Option Investor

Daily Newsletter, Tuesday, 10/27/2009

Table of Contents

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

Market Wrap

Economics Fading Along With Earnings

by Jim Brown

Click here to email Jim Brown

Consumer confidence hits a three-month low as earnings reports fail to impress traders.

Market Stats Table

The first piece of negative news this morning was the three-month low in the Consumer Confidence for October. The headline number came in at 47.7 and a sharp drop from the 53.1 reading in September. This was only three tenths of a point above a new six month low. This is not a good sign for the economy heading into the holiday season.

This suggests consumers remain deeply pessimistic about the economy. Also, the possibility of a new health care reform package came back to life over the last couple weeks during the confidence survey period. The return of the hostile discussions in the press more than likely had a detrimental impact to consumer confidence.

The job market is also weighing on consumers with the percentage viewing jobs as hard to get reaching a new cyclical high and those who view jobs as plentiful falling to the lowest level since 1983 at 3.4%. The number of people planning on buying an appliance, car or home fell again for the second consecutive month to the lowest level since 1995. Also an overwhelming majority of consumers expect the stock market to decline over the next 12 months.

It appears that consumers are not convinced the recession has ended and are still hiding in their caves. The savings rate rose again in September indicating consumers are hoarding money rather than consuming. Fear of job losses causes consumers to save and there is also the reduction in outstanding credit. With open credit lines shrinking it forces consumers to spend less and save more.

The present conditions component fell from 23.0 to 20.7 but the real damage was in the expectations component. Expectations fell from 73.7 to 65.7 for a whopping -8 points! It is hard to make a case that the economy is in rebound mode if consumers are moving deeper into the cave.

Retailers took a significant hit on the confidence news. Starbucks (SBUX) gave back -5% on the idea that coffee sales would slow.

Consumer Confidence Chart

Another negative economic indicator was a sharp drop in the Richmond Fed Manufacturing Survey for October. After three months at two-year high of 14 the survey took a sharp plunge to 7 for October. While any number over zero is an expansion of economic activity the sharp drop means the expansion slowed dramatically in October. Obviously we are much better off than the -55 in December but the failure to grow over the last three months is troubling. Shipments fell to only 11 from 22 in September. New orders fell to 6 from 7 but backorders fell sharply for the second straight month to -11 and contraction territory. That is the lowest reading since April. Hiring continued to decline in October with a drop from +3 to +2. Companies are hiring but only at a very low rate.

The availability of credit to manufacturers and purchasers remains limited and that is restricting the pace of the recovery. If you can't borrow money to buy inventory it cuts the orders to manufacturers. If manufacturers can't borrow money for parts and equipment it restricts their ability to expand their business. It is a vicious cycle with the consumer the motivating force. If consumers were dumping money on retailers and cleaning inventory off shelves the supply chain would find a way to produce more. Without the consumer component the entire supply chain is stagnant.

Richmond Fed Chart

There was also a new Case Shiller home price update today that showed prices rose +1% for the period ending in August. On a year ago basis home prices were 11.4% below August 2008 prices. This is an improvement but it is a lagging report and has no real impact on the markets.

Reports on Wednesday include Durable Goods and New Home Sales. Durable goods will be the most important and is expected to show a +1% increase for September compared to the -2.4% decline in August. New home sales are expected to be basically flat at 440,000 units.

The big report is the Q3-GDP due out on Thursday. Expectations are still for a gain of 3.2% but analysts are starting to hedge their numbers. Quite a few are now expecting a potential negative surprise given the recent decline in monthly economic numbers. This could be an ugly report for the market even with expectations already declining. This suggests a positive surprise could be bullish except that an unexpected move higher would bring up worries that the Fed might become over reactive and start withdrawing stimulus. The GDP needs to be over 2.8% and less than around 3.3% in order to be in the expectations window and not create a negative market event.

The earnings story is still impacting the market and nowhere was it more visible than the drop in Baidu (BIDU). The company traded at $437.50 on Monday but fell to $374 intraday on Tuesday. The $63 dollar drop was nearly 15% and came on a +42% increase in earnings that beat street estimates. The problem came from a "temporary negative impact" on Q4 revenue as it transitions to a new online advertising system. Baidu said the transition to the new system would provide better revenue and more advertising opportunities but the change could create a temporary revenue dip as customers moved from one system to another. That potential for a temporary dip in Q4 revenue created a temporary dip in the stock price to close at just over $380 and right on support. Note to Baidu, announce a 4:1 split next week and your temporary dip will be history. Splitting the stock back to $100 would allow more investors an opportunity to join in the 2010 rebound and the announcement would probably be good for a 10% bounce in the stock price. BIDU is up from a low of $105 in January.

BIDU Chart

TD Ameritrade (AMTD) reported profits of 26-cents that fell -9% despite handling 35% more trades per day and a 38% boost in revenue. Analysts were expecting 22-cents. The company said lower interest rates and rising expenses depressed earnings. The lower interest rates caused a 29% decrease in profit for that line item. AMTD said for every quarter point increase in interest rates they will earn an extra 7-cents per share. The higher expenses came from the acquisition of Think or Swim earlier this year. AMTD reported an average of 410,576 trades per day in Q3.

E-Trade (ETFC) posted a loss of 66-cents per share including items and a $773 million charge. Ex-items ETFC lost -5 cents compared analysts estimate for a 6-cent loss. ETFC is suffering under a load of bad mortgages it bought when money was flowing in higher volume. Average trades were 196,413 and a 7% increase. E-Trade said it has 4.5 million customer accounts and 2.7 million brokerage accounts with customer assets of $148.7 billion. The sharp spike in AMTD volume compared to ETFC trade volume was due to the acquisition of Think or Swim's options business. Still ETFC has a long way to go to regain its lost stature. ETFC shares were unchanged at $1.57 in after hours.

Visa posted earnings after items of 74-cents compared to estimates of 72-cents. Earnings rose +23% while revenue rose +10% to $1.9 billion. Transactions increased to 10.3 billion but there were some challenges. Visa debit card transactions rose +5% but credit card transaction volume fell -10%. So far in October credit card volume was down -4% and debit card volume +11%. The drop in credit card volume illustrates the problems in shrinking credit lines and less consumer spending. The increase in debit card volume means consumers are spending cash and not risking higher credit balances on what little credit they have left. Visa estimated their profits would rise +20% in the coming year. Visa stock rose about $2 in after hours.

Intel CEP Paul Otellini said at a press conference in India that he expects businesses to increase spending significantly on computer equipment in 2010. CFO Stay Smith said last week that the PC market was recovering nicely but overall enterprise spending remained weak. That makes Otellini's comments today even more significant. It is clear that Intel is seeing demand increase and that is good for the entire tech sector. Intel closed the session flat.

IBM gave the Dow a boost this morning when they announced they were adding $5 billion to their stock buyback program. This brings the total allocated for stock purchases to $9.2 billion. IBM plans to ask the board for permission to buy back even more stock at the April 2010 board meeting. IBM said it had spent $73 billion on dividends and buybacks since 2003. That is nearly half their current market cap of $158 billion. IBM stock rallied to more than $122 on the announcement and brought the Dow back to positive territory but IBM declined to close at $120.66 and a gain of only 54-cents for the day. It was still a positive influence on the Dow along with XOM +1.68, CVX +1.14 and AXP +1.07.

I have an interesting side note on American Express. On Friday my wife used a different bank credit card to make an online purchase. Within 12 hours there were nine fraudulent charges on that card. I disputed the charges, cancelled the card and had the bank send me another one. On Monday I tried to use my America Express card and it was declined. I immediately called American Express and they said there was a fraud hold on my account because the other unrelated MasterCard number had been reported stolen. Once I convinced them I was still in possession of the AXP card they removed the hold. The moral to the story is that you can never assume any financial company does not know exactly what your financial position is on any given day. The more obvious warning is to NEVER assume any Internet merchant is 100% honest. The merchant may be honest but there are dishonest employees in every organization. Deal ONLY with reputable online merchants.

This is the week for energy earnings and that is about the only sector that has sown any resilience to the current market weakness. BP reported better than expected numbers on Tuesday with profits of $4.98 billion compared to estimates of $3.2 billion. BP suffered with declining oil prices but still managed to come out on top. Other companies reporting this week include COP, CVX, RD and XOM.

Valero (VLO) missed street estimates after profits were squeezed by rising oil prices and low gasoline demand. Valero posted a loss of 39-cents on a 46% drop in revenue. Analysts were expecting a 33-cent loss. Valero expects a similar loss in Q4. Valero said production in Q4 could run as low as 73% of capacity compared to 79.5% in Q3. Valero said the slowdown was due to lack of demand, which forced the temporary closure of some refineries due to low profit margins. The 235,000 Aruba refinery was one refinery shutdown due to poor margins. However, the MasterCard spending pulse report today showed nearly a 5% increase in gasoline demand for the second week in a row. That is a positive sign on many levels not just for refinery demand. Crude prices declined to $78 fro last week's high of $82 after the dollar index shot up to a two week high of 76.32 after hitting a low of 74.94 only a couple days earlier. The strength of the rebound was due primarily to short covering but it was still a rebound. Crude appears to have found support at $78 but there is no fundamental reason for it at this level. Even though I believe oil prices will be much higher in the long-term I am cautious at this level and expect to see something around $70 again before global demand accelerates over the next couple years.

Crude Oil Chart

Is it real or is it Memorex? If you are older than 40 you probably remember the TV commercials where some singer was breaking glass with her voice and the tag line asked you if it the voice was live or recorded on Memorex tape. That is the way I feel about the market decline over the last week. Is this a real decline or just another bear trap to lure the shorts back into the market so they can be crushed again?

It is worse for me since I was expecting a decline. Now that we have one that has come to rest on initial support the real question is what next? Is this the start of a real correction or is it a fake. If it is a head fake then we should see a rebound from these levels. The S&P bottomed today at 1060 and exactly where you would expect it to find support. If this level breaks then we should watch 1040 and 1020. If we do break 1060 I would bet on a test of 1020.

S&P-500 Chart

However, while the current decline is not convincing in terms of movement but it is definitely raising the bar on the volume indicator. Both Monday and Tuesday traded nearly 10 billion shares. Declining volume was 5:1 on Monday and 3:1 on Tuesday. New 52-week highs at 104 were the lowest since September 2nd. The market internals are definitely weakening despite the minor declines in the indexes.

The Dow was shanghaied by the early morning rally in IBM and then held up by the gains in energy stocks and AXP. This kept the Dow in positive territory while the Nasdaq was fighting to get out from under the 60-point loss in BIDU. That makes both of those indexes less than reliable in determining market health or direction. The Dow did come to rest on initial support so that is a positive sign.

Dow Chart

Dow Table

That leaves the Russell-2000 as the real key to the puzzle. The Russell declined -1.1% and closed at a new three week low and at the low of the day at 587. The next support on the Russell is 580 and a level I believe we will test. That suggests there could be another dip left to play out even if this is just a bear trap. The next real support is around 550. However, the Russell is looking very much like a double top at 622 but we really won't know that until the 580 level breaks.

You have heard me say it a hundred times. Weakness in the Russell means fund managers are making changes and bailing on the illiquid small caps. This could continue through month end and that is Friday. It is also year-end for most funds.

Russell Chart

The Nasdaq should find support at 2100 and again at 2050. Despite today's big decline and the higher volatility over the last couple of weeks the tech stocks really have not sold off that badly. They simply failed to break out over resistance. Today's close was right on uptrend support. If techs really do begin to take profits then today's decline will be the first of many.

Nasdaq Chart

I am not convinced the decline is serious despite my bearish bias. It looks very similar to 2-3 day declines we have had since March where the bulls came rushing back in just as it looked like a real correction might appear. I am withholding my vote on a real correction or a simulated copy until we see what happens the rest of the week. Don't forget the GDP on Thursday. That could be a real market mover.

Jim Brown

New Plays

Semiconductors and REITs

by James Brown

Click here to email James Brown


Netlogic Micro. - NETL - close: 39.53 change: -1.42 stop: 42.65

Why We Like It:
NetLogic Microsystems is a semiconductor stock. Shares of NETL have tripled from their December 2008 lows. Now the stock is beginning to correct. Shares have been consolidating sideways for almost two months. This past week has seen a breakdown under multiple levels of support. Today's decline broke the $40 mark and its 100-dma.

I am suggesting bearish positions now. This is going to be a very short-term play. NETL reports earnings on November 3rd. We'll plan to exit ahead of the report. Our first target is $35.25.

Annotated chart:

Entry on   October 27 at $39.53 
Change since picked:     + 0.00   			
Earnings Date          11/03/09 (confirmed)    <-- amc -->
Average Daily Volume:       392 thousand
Listed on   October 27, 2009    

SL Green Realty - SLG - close: 39.59 change: -2.22 stop: 43.65

Why We Like It:
SLG is a REIT stock. Shares are topping out and now they're breaking support on rising volume. Today's drop broke support at $40.00 and its 50-dma. I'm suggesting bearish positions now. Our first target is $35.25. Our second target is $33.00.

This stock can be somewhat volatile. I'm suggesting small position sizes.

Annotated chart:

Entry on   October 27 at $39.59 
Change since picked:     + 0.00   			
Earnings Date          10/26/09 (confirmed)    
Average Daily Volume:       2.1 million 
Listed on   October 27, 2009    

In Play Updates and Reviews

CAR Accelerates Lower, Hits Target

by James Brown

Click here to email James Brown

BULLISH Play Updates

HMS Holdings - HMSY - close: 41.00 change: -0.24 stop: 40.40 *new*

HMSY is still holding on to most of its gains. The stock has been trading sideways the last few days. We are down to our last two days. The plan is to exit on Thursday at the closing bell to avoid holding over earnings on Friday morning. I am raising our stop loss to $40.40. Our upside target is $44.90.

Entry on   October 17 at $41.55 /gap open higher 
                           /originally listed at $41.30
Change since picked:     - 0.55   			
Earnings Date          10/30/09 (confirmed)    
Average Daily Volume:       227 thousand
Listed on   October 17, 2009    

Jacobs Engineering - JEC - close: 45.89 change: -0.10 stop: 44.75

Profit taking in JEC has been mild. The lack of any real follow through after yesterday's bearish reversal is also positive. However, if the S&P 500 does break support and accelerates lower we can expect JEC to reverse and follow it lower.

More cautious traders may want to exit early right now. I am not suggesting new bullish positions. Our first target is $49.50. Our second target is $53.00 but we'll plan to exit ahead of the mid November earnings report.

Entry on   October 15 at $45.88 
Change since picked:     + 0.01   			
Earnings Date          11/17/09 (unconfirmed)    
Average Daily Volume:       1.2 million 
Listed on   October 15, 2009    

Petrobras - PBR - close: 48.25 change: -0.81 stop: 45.95

PBR is contracting as we expected. Look for support in the $47-46 zone. I'm not suggesting new positions at this time.

Our first target is $52.50. Our second target is $59.00. The P&F chart is bullish with a $63 target.

Entry on   October 08 at $46.80
Change since picked:     + 1.45  			
Earnings Date          11/13/09 (unconfirmed)    
Average Daily Volume:      12.8 million 
Listed on   October 07, 2009    

Pride Intl. Inc. - PDE - close: 31.96 change: -0.03 stop: 31.49 *new*

Profit taking in PDE was very mild today. Unfortunately we're out of time. PDE reports earnings on October 29th. That means we'll need to exit tomorrow (Wednesday) at the closing bell. I am inching up our stop loss to $31.49.

Entry on   October 08 at $31.15
Change since picked:     + 0.81
                         /sell half @ 32.95 (+5.7%)
Earnings Date          10/29/09 (confirmed)    
Average Daily Volume:       3.7 million 
Listed on September 12, 2009    

UltraShort Russell - TWM - close: 29.67 change: +0.66 stop: 26.30

The TWM continues to climb and volume is rising. The TWM has reached its 50-dam. Our first target is $31.90. Our second target is $34.50.

This is the ultra-short (double short) ETF on the Russell 2000 index that seeks to deliver twice the inverse of the daily performance of the Russell 2000.

Entry on   October 24 at $28.41 
Change since picked:     + 1.26   			
Earnings Date          00/00/00 
Average Daily Volume:       4.2 million 
Listed on   October 24, 2009    

VisionChina Media - VISN - close: 8.99 change: -0.65 stop: 8.65

VISN was overbought and due for a pull back. Shares lost 6.7% and paused at the $9.00 level. This was short-term resistance on the way up and could be short-term support. We are not suggesting new positions at this time.

Over the weekend we adjusted the plan to sell half (shares were at $10.40 Monday morning). Our second and final target is $12.45. This is a very aggressive trade and we wanted to keep our positions small.

Entry on   October 07 at $ 8.53 
Change since picked:     + 0.46
                          /take profits 10/24/09 (+20.3%)
Earnings Date          10/29/09 (unconfirmed)    
Average Daily Volume:       407 thousand
Listed on   October 07, 2009    

BEARISH Play Updates

Navistar Intl. - NAV - close: 34.78 change: -0.54 stop: 40.25

NAV lost 1.5% and closed under round-number support at $35.00. Our first target is $30.50. Our second target is $27.75.

FYI: We initiated this play with half a position. If NAV bounces to $37.50 we'll double down and make it a full-sized position (position size depends on the size of your trading account and how much you normally risk on each trade).

Entry on   October 24 at $35.41 (buy half a position)
Change since picked:     - 0.63   			
Earnings Date          12/30/09 (unconfirmed)    
Average Daily Volume:       1.5 million 
Listed on   October 24, 2009    

NASDAQ OMX Group - NDAQ - close: 18.61 chg: -0.63 stop: 20.65

The correction in NDAQ is accelerating. The stock lost another 3.2% today. Our target to take profits is at $17.85. We'll plan to exit ahead of the November 5th earnings report.

Entry on   October 26 at $19.45
Change since picked:     - 0.84   			
Earnings Date          11/05/09 (confirmed)    
Average Daily Volume:       2.8 million 
Listed on   October 24, 2009    

Steel Dynamics - STLD - close: 14.35 change: -0.36 stop: 16.21

STLD gave up 2.4% on above average volume. Shares could see a little oversold bounce soon. The stock is nearing potential support near its October lows. Wait for a failed rally near $15.00 before launching new positions. Our target to take profits is at $12.60. Keep an eye on the simple 200-dma near $13.50, which will probably act as short-term support so expect a bounce there.

Entry on   October 24 at $15.03 
Change since picked:     - 0.68   			
Earnings Date          10/19/09 (confirmed)    
Average Daily Volume:       8.0 million 
Listed on   October 24, 2009    

Exide Tech - XIDE - close: 6.61 change: -0.13 stop: 8.05

XIDE tagged support near $6.50 but shares didn't bounce very far. I would still expect some sort of bounce tomorrow as long as the market doesn't fall apart.

I am going to keep our target to exit at $6.10. We'll exit 100%. More aggressive traders could aim lower. This an aggressive, higher-risk trade. We want to exit ahead of the early November earnings report.

Entry on   October 21 at $ 7.21 
Change since picked:     - 0.60   			
Earnings Date          11/05/09 (unconfirmed)    
Average Daily Volume:       545 thousand
Listed on   October 21, 2009    

Financial SPDRs - XLF - close: 14.60 change: -0.11 stop: 15.51

The XLF has broken technical support at its 50-dma. Our target is $13.10 but that might be a little optimistic. The rising 100-dma and the exponential 200-dma will probably offer some support. A very similar play would be bearish positions on the IYF financial ishares.

Entry on   October 26 at $14.71 (small positions) 
Change since picked:     - 0.11   			
Earnings Date          --/--/-- 
Average Daily Volume:       102 million 
Listed on   October 26, 2009    


Airgas Inc. - ARG - close: 48.41 change: -0.30 stop: 48.49

ARG tried to bounce today but eventually succumbed to more profit taking. The stock hit our stop at $48.49 closing the play.


Entry on September 25 at $47.25
Change since picked:     + 1.16 <-- stopped @ 48.49 (+2.4%)
Earnings Date          10/29/09 (confirmed)    
Average Daily Volume:       1.5 million 
Listed on September 19, 2009    

Sotheby's - BID - close: 16.46 change: -0.60 stop: 16.80

The correction in BID is accelerating and shares hit our stop at $16.80. The plan was to use small position sizes to limit our risk.


Entry on   October 13 at $18.21 (small pos 1/2 to 1/4)
Change since picked:     - 1.41 <- stopped @ 16.80 (-7.7%)
Earnings Date          11/05/09 (unconfirmed)    
Average Daily Volume:       861 thousand
Listed on   October 13, 2009    


Avis Budget Group - CAR - close: 9.19 change: -0.77 stop: 12.05

Target achieved. Our plan was to exit at $9.55. CAR kept right on going and fell to $9.09. The stock settled on technical support at the 100-dma.


Entry on   October 20 at $11.25
Change since picked:     - 1.70 <--Target hit @ 9.55 (-15.1%)
Earnings Date          11/02/09 (confirmed)    
Average Daily Volume:       3.8 million 
Listed on   October 17, 2009