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Daily Newsletter, Tuesday, 1/22/2019

Table of Contents

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

Market Wrap

Fake News

by Jim Brown

Click here to email Jim Brown

The administration cancelled a trade meeting and warned tariffs were coming.

Market Statistics

News reports broke claiming the White House had cancelled a trade planning meeting with China this week because of outstanding disagreements over intellectual property rules. The scheduled meeting was to plan topics to be discussed with Vice Premier Liu He at the end of January. Reportedly, the White House told the advance party there was no need to show up if they were not prepared to provide assurances of progress on the intellectual property complaints. The threat of increased tariffs already scheduled for March 1st, was repeated. The market collapsed with the Dow trading down -467 points at the lows.

Just before the close, Larry Kudlow, head of the NEC, denied on CNBC that a meeting had been cancelled. He said the report was "totally inaccurate." He also said there had not been any intermediate meetings scheduled other than the visit by Liu next week. The market immediately rebounded but the clock ran out on the recovery.


Adding to the negative bias this morning was a sharp decline in existing home sales to the lowest level since November 2015. December sales fell -6.4% from November and -10.3% from December 2017. Sales declined to 4.99 million, annualized, and there was weakness in all four regions. On a year over year basis sales were down -6.8% in the Northeast, -11.2% in the Midwest, -5.4% in the South and -1.9% in the West. Months of supply declined from 2.9 to 3.7 months and the lowest in a year. Median prices declined from $257,300 to $253,600.

This decline is for December, so it had nothing to do with the shutdown. The key was more than likely the spike in interest rates in Oct/Nov and that caused many potential home buyers to reconsider their plans. This report is based on closings and contracts would have been signed in Oct/Nov. Now that rates have declined again there has been a spike in the mortgage applications in January. For the week ended January 4th, applications were up 23.5%. For the week ended on the 11th, applications were up 13.5%.



The economic calendar for the next two days will take a backseat to earnings. The Richmond Fed survey and Kansas Fed survey are not normally market movers. The next economic hurdle will be the housing starts and new home sales on Friday. If they come in as bad as the existing home sales, it could drag the market lower.

The FOMC meeting the following week normally sees a positive market the Tuesday before the announcement. I just hope we do not have to wait that long for investors to shake off the China blues.


The big guns on the earnings calendar for Wednesday are Texas Instruments, United Technology, Procter & Gamble, Ford and United Rentals.

As of 10:AM this morning 61 S&P companies had reported earnings for Q4 with 14.1% earnings growth and 5.7% revenue growth.


Earnings were not kind to Stanley Black & Decker (SWK). The company reported earnings of $2.11 that edged out estimates by a penny. Revenue of $3.63 billion barely edged out estimates for $3.62 billion. The problem came in the guidance. The company predicted earnings for fiscal 2019 of $8.45-$8.65 and analysts were expecting $8.79. The company is in the middle of a large $250 million restructuring program that is impacting costs in the short term.

Analysts were quick to moan about the falling housing market and how it was impacting this sector. However, about 90% of home improvement sales come from consumers not selling their homes. Investors were quick to dump Home Depot thinking weakness at SWK meant weakness at Home Depot since they are their biggest customer.

Investors need to focus. Revenue hit the target, restructuring costs are impacting earnings, Home Depot has not reported any sales declines. Unfortunately, SWK shares fell $21 on the news. Buy the dip once it finds a bottom.


Dow component Johnson & Johnson (JNJ) reported earnings of $1.97 that beat estimates for $1.95. Revenue rose 1% to $20.4 billion and beat estimates for $20.2 billion. They guided for 2019 revenue of $80.4-$81.2 billion and earnings of $8.50-$8.65. Unfortunately, analysts were expecting $82.61 billion.

In other news the company settled with 46 states for $120 million on prior sales of metal-on-metal hip implants. The maker of the implants, DePuy said the settlement involved no admission of liability or misconduct. According to the states, J&J made misleading claims about the longevity of those implants and led to patients having to undergo revision surgery before the company's advertised life span of 5 years. In 2010 DePuy recalled 93,000 of its hip implant systems and paid $2.47 billion in expenses.


Travelers (TRV) reported earnings of $2.13 that beat estimates for $2.10. Revenue of $7.7896 billion easily beat estimates for $6.763 billion. Catastrophe losses rose from $499 to $610 million because of the California wildfires. All their business lines showed improvement except for its commercial auto business. Shares declined with the market.


TD Ameritrade (AMTD) reported earnings of $1.11 that beat estimates for $1.00. Revenue of $1.52 billion beat estimates for $1.47 billion. New client assets rose 10% to $32 billion. Average client traded rose 28% to 928,000. Average mobile trades rose more than 50% to 240,000. The CEO said investor sentiment shifted due to the macroeconomic uncertainty that moved the markets. This prompted more trades. Shares rose slightly in afterhours.


Halliburton (HAL) reported earnings of 41 cents that beat estimates for 37 cents. Revenue of $5.94 billion beat estimates for $5.86 billion buy was flat year over year. A decline in fracking services led to an 11% drop in North American revenue to $3.3 billion. The company plans to cut capex spending by 20% to $1.6 billion in 2019. Halliburton's vision of the industry was somewhat more sedate than competitor Schlumberger. SLB was upbeat when they reported last week.


After the bell the first big tech stock reported strong results. IBM reported earnings of $4.87 that beat estimates for $4.82. Revenue of $22.54 billion beat estimates for $21.73 billion. For the full year they reported $13.81 in earnings compared to estimates for $13.79. They guided for fiscal 2019 for earnings of "at lease $13.90" while analysts were predicting $13.79. Cognitive solutions revenue was $5.46 billion that beat estimates for $5.27 billion. This includes the Watson unit. Cloud revenue was $8.9 billion and missed estimates for $9.04 billion. The global business segment saw revenue of $4.3 billion that beat estimates for $4.15 billion. Overall revenue declined slightly due to the sale of some software assets to HCL Technologies for $1.8 billion.

IBM is paying $34 billion to acquire Red Hat and the deal is expected to close in the second half of 2019. This will be a transformational event according to Keybanc. It will revolutionize IBM's cloud offerings. Shares rose $8 in afterhours.


Shares of Capital One (COF) declined 3% in afterhours after reporting earnings of $2.48 that beat estimates for $2.39. Adjusted revenue rose 1% to $7 billion and missed estimates for $7.1 billion. For the full year earnings were $11.82 on revenue of $23.08 billion.


Ebay (EBAY) shares soared 8% at the open after Elliott Management sent a letter to the board laying out a five-step plan that could lift shares to $55-$63 by the end of 2020. Shares are currently at $33. Elliott said Ebay could spin off the "market leading" StubHub business and the Ebay Classified Group that once owned 25% of Craigslist. Now Ebay Classifieds is a collection of ten brands around the world that cater to local shoppers in their own neighborhoods.

Elliott said spinning off those businesses would return value to shareholders and allow management to focus on running the core Ebay business and move beyond its history of "inefficient organizational structure, wasteful spending and misallocation of resources." The WSJ reported that Starboard Value LP also wants Ebay to think about separating those businesses. With two activist shareholders in the mix, something may eventually get done.


Crude prices declined with the market on worries about China's GDP growth, the IMF's global slowdown warning and the potential for the trade deal to die. All of those events project slower growth in oil demand. This should be only temporary because the OPEC+R production cuts are in full swing and January production should be down sharply.



Markets

Today was a headline reaction day. Nothing changed in the market. While there were some less than exciting earnings the majority are coming in as expected. The combination of the IMF economic warning and decline in China's GDP over the weekend, put the market in a defensive posture before the open. The bogus story about the cancelled meeting was just additional grease for the market slide.

With Kudlow claiming the meeting cancellation was fake news, the market rebounded into the close and the S&P futures are up slightly at +8. Anything can happen before the open but as of this evening it would appear Tuesday could be either a one-day wonder OR the opening round of some multiday selling in an overbought market. If we do get additional selling, I do not expect a material move lower this week.


The Dow was handicapped by the four most tariff sensitive stocks taking a serious dive. Boeing, Caterpillar and 3M were hammered. The SWK earnings caused a $2 drop in Home Depot, down more than $4 intraday, and Apple was back in the tariff hotseat even though they have not yet been impacted. Like BA and CAT, they are always mentioned in tariff discussions but are so far untouched.

The Dow stopped exactly on resistance at 24,750 on Friday and today's decline was just a normal bout of headline profit taking. However, if Tuesday's low of 24,244 is broken, an entire army of analysts will surface predicting a retest of the December lows.



Tech stocks were crashing with the index down -178 intraday. Amazon closed 23 points off its lows but still lost $64. The Jeff Bezos divorce is getting more play in the analyst community because nobody knows how his 16% ownership of Amazon will be split with his wife.

Google/Alphabet is weak as the privacy issues seem to pick up steam around the world. Netflix was weak on continued post earnings depression but may have found support at $320.

Tech stocks should get a sentiment boost from the IBM earnings after the bell and with the approaching Intel earnings on Thursday. Intel is expected to do well because pricing for processor chips has remained firm due to a shortage.

The Nasdaq has minor resistance at 7,150 but it is entering a period of congestive resistance all the way to 7,500.



The Russell 2000 was down -31 points at the low and just above short-term support at 1,450. The small caps were due for a sharp decline after the monster rally from the December lows. We need the Russell to rebound back over 1,500 to rejuvenate bullish sentiment.


While the market decline today was triggered by a flurry of headlines, we were due for some profit taking. They say the market does not need a reason to decline but it does take advantage of those reasons when they appear. Today could be a one-day wonder. We will not know that until the weekend. Just as the overbought dip was sudden, a short-term oversold rebound can be just as sudden and neither have any relation to the market trend. These are just reactions. I still believe we should be buying the dips until proven wrong.

Enter passively, exit aggressively!

Jim Brown

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New Option Plays

Unexpected Disaster

by Jim Brown

Click here to email Jim Brown

Editors Note:

After rising trade expectations last week nobody expected a complete reversal. The market drops that hurt the worst are the ones that nobody expects. The negotiations with China seemed to be proceeding towards a favorable conclusion. That assumption was dashed on Tuesday and it could take several days before the market recovers unless there is a positive headline to put the negotiations back on track.

 

New positions are only added on Wednesday and Saturday except in special circumstances.


NEW DIRECTIONAL CALL PLAYS

No New Bullish Plays


NEW DIRECTIONAL PUT PLAYS

No New Bearish Plays



In Play Updates and Reviews

Easy Come, Easy Go

by Jim Brown

Click here to email Jim Brown

Editors Note:

Positive rumors produced a major rally, negative rumors took it back. The market was overbought on news of a potential deal with China. That deal evaporated and the tariff warnings came back, and equities erased much of their gains from late last week. While tariff sensitive stocks were crushed others declined with the market. Salesforce.com, has nothing to do with China but had been up significantly. Shares fell over $4 in the market crash.



Current Portfolio


Stop Loss Updates

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


Profit Targets

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





Current Position Changes


IBB - iShares Biotech ETF
The long call position was entered at the open.

QCOM - Qualcomm
The long call position was stopped at $54.35.


Full updates on all plays on Wednesday and Saturday. Only closed plays are updated on other days.


BULLISH Play Updates

QCOM - Qualcomm - Company Profile

Comments:

The court battle entered its 9th day with Qualcomm finally getting a chance to defend itself. Right out of the box they got Apple to admit that Qualcomm was the only supplier for 4G chips in 2012 and that Qualcomm's 120,000 patents are essential for the smartphone market today. Having leadership technology and selling it to manufacturers is not monopolistic. It is just business. If they do not want to buy it that is their decision.

We were stopped out of the long call position in the market decline. The long put position remains open.

Original Trade Description: Dec 31st

QUALCOMM Incorporated designs, develops, manufactures, and markets digital communication products worldwide. It operates through three segments: Qualcomm CDMA Technologies (QCT); Qualcomm Technology Licensing (QTL); and Qualcomm Strategic Initiatives (QSI). The QCT segment develops and supplies integrated circuits and system software based on code division multiple access (CDMA), orthogonal frequency division multiple access, and other technologies for use in wireless voice and data communications, networking, application processing, multimedia, and global positioning system products. The QTL segment grants licenses or provides rights to use portions of its intellectual property portfolio, which include various patent rights useful in the manufacture and sale of wireless products comprising products implementing CDMA2000, wideband CDMA, CDMA time division duplex, and/or long term evolution standards and their derivatives. The QSI segment invests in early-stage companies in various industries, including automotive, Internet of things, mobile, data center, and healthcare for supporting the design and introduction of new products and services for voice and data communications, and new industry segments. The company also provides products and services for mobile health; products designed for the implementation of small cells; development, and other services and related products to the United States government agencies and their contractors; and software products, and content and push-to-talk enablement services to wireless operators. In addition, it licenses chipset technology, and products and services for use in data centers. QUALCOMM Incorporated was founded in 1985 and is headquartered in San Diego, California. Company description from FinViz.com.

The last 12 months have been turbulent for Qualcomm. First they tried to acquire NXP Semiconductor (NXPI). They received approvals from 7 of the 8 countries that needed to approve the transaction. While they were waiting on China's approval, Broadcom (AVGO) made a hostile offer to acquire Qualcomm for $121 billion. Qualcomm would be forced to drop the bid for NXPI if they accepted the Broadcom bid. Qualcomm fought Broadcom and finally got the government to veto the deal under a national security rationale.

Broadcom quickly made a big show of becoming a U.S. company by changing its domicile to the U.S. That was not enough to convince CFIUS they were not a threat. Eventually Broadcom dropped its bid.

Qualcomm tried to continue its acquisition of NXPI but China refused to approve the acquisition and Qualcomm was forced to abandon the acquisition attempt and pay a $2 billion breakup fee.

While Qualcomm and NXPI would have been stronger together, Qualcomm is not sitting still. They are rapidly moving forward on 5G communications, automotive chips, internet connectivity, Internet of Things, network processing, etc.

The company just announced a $30 billion stock buyback. That is one-third of the company using the funds they had set aside for the NXPI acquisition.

The next challenge for Qualcomm is settling the patent dispute with Apple. The phone company has protested the way Qualcomm collects royalties on its products. Instead of only charging a royalty on the specific parts in the phone, Qualcomm has always charged a royalty on the entire cost of the phone. In the beginning, companies did not balk because without Qualcomm's parts the phone would not have been possible. After paying royalties to Qualcomm for years, Apple decided they were paying too much money to Qualcomm and sued them to change the patent. Since Apple and every other phone manufacturer had been paying Qualcomm under this structure for years, Apple does not have a very good chance of winning. They do have a lot of money and the best lawyers in the world but the law is the law and signed agreements are tough to fight.

This suit is expected to be settled soon. Qualcomm has been successful in getting some models of iPhones blocked from sale and with each court action they are making it more likely there will be a settlement soon. The CEO said he thought it would be in Q4 but it has not happened yet.

With a 4% dividend and buying back 33% of the stock, there is no reason for Qualcomm shares not to rise in the coming months. The stock should also be somewhat immune to market movement over the coming weeks thanks to the monster buyback.

Qualcomm reported earnings of 90 cents that beat estimates for 83 cents. Revenue of $5.80 billion also beat estimates for $5.52 billion. However, the company guided for Q4 revenue of $4.5-$5.3 billion and earnings of $1.05-$1.15. Analysts were expecting $5.57 billion and 95 cents. The decline was due to a lack of Apple sales. Apple normally buys 35-50 million chips in Q4 but they have dropped Qualcomm as a supplier until the royalty fight is concluded in court. Shares lost $7 post earnings.

Cowen recently reiterated a buy rating and $73 target. Canaccord Genuity reiterated a buy and $75 target. Bank of America reiterates a neutral and $67 target.

Earnings Feb 6th.

Apple is trying to push out a software update to force phones to remove patent liabilities in China. Qualcomm is pressing the court to force an immediate halt to sales. Apple said late in the day that the China sales ban would force them to settle the patent suit with Qualcomm. Obviously that is exactly what Qualcomm has been trying to accomplish. Apple said being forced to settle with Qualcomm would force all other manufacturers to pay higher royalties as well. Everyone has been hoping Apple would be victorious and they would benefit from the same lower royalties if Apple won. Apple is trying to claim that Qualcomm's royalty agreements, which they signed and paid royalties on for years, is no longer valid because the price of the phone has risen so high. The agreement calls for a set percentage of the sales price as the royalty amount. When phones sold for $400 it was a smaller amount but now with $1,000-$1,500 phones that same percentage is a lot bigger number.

Apple is also playing politics in their court filings warning that China will lose millions of dollars in taxes and revenue if the ban is enforced. Of course, they could just pay Qualcomm what they owe and there would be no ban.

Qualcomm also won an injunction in Germany to force Apple to halt sales of iPhones.

Starting on January 4th, Qualcomm will participate in a 10-day non-jury trial against the FTC. This trial is the key to the settlement of Apple's suits around the world. Qualcomm will argue for its current patent and licensing model and fee schedules. The outcome of the trial will either boost Qualcomm's $5.2 billion a year royalty stream or crash it to a fraction of that amount. LINK

Nobody disagrees that Qualcomm's engineering and designs are the best in the business. They are simply whining that Qualcomm charges too much to license those technologies.

The outcome of this trial could move the stock $10 or more in either direction. I am proposing we buy a call and a put and hang on for the ride. One of them could been deep in the money and the other will expire worthless.

Update 1/5: Qualcomm acted to enforce the ban on iPhones in Germany and Apple was forced to pull the specific models from stores. Germany's biggest retailer, Gravis, said it still had all Apple products on sale but that is likely to end quickly. Qualcomm posted a bond of 1.34 billion euros in order to put the enforcement into effect. According to the court order, Apple had to stop the sale, offer for sale and importation for sale of all infringing iPhones in Germany. The court also ordered Apple to recall the affected iPhones from third-party resellers in Germany.

The 10-day non-jury trial with the FTC over patent procedures began on Friday.

Position 12/31/18:
Closed 1/22: Long Mar $60 Call @ $2.06, exit .60, -1.46 loss.
Long Feb $52.50 put @ $1.39, see portfolio graphic for stop loss.

We should know from the trial watchers if Qualcomm proved their case by the middle of January. I only recommended the Feb put because any downside move should be nearly immediate while any upside move could be lasting.


BEARISH Play Updates

No Current Puts