performance. Amazon accounted for 42% of all E-Commerce revenue in Q1. The stock briefly eclipsed Facebook as the second largest market cap stock at $341 billion compared to Apple's $547 billion. Shares are up 70% in a year and 20% over the last quarter. Do not short this stock.


Apple (AAPL) shares declined slightly after Nikkei.com reported Apple may be preparing to lengthen its product cycle from 2 years to 3 years. The theory is that Apple could reduce costs of having to retool every other year and overhaul their manufacturing process. By stretching it to 3 years, it would give them more use of the components for each generation of the phones. Since consumers are keeping their phones longer, it would make sense. It would also allow the company time to come up with some new features that would make the new phones more desirable.

There are numerous rumors in circulation that the iPhone 7 will barely even be a refresh much less an entirely new phone. Some rumored new features are now being projected out to the iPhone 8 rather than the 7. If they did switch to a 3 year cycle that would put the delivery of the 8 all the way out into Q4-2019. The term "peak smartphone" is gaining more traction because there are only so many features you can pack into a smartphone case. Most new phones have similar features and Apple is the most expensive. CEO Tim Cook has said that Apple is developing some things that we will not be able to live without and we will wonder how we ever got along without them. Apparently, that is not going to be in the iPhone 7.


Crude prices traded up to $50.10 in the morning on worries over the continued attacks in Nigeria. However, the microphone grab contest has already started and the UAE Oil Minister Mohammed al-Mazroui started the headline fest by saying he was "happy with the oil market" now that oil prices have corrected higher. "We are optimistic. We are seeing the market correct upward." Having OPEC oil ministers "happy" going into the production meeting on Thursday suggests there will not be a big effort to freeze production. We may actually see some additional production to capture the current prices.

Further news out of OPEC included a claim by Iraq that it will supply 5 million barrels of extra crude to its partners in June. Last week the country said production had fallen from 4.7 mbpd to 4.5 mbpd because of infrastructure problems. Apparently, those problems have been corrected and now Iraqi pipelines are brimming with fresh oil. Iraq had been targeting exports of 3.47 mbpd ahead of the OPEC meeting.

Saudi Arabia, Kuwait, Iran and the UAE have already announced production increases for Q3. It would be hard to force through a production freeze given those announcements. The odds of anything positive coming out of the OPEC meeting are nearly zero.

Crude prices declined to $48.75 after the UAE comments. Long futures positions on the NYMEX are at the highs for the year and growing by 0.6% per week. Speculative short positions have been falling by 8% per week.


Markets

The S&P rallied to 2,103 at the open but the hang time was brief and is quickly fell back to 2,088 in late afternoon. The surge at the close back to 2,096 was helped by the rebalancing of the MCSI indexes. MCSI added half of the U.S. listed Chinese stocks back in December and they added the other half at the close today. That caused volumes to spike significantly and prices for some of those stocks also spiked. For instance Alibaba (BABA) has an average volume of 12 million shares and volume spiked today to 78 million. You can follow that volume all across the other Chinese ADRs including BIDU, CTRP, QIHU, etc. However, not all Chinese stocks went up. BIDU crashed at the close for a -$6.47 drop.

Goldman estimated there would be $43 billion of net buying on the Chinese ADR stocks. The amount of buying was expected to consume 14.4 days of net volume on those ADRs. However, quite a few of them were bought on Friday in anticipation of today's index rebalancing. Those traders that bought on Friday expected to sell into a surge this afternoon and apparently, some of them were significantly overbought.


The S&P closed right at the bottom of strong resistance that has held more than once since last August. The index is less than 2% away from a new high at 2,132 but the bloom from last week's rally may be fading. We would expect at least some retracement before the index tries to push higher but the number of bears coming out of the woodwork today suggests moving higher could be a really tough climb.


The Dow opened at just under 17,900 and then declined -175 points to 17,724 before the rebound at the close lifted the index back to -86 at 17,787. At one point, only two Dow components were positive and it was starting to look like a rout but the end of day buying rescued the index from dipping below the 17,700 level. The Dow has failed at about the same level for four consecutive days. The 17,880-17,900 range has turned into resistance that I did not expect until 17,925.

The Dow could be the weaker index for the rest of the week. The negative economic reports are taking some of the expectation out of a Fed rate hike and the potential for a further decline in oil prices is weakening XOM and CVX. Disney was weak after the Alice: Through the Looking Glass movie did poorly over the weekend.



The Nasdaq pulled a little closer to the resistance at 4,968 thanks to a 1.6% rally in the biotech sector. The acquisitions plus the ASCO cancer conference starting this weekend provided support for biotech stocks. In the point gainer list below note that most are biotechs. The $11 gain by Amazon did not hurt either.

The Nasdaq has further resistance at 5,000 and a strong resistance band between 5100-5160. Support is well back at 4,885 and then 4,700.



The biotech index hit resistance at 3,250 and this could be a problem for the rest of the week. The individual stocks have already run up ahead of the ASCO meeting and remains to be seen whether they can continue their run. If the biotechs stall here, the Nasdaq will lose one of its support pillars.


The Russell 2000 has strong resistance at 1,156 and the high today was 1,158 before the index pulled back to close at 1,154. If the index gets through this level the 1,165 resistance could also be strong. Small caps have been helped by the biotech rally and gains in financials and energy. All of those support pillars may be losing traction.


There are a lot of headlines coming out this week. The economic reports, payroll reports, OPEC, etc are all going to potentially roil the market. It would be hard to construct a scenario of events that would be market positive. The S&P futures are slightly positive tonight but that could change before morning. The continued news about the Brexit will only become more urgent over the next three weeks and the FOMC meeting is right in the middle. I would be careful about adding too many positions in either direction ahead of this mixmaster of events. We could easily move triple digits in either direction OR both.

Enter passively, exit aggressively!

Jim Brown

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New Plays

Direction in Doubt

by Jim Brown

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Editor's Note

The Dow fell -175 points from its intraday high and the Nasdaq and Russell were mildly positive. The market closed right at resistance after declining most of the day and the direction in an event heavy week is undecided. We could easily move triple digits in either direction or both at any time. Buying new longs at strong resistance levels in the market could be suicide. We could win but it is not a favorable setup. I am recommending we hold what we have, which is 3 longs and 3 shorts. We were heavily short a week ago as the Dow tested 8-week lows and we were forced to exit those shorts. The market is at a turning point. If it moves up from here, we will be richly rewarded. If it moves down, we are hedged. There is no reason to add plays every day of the week. Lately, every Tuesday has been a turnaround Tuesday of some sort leaving market direction in doubt.


NEW BULLISH Plays

No New Bullish Plays


NEW BEARISH Plays

No New Bearish Plays



In Play Updates and Reviews

Dow Decline

by Jim Brown

Click here to email Jim Brown

Editors Note:

The Dow was not supported by the biotech stocks and closed at a 4-day low while the Nasdaq gained +14 on biotech strength. The Biotech Index gained +1.6% to give the Nasdaq and Russell 2000 a lift.

The rebalancing of the MSCI indexes at the close provided a lot of extra volume and also provided a boost to the Nasdaq as the U.S. listed Chinese stocks like CTRP, BABA, BIDU, etc are all Nasdaq stocks.

Tomorrow is going to be a pivotal day with traders back at work and a lot of economic activity. If we do not decline on Wednesday and if the Dow closes about 17,900 I would expect the next market direction to be higher.

The bearishness from the prior week is fading but there does not have to be a reason for a market decline or a rally. It is simply a matter of more buyers than sellers or vice versa. We rarely know when a big move is coming and there is always something to blame after the event occurs.




Current Portfolio





Current Position Changes


CLVS - Clovis Oncology

The long recommendation was entered at the open at $16.80.


SWIR - Sierra Wireless

The long position remains unopened until a trade at $20.30.


Profit Targets

Check the graphic above for any profit stops in green. We need to always be prepared for a profit exit at resistance.


Stop Loss Updates

Check the graphic above for any new stop losses in bright yellow. We need to always be prepared for an unexpected decline.



BULLISH Play Updates


CLVS - Clovis Oncology -
Company Profile

Comments:

No specific news. Shares were up early with the sector but faded slightly into the close.

Original Trade Description: May 29th.

Clovis Oncology is a biopharmaceutical company that focuses on acquiring, developing and commercializing anti cancer agents worldwide. It is developing three product candidates, which include Rociletinib, an oral epidermal growth factor receptor and mutant-selective covalent inhibitor that is under review with the U.S. and E.U. regulatory authorities for the treatment of non-small cell lung cancer; Rucaparib, an oral inhibitor of poly polymerase, which is in advanced clinical development for the treatment of ovarian cancer; and Lucitanib, an oral inhibitor of the tyrosine kinase that is in Phase II development for the treatment of breast cancers.

Clovis announced it would make three presentations at ASCO and one discusses the potential for using Rucaparib for treatment of a different cancer other than the drugs original intent. That presentation is on pancreatic cancer and the other two are on ovarian cancer.

These are promising drugs and any positive data that Clovis releases could give the stock a significant boost.

In their recent earnings, they reported a loss of $1.98 compared to estimates for -$2.15. Because it is an experimental drug company, the earnings are not that material. Shares did decline about $1.50 after the report but have risen $4.50 in the last two weeks.

Earnings August 4th.

Resistance is $20.30 and shares closed at $16.70 on Friday. I would gladly take a $2 gain out of the middle over the next week and they tighten the stop loss as the multi-day conference begins next Friday.

Position 5/31/16:

Long CLVS shares @ $16.80, initial stop loss $15.35

No options recommendation because of wide spreads.



OMED - OncoMed Pharmaceuticals - Company Profile

Comments:

No specific news. Big spike at the open but faded with the weak market.

Original Trade Description: May 21st.

OncoMed Pharmaceuticals is a clinical-stage company focused on discovering and developing novel anti-cancer stem cell and immuno-oncology therapeutics. OncoMed has seven anti-cancer therapeutic candidates in clinical development, where each target key cancer stem cell signaling pathways including Notch, Wnt and R-spondin LGR. OncoMed is advancing its wholly owned GITRL-Fc candidate and an undisclosed immuno-oncology candidate (IO#2) toward clinical trials in the 2016-2017 timeframe. OncoMed has formed strategic alliances with Celgene Corporation, Bayer Pharma AG and GlaxoSmithKline (GSK).

OncoMed is making six presentations at ASCO related to six oncology drug candidates, including robust preclinical anti-tumor activity data for its wholly owned GITRL-Fc candidate and from clinical trials of vantictumab, ipafricept, demcizumab and tarextumab.

All of that is Greek to me but this is a cancer conference and OncoMed is an up and coming cancer drug company. They should be right at home and the notes I have read suggest several of their drugs are very promising. They have milestone payments coming from GSK, Bayer and Celgene coming in 2016-2017 of more than $270 million.

Shares have risen steadily since the earnings miss on May 5th. As a preclinical company they do not have retail revenues and depend on funding from their partners. They will have operating losses until their drugs are in the marketplace.

Shares spiked on the 28th after AbbVie said they were buying cancer drug company Stemcentrx for $10.2 billion. That company is in the same stem cell research sector as OMED.

Earnings August 4th.

With the ASCO meeting still 10 days away we could benefit from some of the building excitement and hopefully the company's presentations at the meeting will increase the interest in the stock.

Position 5/23/16:

Long OMED shares @ $12.80, see portfolio graphic for stop loss.

No options recommended because of wide spreads.



SWIR - Sierra Wireless - Company Profile

Comments:

No specific news, no gain. Shares are still holding at resistance at $20. Eventually there will be a high volume breakout or break down.

The position remains unopened until a trade at $20.30. High today was $20.25.

Original Trade Description: May 26th.

Sierra Wireless engages in building the Internet of Things with intelligent wireless solutions. They operate in three segments, Original Equipment Manafacturer, Enterprise Solutions, and Cloud Connectivity Services. They offer cellular embedded modules, software and tools to integrate wireless connectivity into various products and solutions.

In their recent earnings they reported an adjusted profit of 8 cents. Revenue declined -5.1% because of previously reported softness in orders from several existing automotive customers. For Q2 they expect earnings in the range of 9-17 cents on revenue of $150-$160 million. For the full year they guided to earnings of 60-90 cents on revenue of $630-$670 million. They bought back 549,583 shares in the quarter.

The revenue in the OEM solutions segment declined -9.1% due to softness in auto production in Q1. Enterprise solutions revenue rose 9% and cloud and connectivity systems revenue rose 92%. They began upgrading their global LTE core network to provide additional connectivity for wholesale operators.

In their guidance, they said business should improve significantly because of more than 40 new customer programs moving into production on new IoT products. They manufacture to customer specifications when the customer adds a new product.

Earnings Aug 4th.

To go from an 8 cent profit in Q1 to 60-90 cents for the full year is a major gain in profitability. Shares have been rising since the earnings report and showing no weakness when the market was down.

With a SWIR trade at $20.30

Buy SWIR shares, currently $19.90, initial stop loss $18.45.
No options recommended due to wide spreads.




BEARISH Play Updates

ENDP - Endo Intl Plc - Company Description

Comments:

No specific news. Every day there are new class action suits. Shares are firm because of the ASCO meeting next weekend.

Resistance is 15.85 to 16.15 and I recommend we stay with it until we see if that resistance will hold. The current stop loss of $16.45.

Original Trade Description: May 11th.

Endo develops, manufactures and distributes pharmaceutical products and devices worldwide. The market well known brands including Percocet, Lidoderm, Voltaren and a wide range of pain medications and testosterone replacement therapies.

Shares have declined from $26 last week to $14 today. The company slashed full year guidance by -11% on revenue and -23% on earnings. The acceleration of the decline over the last several weeks has been in reaction to some generic competitors expected to receive approvals from the FDA soon.

The company also disclosed they were being investigated by the U.S. Attorney's Office for its relationship with pharmacy benefit managers or PBMs. In light of the improper relationship between Valeant and Philidor the USAO is investigating to see if the same problems exist at Endo. In November, Novartis had to pay a $390 million fine to settle charges it paid specialty pharmacies for illegal kickbacks in exchange for inducing patients to refill certain medications.

Endo is also under pressure as a result of the Valeant Pharmaceutical disaster and the overall decline in the biotech sector.

Earnings are August 4th.

Even though shares are down significantly from the May 6th news, I believe they will continue falling and could go into single digits. The similarities to Valeant's pharmacy problems and the impact to Valeant's stock are too close and should weigh on Endo.

Position 5/12/16:

Short ENDP shares @ $13.81, see portfolio graphic for stop loss.

Optional

Long June $12.50 put @ $1.05, see portfolio graphic for stop loss.



FDC - First Data - Company Profile

Comments:

No specific news. Only a minor gain. Resistance is holding but maybe not for long.

After today, I am moving this position to the weekly update section and it will be updated only on the weekend.

While we were stopped out on the short on 5/23 there was no stop loss on the option and that position remains open. At the current 10-cent price that is a lottery ticket that the headlines will fade and the original direction will return.

Original Trade Description: May 16th.

First Data provides electronic ecommerce solutions for merchants, financial institutions and card issuers worldwide. The operate in three segments including global business solutions, global financial solutions and network & security solutions. This includes retail point of sale solutions, mobile ecommerce solutions and webstore solutions.

In their Q1 earnings, they grew revenue 3% and operating income rose from $185 to $220 million. Earnings of 24 cents were slightly above expectations for 21 cents. Revenue of $1.69 billion was below estimates for $1.71 billion. Unfortunately, FDC has $19 billion in debt compared to its $3 billion market cap. Interest expense in the first quarter was $263 million or more than $1 billion a year.

Global business solutions revenue declined in the quarter while financial solutions and security solutions showed only marginal growth.

Earnings July 21st.

While the company tried to put a positive face on the future by projecting revenue growth, it appears investors were not impressed. Shares have fallen from $13.50 to $10.50 over the last three weeks since earnings. FDC does not provide guidance and that is troubling to some investors.

I am anticipating a retest of the post IPO low at $8.50 or even worse, depending on the market.

Position 5/17/16:

Long July $10 put @ $.60, no stop loss.

Previously closed 5/23/16: Short FDC shares @ $10.69, exit $11.55, -.86 loss.



LOCO - El Pollo Loco - Company Profile

Comments:

No specific news. Moving very slowly on no news.

Original Trade Description: May 18th.

El Pollo Loco develops, franchises, licenses and operates quick service restaurants in the USA. The company offers individual and family sized chicken meals, Mexican inspired entrees and sides. They currently have 430 company owned and franchised restaurants. They are planning opening 16-20 additional stores in 2016.

The big spike on the IPO came on name recognition, a successful roadshow and a small number of shares initially offered. They later waived the lockup period and allowed insiders to sell their shares on November 19th, 2014, two months earlier than stated in the IPO documents. Shares crashed from $33 on the news and have never recovered that level.

The reported earnings on May 5th of 17 cents that missed estimates for 18 cents. Revenue of $94.4 million also missed estimates for $96.9 million. They guided for full year earnings of 70-74 cents, which was almost zero growth from the Q1 numbers. That suggests the competition is fierce and they are having trouble gaining market share. Earnings in 2015 were 71 cents.

Net income declined -19.8% in Q1. Same store sales declined -0.6% for company operated restaurants. That is not a good track record to use when selling new franchises.

Next earnings August 4th.

I think the crazy chicken is dying. Their moment in the sun is fading along with their stock price. Shares are rapidly approaching their post IPO low of $9.58 and once you break under that $10 level it is very hard to recover.

Position 5/19/16

Short LOCO shares @ $10.61, see portfolio graphic for stop loss.
No options recommended.





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