Option Investor
Newsletter

Daily Newsletter, Monday, 6/13/2016

Table of Contents

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

Market Wrap

Market Falters Ahead Of FOMC

by Thomas Hughes

Click here to email Thomas Hughes

Introduction

The market fell again today as we await the FOMC meeting, but there is more danger ahead than just the FOMC. This is going to be a full week, to say the least. The FOMC will announce their policy decision on Wednesday, we'll get the newest reads of PPI and CPI, the BOE is scheduled to meet, the BOJ is scheduled to meet, the Swiss National Bank is scheduled to meet, the first report for 2nd quarter earnings is scheduled... and the Brexit vote is next week... more than enough to spark some market volatility.

International markets are not immune. Indices from Japan to China and into Europe fell in today's action. In Asia Japanese and Chinese indices fell more than -3% on concern over the BOJ's possible policy changes, a surging yen and weak Chinese data. The BOJ is expected to move in order to further stimulate the economy, but maybe not at this meeting in order to coordinate efforts with a government fiscal package later this year. Chinese data shows slowing in fixed-asset investment growth. European indices fell roughly -1.80% on the latest polling from Britain which shows an increasing number of Britons favoring a Brexit.

Market Statistics

Futures trading reflected global pessimism, down about -0.4% from the earliest part of the electronic session. Without much in the way of economic data or earnings to alter sentiment futures maintained their early levels all morning and into the open of trading. The indices opened as indicated but quickly attempted to regain losses. By 10AM the SPX was flirting with positive territory and by 10:30AM were in the green, but this did not last long. By 11AM the indices were retreating from the early high and moved steadily lower over the next hour. A mid-day low was hit around noon, and then by 2PM the market was moving lower again and didn't stop until the close of the day.

Economic Calendar

The Economy

There was no official economic data for the US today, but there is quite a bit this week. Tomorrow we'll get Import/Export Prices, Retail Sales and Business Inventory. Wednesday is the FOMC announcement, at 2PM, before that PPI, Empire Manufacturing, Industrial Production and Capacity Utilization are all on tap. Thursday is Initial Claims, CPI, Philly Fed and the Home Builder Sentiment. Friday closes out the week with Housing Starts and Building Permits.

Moody's Survey Of Business Confidence gained 0.8%, rebounding from a multi-year low set last week. The index is now sitting at 27.5, slightly below the previous multi-year low set in late February. According to Mark Zandi the index is showing a downturn in global sentiment begun earlier this year with varying conditions from region to region. The US remains the strongest but has also suffered a downturn in sentiment.


There are 2 S&P 500 companies left to report earnings for the 1st quarter; unless they surprise the rate of earnings decline for the quarter will be very close to -6.7%. Looking forward to the 2nd quarter earnings cycle the first company will report earnings this week. As for the 2nd quarter, projections continue to slide. The expected rate of earnings decline fell over the past week to -4.9%, down a tenth from the last estimate. The energy sector is expected to post the largest decline, about -74.5%, but that projection has been ticking upward over the last two weeks. Materials is expected to post the 2nd biggest decline, about -11.6%, with telecom leading positive gains at +8.1%.


Looking beyond the 2nd quarter growth is expected to return in the 3rd. Projections for 3rd quarter growth are holding steady around 1.4% but still in danger of downward revision to negative territory unfortunately. Growth is expected to expand into the 4th quarter, to 7.6%, with that estimate ticking higher by a tenth in this week's report. Full year 2016 estimates are holding steady near 0.9% while full year 2017 estimates have gained 2 tenths to hit 13.6%.


The Dollar Index

The Dollar Index lost some ground today as markets try to handicap this week's round of central bank meetings. The index fell about -0.25% from the short term moving average to test support at the $94.25 level. Support held and may lift the index higher but this will of course depend heavily on the FOMC and other bank policy decisions. The indicators are mixed, bearish but confirming near term support with declining downside momentum and a very weak bullish crossover on the stochastic, but consistent with a bounce from support. The index may hover at or near current levels, between resistance at the short term moving average and support near $94.25, until the FOMC and/or BOJ statements with a break above being bullish and a break below being bearish. The CME tool is showing only a 2% chance of FOMC rate hike at this meeting.


The Oil Index

Oil prices had another day of volatility. Early trading saw price for WTI fall nearly -2% only to rebound and regain positive territory, climbing by more than 0.6%, only to fall again later in the day. By close of session WTI had lost about -1% for the day. Driving today's volatility was last week's US rig count, the 2nd week of gains, and profit taking offset by high refinery demand, a cut to China output and supply/production disruptions in Iraq, Libya and Nigeria. Today's action centered around the $49 level, with a settlement near $48.60.

The oil producers continued their decline from 6 week's highs on today's drop in oil prices. The Oil Index fell for the 4th day in a row, dropping below the short term moving average, and posted a loss near -1%. The index surge to a 6 week high has already fizzled out, with the price of oil so questionable may not reach that level again. The indicators are consistent with a fall from resistance and may be indicating lower prices ahead through bearish crossovers. The stochastic is rolling over, well below the upper signal line and consistent with resistance, while MACD has retreated to the 0 line. This, along with today's move below the short term moving average, do not bode well for near term prices. If today's move is confirmed, and if oil prices remain below $50 and/or move lower, the index could easily retreat to 1,050.


The Gold Index

Gold prices got a lift today on flight to safety, driven by BOJ concerns and the Brexit, as well as a weaker dollar, also driven by BOJ concerns. The spot price rose nearly 1% intra-day, closing with gains near 0.8%, and are approaching resistance levels near $1290. This move is also aided by declining FOMC interest rate fears which, ahead of the meeting, have sent prices up to the top of their range and leave little room for upside movement... unless the FOMC is more dovish about rate hikes than the market expects. Regardless of what they do this meeting they are still expected to raise rates sometime this year and that could keep prices from moving above $1300. Even without the FOMC, there is also the BOJ to consider. They may cut rates, or indicate a willingness to do so, which could also strengthen the dollar and put a lid on gold prices. And there is also CPI/PPI data to consider.

The gold miners have benefited from gold's move higher and are trading near multi-year highs. Today's action took the miners ETF GDX up to the $26.70 resistance target at the open but the candle is not too promising. The abandoned baby possibility I outlined last week did not play out but nonetheless bearish signals continue to appear. Today's candle is long and black, and qualifies as dark cloud cover appearing at resistance levels. The indicators are mixed but generally consistent with resistance, but not yet reversal. If the ETF continues to move lower downside target is near the short term moving average, about $24.15, with next target near $22.50. A break above the $26.70 level would be very bullish and could indicate a continuation of this years bull market in gold.


In The News, Story Stocks and Earnings

The big story of the day, in terms of business news, is Microsoft's announced purchase of LinkedIn. The move came as a big surprise for shareholders of LinkedIn, but welcome in that it created a near 50% surge in share value. The move is worth $26.2 billion and will merge LinkedIn with Microsoft's cloud service. The deal is questionable, the value of LinkedIn to Microsoft's cloud presence is yet to be ascertained. In light of Microsoft's history of non-accretive purchases I am skeptical. Shares of Microsoft fell nearly -3% on the news.


Apple's annual developers conference began today. The company announced a number of changes to systems including the addition of Siri to desktop operating systems, a change to the watch operating system, Apple TV gets an upgrade with Siri and connectivity to phones, Siri and Maps are being opened up to outside developers and a preview of iOS 10. The news was welcomed, but not thought to be substantive in terms of forward earnings and the company's ability to sell its products. Shares of Apple fell more than -1.25%, helping to confirm resistance at the $100 level and falling below the short term moving average.


I haven't touched on the VIX in a while, today's action is noteworthy. The volatility index gained more than 20% in a move extended last week's break above the short term moving action and closed above the 20 level. The index is moving higher on central bank fear, as well as Brexit and perhaps earnings season fear, and confirmed by both indicators. This move could continue into next week, when the Brexit referendum is held, with first upside target near $25 and next target near $30.


The Indices

The indices tried to rebound this morning from a lower opening but were not able to do it. FOMC and central bank fear, along with the Brexit and earnings outlook are weighing on equity prices. By mid-day they were testing the early lows, and only moved lower from there. Today's leader was the Dow Jones Transportation Average which lost -1.14% in a move that brings the index below the short term moving average. Today's action is accompanied by weakening indicators and a possible bearish signal. Stochastic has already rolled over, following a bearish crossover, with MACD sitting on the zero line and in position to confirm. A move lower could go as low as 7,500, first target for strong support.


The next largest decline was posted by the NASDAQ Composite which was hindered by Microsoft and Apple. The tech heavy index fell -0.94% in a move that broke below the short term moving average. The index appears to be moving toward the bottom of a near term range and confirmed by the indicators. Both stochastic and MACD confirm a downward movement with first target for support near 4,800. A break below this level could move down to to 4,600 with possible support targets near 4,700.


The S&P 500 made the third largest decline in today's session, just over -0.80%. The broad market fell beneath the short term moving average and is approaching potential support at 2,075. The indicators confirm the fall from resistance, today confirmed by a MACD crossover, with a possible target of 2,075. A break below this level could go as low as 2,050 in the near term.


The Dow Jones Industrial Average fell the least, but still nearly 0.75%. The blue chips also fell beneath the short term moving average, a move confirmed by stochastic, with downside target near 17,600. MACD reached the zero line today, a crossover to the downside helps confirm downside target and may draw in additional sellers. A break below 17,600 could go as low as 17,250, near the long term up trend line.


I've been very cautious over the past month or so, maybe a little longer, and still see Q2 negative earnings growth as a major hurdle for the market. The reasons for today's sell-off include the FOMC, and the Brexit, as well as earnings and could be the onset of a larger of correction. If so, I'm not of the mind it will be a very deep one, maybe 3-5%, which would bring the indices down to or slightly below the targets I listed today. Even if the FOMC, and the other central banks set to meet this week, do not scare the market there will still be the Brexit to worry about, and the earnings, so I won't be expecting them to cause to much of a bounce. Needless to say this week is likely to be very volatile, and I haven't even mentioned yet the fact that this Friday is OPEX.

What I really want to see before I get bullish again is Q2 earnings better than expected, maybe move into positive growth, with rising expectations for Q3, Q4 and maybe even next year.

Until then, remember the trend!

Thomas Hughes


New Plays

Roto-Router

by Jim Brown

Click here to email Jim Brown
Editor's Note

Cardiovascular Systems is the Roto-Router for your arteries. I had a hard time writing this recommendation because I have blockages from being inactive and sitting in front of a PC for the last 20 years.


NEW BULLISH Plays

CSII - Cardiovascular Systems - Company Profile

Cardiovascular Systems, a medical technology company, develops, manufactures, and markets devices to treat vascular diseases in the United States. It offers peripheral arterial disease products, including Stealth 360° Peripheral Orbital Atherectomy System (OAS), Diamondback 360 Peripheral OAS, Diamondback 360 60cm Peripheral OAS access device, and the 4 Diamondback 360 French 1.25 Peripheral OAS access device products for treating a range of plaque types, such as calcified plaque, in leg arteries both above and below the knee and address many of the limitations associated with existing surgical, catheter, and pharmacological treatment alternatives, as well as Diamondback 360 Coronary OAS, a catheter-based platform to facilitate stent delivery in patients with coronary artery disease.

In the last quarter revenues rose 7%, gross margin rose from 77.8% to 80.4% and operating expenses decline -5%. They expect to reduce expenses by another 7% in the current quarter. Coronary revenues rose +31%.

With more than 18 million Americans suffering from Peripheral Artery Disease (PAD), which is the accumulation of plaque in the peripheral arteries, their market is booming. Coronary Artery Disease is a leading cause of death in the USA. With more than 40% of the population already diagnosed and probably another 20% undiagnosed the market for their products is also growing rapidly. With the baby boomers retiring and these health problems becoming more life threatening as they age the number of "interventions" as my cardiologist calls them is growing rapidly. Stenting any patient with any symptoms of heart disease is becoming more common than tonsillectomies for children. More than 600,000 Americans die from heart disease annually. That is equivalent to 6 jumbo jet crashes every day.

In Q1, Broadfin Capital added a 1.46 million share stake in CSII or 4.47%. Point72 Asset Management added 102,000 shares. Shares have broken out of resistance at $16 and continue to creep higher.

Earnings are August 3rd.

There was only a minor decline today in a very weak market.

Buy CSII shares, currently $18.24, initial stop loss $16.45.

No option recommended because of wide spreads.



NEW BEARISH Plays

No New Bearish Plays



In Play Updates and Reviews

Outlook Fading

by Jim Brown

Click here to email Jim Brown

Editors Note:

The big drop in Asia and Europe led to a drop in the USA and futures are very negative for Tuesday. The Nikkei fell -3.5% and the Shanghai Composite fell -3.2%. Europe was down -1.8% on average. The Dow and S&P both closed under critical support and the S&P futures are down -5 in the afterhours session. The outlook for Tuesday is not good.

Historically, the market has an upward bias in the 36 hours before a Fed announcement. The bias will have to reverse for it to be positive tomorrow. The weak economics in China and Japan and the impending Brexit vote in the UK and the Fed meeting in the U.S. has put an ominous cloud over the U.S. markets.

The Dow closed under support at 17,750 and the S&P closed under support at 2,085. The three-week rally may be on its way towards being erased.





Current Portfolio





Current Position Changes


GOGO - Gogo Inc

The Short position was entered at the open with a trade at $8.99


HTZ - Hertz Global

The long recommendation has been cancelled.


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


HPE - Hewlett Packard Enterprise -
Company Profile

Comments:

No specific news. Down on profit taking in a weak market.

Original Trade Description: June 2nd.

Hewlett Packard Enterprise was spun off from Hewlett Packard (HPQ) to be the high growth segment of the company. The remaining HPQ was the slower growing PC and printer company.

HPE reported adjusted Q1 earnings of 42 cents and in line with estimates. Revenue of $12.711 billion would have been up +4% on a constant currency basis. Analysts were expecting $12.419 billion.

For the current quarter, HPE guided to earnings of $1.10 to $1.14. For the full year, they expect $1.85-$1.95 and that was more than analysts expected at $1.89. They increased free cash flow +101% to $1.1 billion for the quarter.

The good news came from their plans for the cash flow. HPE expects to generate $2.0-$2.2 billion in free cash flow in 2016. They are receiving $2 billion from the Tsinghua transaction which closed in early May and the money will be used for share repurchases. In 2016, HPE is increasing its commitment to return 100% of the free cash flow to investors in dividends and buybacks.

This means over the next couple of months we should see significant share activity as funds position themselves to be the beneficiaries of all this buyback/dividend activity that could exceed $4 billion in 2016. $2.5 billion of that is in an "accelerated" buyback program. The board authorized another $3 billion in buybacks to bring the current authorization to $4.8 billion.

They also announced a tax-free spinoff of their services division to Computer Sciences Corporation (CSC), which is expected to close in March 2017. This will produce another $8.5 billion in value to HPE shareholders in the form of $4.5 billion in equity in the combined company and $1.5 billion in a cash dividend and the removal of $2.5 billion in debt from HPE.

Earnings Aug 23rd.

HPE shares have shaken off their May weakness and closed today at a historic high. I am recommending we buy this stock in anticipation of additional fund investors moving in ahead of future dividends, buybacks and the spinoff.

Position 6/3/16:

Long HPE shares @ $18.40, see portfolio graphic for stop loss.

Optional:

Long August $20 call @ 40 cents. No stop loss.



HTZ - Hertz Global Holdings - Company Profile

Comments:

No specific news. With only five days left before the spinoff and the stock moving lower instead of higher, I am cancelling this recommendation. The concept was to ride HTZ higher into the spin and then decide if we wanted to hold over and end up with the new shares as well. Apparently everyone else is bailing before the spin as well.

Original Trade Description: June 8th.

Hertz engages in the rental and lease of cars and trucks worldwide. It operates through four segments: U.S. Car Rental, International Car Rental, Worldwide Equipment Rental, and All Other Operations. The company rents various makes and models of cars, crossovers, and light trucks under the Hertz, Dollar, Thrifty, and Firefly car rental brands on hourly, daily, weekend, weekly, monthly, or multi-month basis through a network of company-owned rental airport and off-airport locations, as well as franchise locations. They operate 9,980 corporate and franchise locations. They also rent industrial equipment like earthmovers, air compressors, power generators, etc.

Last week Hertz shareholders formally agreed to the proposed split of hertz into two companies. Hertz Global will remain a car rental company. Herc Holdings will be the equipment rental company and trade under the symbol HRI.

The HRI stock will be spun off on June 30th to shareholders on June 22nd as a dividend distribution and therefore taxed at a lower rate when sold.

Shareholders will receive one HRI share for every five HTZ shares they own. Further complicating the process the HRI shares will have a reverse split of 15:1 on July 1st. The HRI portion of Hertz is significantly smaller and the reverse split is to boost the initial share price.

Activist investor Carl Icahn filed a notice with the SEC last week that he had increased his stake in Hertz to 15.24%. The Herc Holdings company will add three Icahn affiliate directors when the spinoff occurs.

With Icahn remaining on board the company should continue to be shareholder friendly. Icahn was instrumental in forcing the company split.

Also, the Hertz CEO was instrumental in producing a boost in the stock earlier in the week when he said the tide had turned for pricing in the rental car market. The fleet sizes had been reduced, everyone was running very tight and rental prices were rising. That fueled the sector on hopes of better earnings.

I am recommending we add the stock now and then decide on June 21st if we want to hold over the spinoff. Shares are right at resistance from March at $11.50. I would like to see them move over that level before we jump in.

Recommendation cancelled.


UIS - Unisys Corp - Company Profile

Comments:

Unisys announced it was expanding a global alliance with Microsoft on cloud management and security services. They are going to cooperate to increase cyber security in the cloud. Shares were only down a nickel in a very weak market.

Original Trade Description: June 6th.

Unisys Corporation provides information technology services worldwide. It operates through two segments, Services and Technology. The Services segment provides cloud and infrastructure services, application services, and business process outsourcing services. The Technology segment designs and develops software, servers, and related products. It offers a range of data center, infrastructure management, and cloud computing offerings for clients to virtualize and automate data-center environments. This segments product offerings include enterprise-class servers, such as the ClearPath Forward family of fabric servers; the Unisys Stealth family of security software; and operating system software and middleware. The company serves commercial, financial services, public sector, and the U.S. federal government through direct sales force, distributors, resellers, and alliance partners.

Unisys has morphed in its 143 years of operation into a global cloud, IT and infrastructure services company. That is a long way from the original company that produced the first commercially viable typewriters and adding machines under the name Burroughs, Sperry and Remington Rand.

Today one of their main products is Unisys Stealth for protection of digital and physical assets. Stealth Mobile protects secur emobile applications and Stealth Cloud expands that protection to the cloud.

Just before their recent earnings they announced a deal with Mitel to provide the Unisys stealth technology to protect their 60 million mobile and enterprise customers. Business is booming but it has been a long time coming. In Q1 revenue declined -3% and services declined -2%. However, the company said its "lumpy" quarter-to-quarter strategy was changing with a stronger focus on the Stealth products and their rapid wide scale adoption. They expect the amount of money spent on cybersecurity to more than double from the $75 billion in 2015 to more than $170 billion in 2020. The cost of data breaches will rise to $2.1 trillion annually by 2019 and more than four times the cost in 2015.

Unisys has been a stealth company for the last year with shares declining from $30 to $7. With their new products and the rapid acceptance of those products their stock is rebounding off the three month consolidation pattern.

Earnings July 28th.

Shares moved over resistance at $8.25 last week and are preparing to move higher. The big decline in March was a $190 million offering of convertible senior notes due 2021 with a conversion price of $9.76. That was a 20% premium to the stock price post announcement.

If the current rebound continues the next material resistance is $12.

Position 6/7/16:

Long UIS shares @ $8.47, no initial stop loss.

Optional:

Long October $9 call @ 80 cents. No stop loss.




BEARISH Play Updates

GOGO - Gogo Inc - Company Profile

Comments:

No specific news. New historic low at the close.

Original Trade Description: June 11th.

Gogo provided communication services to the commercial and business aviation markets in the U.S. and internationally. They provide in-flight connectivity and wireless digital entertainment solutions to commercial airline passengers to and from North America.

Gogo has had a rough few months as airlines complained about the service and some removed the Gogo service and replaced it with a competitor.

On May 23rd Gogo announced the pricing of $525 million in senior secured notes. On May 26th the stock spiked 20% after the company filed a notice with the SEC saying an unspecified airline had requested a proposal for service to cover its large domestic fleet. Under the proposal Gogo would provide Wi-Fi to a "meaningful" portion of the domestic fleet that is is currently serving. Gogo cancels the $525 million debt sale.

On June 3rd shares plunge as the unspecified airline turns out to be American Airlines and the proposal is far less than expected. American picked ViaSat (VSAT) to provide internet access on 100 new Boeing jets. Gogo updates its SEC filing to say it would provide service on 140 American planes and continue service on 400 others. However, American retained the option to remove Gogo equipment on any American planes at any time. Gogo said it now expects American to remove its equipment on the "mainline" planes over the next several years. American said it was planning on upgrading the service on its planes but had not picked a successor. That means the 100 ViaSat planes will be a live test and will likely replace Gogo. ViaSat provides 12 mbps of bandwidth to each seat while Gogo provides 70 mbps for the entire plane and that bandwidth has to be shared by all passengers. There is a significant difference.

On June 9th Gogo reinstates the $525 million debt offering and priced it at 12.5% after Moody's rated it a B3-PD (Probability of Default) credit.

Earnings Aug 4th.

The future is not bright for Gogo. They are trying to produce a faster service through satellite connections rather than ground based systems but the testing and roll out is not going smoothly. Several years of hostility between passengers and carrier over the slow bandwidth has poisoned the relationships and ViaSat appears poised to take over the market.

Shares closed at a historic low on Friday at $8.97 and the downward trend is likely to continue.

Position 6/13/16:

Short GOGO shares @ $8.99, initial stop loss $10.05.

I am not recommending an option but the August $8 put is $75 cents.



LE - Land's End - Company Profile

Comments:

No specific news. Shares were flat and closed at Friday's new low.

Original Trade Description: June 9th.

Land's End operates as a multi-channel retailer. The company operates through two segments, Direct and Retail. It offers casual clothing, accessories, footwear, and home products. The company sells its products through its e-commerce Websites, direct mail catalogs, dedicated LandsÂ’ End Shops at Sears, stand-alone LandsÂ’ End Inlet stores, and international shop-in-shops. As of January 29, 2016, it operated 227 LandsÂ’ End Shops at Sears; and 14 LandsÂ’ End Inlet stores in the United States, as well as 5 United Kingdom based shop-in-shops.

Land's End operated in the world of Amazon and they are getting crushed. They use the term multi-channel because they retail a lot online. Unfortunately, in an Amazon dominated environment they are finding it hard to sell sheets, blankets, towels, shoes and apparel and still make a profit.

In their recent report they lost 18 cents compared to analyst estimates for 2 cents. Revenue of $273.4 million that was below the $299.4 million in the comparison quarter. Retail segment revenue declined -10.4% with same store sales falling -7.1%. Even worse, inventory rose 8.9% to $309.9 million up from $284.6 million. Cash balanced declined -$50 million. Stale inventory is rising, they are burning cash and sales are falling. That is not a recipe for earnings growth.

The retailer was forced to remove Gloria Steinem from their online website and from their catalog after the feminist made some comments on abortion rights. Customers, including numerous religions groups, promised a large scale boycott if Steinem was not removed from all advertising.

The summer months are not likely to be kind to Land's End. They will be forced to further discount products to move them out of inventory in a period where customers are vacationing rather than shopping.

Earnings Sept 1st.

When the market finally rolls over, we could see selling in LE accelerate due to a lack of interest in holding for a Q4 rebound. The historic closing low is $15.81.

Position 6/10.16:

Short LE shares @ $15.80, initial stop loss $17.25.





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