Option Investor

Daily Newsletter, Saturday, 4/30/2016

Table of Contents

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

Market Wrap

Slip Sliding Into May

by Jim Brown

Click here to email Jim Brown

Whether the "Sell in May" adage is correct or not, the constant repeating of the phrase in the press creates a negative bias for the month.

Market Statistics

Friday Statistics

There are multiple surveys and research papers proving the "Sell in May and go away" strategy. However, every year we hear a parade of analysts tell us it is not so. Some claim the market decline from April into summer is a self-fulfilling prophecy because the phrase is repeated so often. I agree the constant repetition creates a negative market bias but research proves the validity of the strategy.

The saying originated in the late 1700s and started out as "Sell in May and go away, comeback on St Leger Day." Established in 1776 the St Leger Stakes is the last thoroughbred horserace of the year and the final leg of the English Triple Crown. The idea was that once horseracing season was over everyone could go back to betting on stocks rather than betting on horses. Coincidentally the Leger Stakes coincided with the end of the worst six months of the market.

The real reason the next six months of the year offer pour returns are simple. The weather is nice, the kids and grandkids are out of school and investors would rather be spending time on the golf course, beach, vacations, etc than glued to their computers worried about what the next market swing was going to do to their portfolio. Volume shrinks significantly and the lack of buyers allows prices to slide. Over the summer, parents/investors are always trying to scrape together money for tuition, books, etc for the 50.1 million kids returning to K-12 school. The older those kids are the more they cost. College tuition today is obscene and replicated over the 20.2 million college students in the USA today it represents more than $300 billion a year in tuition/housing/living expenses. That sucks a lot of money out of the equity market. Note in the graphic below that September is the worst performing month of the year. School Facts

In a 2012 research paper by the University of Miami, they found that market gains for the six months starting in May averaged 0.95% compared to the 10.69% gains in the six-month period from November through April. Even more important they analyzed not just the American markets but they researched 37 different markets from 1998 through 2012 to arrive at those average returns.

The Stock Trader's Almanac first published their "Best Six Months Switching Strategy" in 1986. David Aronson, author of "Evidence-Based Technical Analysis," and his colleague Dr. Timothy Masters back-tested the Best Six Months Switching Strategy using their scientific methods from 1987 to April 2006. Using the S&P-500 as their benchmark the best six months produced an annualized return of 16.3% compared to only a 3.9% return for the worst six months. They concluded the strategy was statistically significant and unlike any of the 6,402 other rules they tested for their book. The chart below from the Stock Trader's Almanac shows why this strategy works. The summer months simply do not perform over the long term.

The Almanac produced this graphic showing the difference in the compounded value of $10,000 invested in the Dow in the best and worst six-month periods since 1950. It is pretty convincing.

Before everyone reading this starts running to cash out of everything on Monday there are other things to consider. If you sell your stocks, you will owe taxes. If you are out of the market and a summer rally breaks out you will miss it. There are some years where summer rallies can produce double-digit returns. They are few and far between but they do happen.

While that graphic above showing the monster gains is intriguing, there is one key point. If you had left that $10,000 invested for the entire 12 months your total return would have only been $1,024 less. It only makes sense to cash out if you expect a material decline over the summer rather than just a flat market.

It has long been proven that timing the market is a far worse strategy than time in the market. Long term the markets go up. If you want to avoid significant market declines, the best timing model is something like the 100-week average. As long as the S&P is over the 100-week average you are long and if it drops below you remain flat or short. You can avoid the sudden exits by adding another moving average like the 50-week in the graphic below. As long as the 50 is over the 100, you remain long. If it moves below the 100, as it is about to do now, you remain flat or short. There are dozens of moving average systems covering various time frames but for long-term investors the various crossover systems are the easiest to follow.

The bottom line is that the sell in May strategy is not a hard and fast rule that is guaranteed to make you more money in the long term. It is the product of the market analysis of hundreds of analysts over time simply showing that the majority of gains come in the best six-month period. If you have a taxable account, you should ignore it completely because the tax consequences of selling will wipe out any gains from the strategy. Time in the market is the key to long-term gains.

Art Cashin called the market decline on Thr/Fri the "Icahn Flush." On Thursday, Carl Icahn repeated his concern over a coming market decline in an interview on CNBC along with news he had bailed on his position in Apple. The stock declined sharply on the news on Thr/Fri and the market sank on his warning about a "day of reckoning ahead."

On Friday, Warren Buffett disagreed with Icahn and said he did not see any specific indications that the market was about to crash. That comment was news about the time the shorts began to cover their positions ahead of the weekend.

The Q1 GDP on Thursday was better than expected at +0.5% growth but still very lethargic. The Chicago Purchasing Managers report or ISM Chicago, declined from 53.6 to 50.4. New orders slowed and backorders were down sharply. The decline in the order components suggest manufacturing activity in future months is going to be weak. When coupled with the Chicago Fed National Activity Index, which has been negative for 9 of the last 12 months and at -0.44 last week was the lowest reading since early 2014, the outlook is weakening.

The Fed statement on Wednesday also said the economy had weakened since the last Fed meeting in mid March. The economic conditions are starting to weigh on the market.

Consumer Sentiment and Confidence are also fading. Sentiment for April declined from 91.0 to 89.0 with expectations declining sharply. The present conditions component rose from 105.6 to 106.7 but the expectations component declined from 81.5 to 77.6. This was the biggest decline since September and this is the lowest level since September 2014. Almost a third of respondents expect unemployment to rise over the next year. Rising gasoline prices are also a challenge.

Next week is payroll week. The ADP Employment on Wednesday is expecting to show a gain of 194,000 jobs while the Nonfarm Payrolls on Friday is expected to show a gain of 210,000 jobs. Both estimates are down slightly from the March numbers.

The ISM Manufacturing report on Monday could be a challenge for the market if it comes in under 50. Estimates are for 51.5 but the regional reports have been weak. The ISM Services on Wednesday is expected to be flat.

The vehicle sales for April are expected to come in around 16.5 million and flat with March. This is well below the highs over 18 million in September through November. I reported last week that car inventories are soaring while truck sales remained steady. The Autonation CEO said they were cutting back on car deliveries and the manufacturers needed to slow production because they were not selling. The cheap gas bounce in the fall has given way to the reality of prices well over $2 and rising. Prices have risen 41 cents in the last 55 days. That is already putting a squeeze on vehicles sales. If the Tuesday report is much under the 16.6 million estimate it could be a problem for the market.

Halliburton (HAL) has a problem. The proposed $28 billion acquisition of Baker Hughes (BHI) is in trouble. Both the U.S. and EU regulators are objecting to the deal and the U.S. Dept of Justice said it could not be fixed because it was so anticompetitive. Halliburton announced they were delaying their earnings from April 25th until May 3rd in what may be a sign the deal is self-destructing. There is a deadline of April 30th to complete the deal, which is not going to happen, or either party can walk away and Halliburton will have to pay a breakup fee of $3.5 billion to Baker Hughes. The parties can agree to extend the deadline for the 4th time. Because Halliburton delayed their earnings, analysts believe they are going to terminate the deal. Halliburton sold $7.5 billion in debt in November in anticipation of closing the deal. They can use part of that money to pay Baker Hughes the fee.

Gilead Sciences (GILD) reported earnings that missed on both the top and bottom lines. Harvoni, their top of the line Hep-C drug, saw sales decline from $3.58 billion to $3.02 billion. U.S. sales of the drug fell 50% on pricing issues. At $94,000 for a 12-week course of treatment, it is definitely pricey but still better than the alternative of eventual liver transplant or death. Patients with insurance have already taken the drug and insurance companies are now demanding discounts of as much as 45%. Some companies are delaying approvals as long as possible as they try to wait until a cheaper alternative is available. Gilead suffered a patent loss in court and Merck (MRK) is aggressively pricing their competitive drug Zepatier. Earnings declined from $2.76 to $2.53 per share. Adjusted earnings of $3.03 missed estimates for $3.12. They ended the quarter with $21.3 billion in cash after spending $8 billion on buybacks in Q1.

Valeant Pharmaceutical (VRX) finally filed their long awaited 10K to remove the danger of a technical default on their debt. Unfortunately, it may have raised more questions than presented answers. In the document, they said they would restate 2014 revenue with a reduction of $58 million and 9 cents a share, and 2015 revenue by $21 million and increase earnings by 7 cents.

The 10K blamed the "tone at the top" referring to top management and the board for numerous errors in accounting and decision making in order to inflate the stock price. Eight of the nine board members had more than $108 million in Valeant stock at risk. CEO Michael Pearson was on the Forbes billionaire list in 2014 because of his massive stock grants. The compensation plans were built around an escalating stock price.

The lax governance, faulty accounting and questionable transactions have made them the target of more than a dozen investigations from every type of regulatory agency including Senate hearings. Five directors will not be standing for reelection and Valeant has recommended three new directors for a vote.

The new CEO Joe Papa has his work cut out for him. His compensation plan includes a $100 million payout if he can rebuild the share price to $150. He will make $500 million if the stock reaches the $270 level within four years. He is of course stepping into the lion's den with the multiple suits and investigations.

Shares spiked at the open on the filing of the 10K but investors sold the news and the stock closed down -5%.

Gilead and Valeant were instrumental in crashing the Biotech Index and that impacted the Nasdaq and the Russell 2000. The $BTK declined -2.5% on Friday after a sharp drop Thursday afternoon.

Under Armour (UA) was hit by a blatant rip off of its logo and garment styles by a Chinese company. Chinese based Tingdei Long Sporting Goods launched its "Uncle Martian" brand of sports apparel very similar to that sold by Under Armour. Just being copies of UA garments was not enough but they copied the logo as well. "Under Armour is aware of the Uncle Martian launch event. Uncle Martian's uses of Under Armour's famous logo, name, and other intellectual property are a serious concern and blatant infringement. Under Armour will vigorously pursue all business and legal courses of action." Unfortunately, with the business in China it will be very difficult to win their fight. The name and logo are registered in China but that does not mean much unless it was an exact copy.

Chinese companies are notorious for copying American products. Business Insider put together examples of some obvious copycat products. Extensive List of Copies

Sqmy Playstation?

Chevron (CVX) reported earnings on Friday that missed estimates. Adjusted earnings of 11 cents missed estimates for 20 cents. Production declined slightly to 2.67 mbpd of oil equivalent, down from 2.68 mbpd. The E&P division lost $1.46 billion because of low oil prices. On a GAAP basis earnings declined from $2.6 billion to a loss of $725 million. That is a drop from $1.37 to a 39 cent per share loss. Revenue declined by nearly one-third to $23.6 billion. The last time Chevron posted a Q1 loss was in 1992 when oil was $18 a barrel. Chevron affirmed its $1.07 dividend for June that will cost the company nearly $2 billion. Capex spending is expected to be $25-$28 billion in 2016.

Exxon (XOM) reported earnings of 43 cents that easily beat estimates for 31 cents. Revenue declined from $67.62 billion to $48.7 billion. Production averaged 4.325 mbpd of oil equivalent. Exxon's earnings beat was helped by a $1.4 billion contribution by the chemical segment. That was up +$373 million from the year ago quarter. Exxon generated $5 billion in excess cash and returned $3.1 billion to shareholders in dividends and buybacks in Q1.

The disaster of the day was Stericycle (SRCL). The company reported earnings of $1.11 and missed estimates for $1.15. Revenue of $874.2 million narrowly beat estimates for $873.6 million. The company guided for full year earnings of $4.90-$5.05, down from prior guidance of $5.26-$5.33. They said the decline in estimates was due to lower volumes of industrial wastes and higher costs associated with international operations. Shares fell -21% on the news.

The winner for the day was Monster Beverage (MNST). The company reported 80 cents and beat estimates for 75 cents. Revenue of $680 million beat estimates for $660 million. The company said its strategic deal with Coca-Cola was paying off and international sales were rapidly expanding. They also have some new products coming out in 2016. Shares rallied 13% on the news.

Earnings for next week are missing the big names we had last week. We will get Tesla, Alibaba, Priceline and Wynn Resorts but they do not have the market moving power of Apple, Amazon, Facebook, Netflix, etc. The quality of earnings should decline but on the bright side, the smaller companies do not have as much exposure to the strong dollar.

According to FactSet, 62% of the S&P have reported with 74% beating on earnings and 55% beating on revenue. Blended Q1 earnings growth improved again last week to a decline of -7.6% compared to -8.7% on March 31st and -9.0% last week. You can thank large beats by Amazon and Ford for the declining estimates. Revenue has declined -1.3%. However, 36 companies have issued negative guidance and only 18 have given positive guidance. The 12-month forward PE is 16.8 and rising. The five-year average is 14.4 and 10-year average 14.2 suggesting the market is currently at the high end of its historical valuations especially when earnings are declining. Q2 earnings estimates are for a decline of -4.4%. The technology has seen the biggest drop with earnings expected to decline -9.4% in Q2.

There are 124 S&P companies reporting this week.

Apple started this tech wreck with earnings after the close on Tuesday. Shares have fallen from $104 to initial support in the $93 range on Friday. However, while some analysts are calling it a screaming buy there are others suggesting it could fall a lot lower.

I believe the downside risk from here is minimal. The 200-week average at $93 corresponds with the horizontal support since late 2014. However, Carter Braxton Worth, an analyst at Cornerstone Macro, believes Apple could decline to the long-term uptrend support at $85 as it did in 2013 after a particularly sharp correction.

I think the bad news is priced in. Who in the market has not heard about the Q1 miss and the lowered production guidance for Q2. I am sure there are a lot of holders that are hoping for a rebound to give them a better exit point but will there really be another $15 drop from here to break that long-term trend line? Over the last five days, Apple has traded more than 325 million shares and shed $62 billion in market cap. Their normal daily volume is about 35 million shares. Anybody that really wanted out is more than likely already out. The stock will remain volatile over the next week or two but I doubt there are any big declines left. Just my 2 cents.

Crude oil rose to the high for the year at $46 thanks to the crashing dollar. The drop in the dollar sent gold surging to a 16-month high at $1,295. The Dollar Index closed at a 16-month low on Friday after the Fed failed to produce a hawkish statement, the U.S. economic reports continued to be weak and the yen rose on the lack of any action by the BOJ. If the dollar continues to fall, the commodity complex will continue to rally.

If there is any doubt about the impact of the dollar on oil prices the chart below should erase that doubt. There is nearly a 100% inverse relationship and this is overpowering the negative fundamentals for crude oil.

We learned last week that Iran has boosted exports from 700,000 bpd to 1.8 million bpd and expects to increase that by another 500,000 bpd by July. OPEC production rose 170,000 bpd from 32.47 mbpd to 32.64 mbpd in April. Saudi Arabian output is expected to rise 350,000 bpd in April. Libyan officials announced on Friday a plan to boost exports from 400,000 bpd to 1.6 mbpd and the pre Gaddafi levels thanks to the backing of the new unity government.

Oil production is rising everywhere except the U.S. and Venezuela but prices are being powered higher by the dollar not the fundamentals. U.S. production declined only 15,000 bpd last week and inventories rose 2 million barrels.

Baker Hughes said active rigs declined -11 to 420 and another new historic low. Oil rigs fell -11 to 332 and gas rigs declined -1 to 87. Miscellaneous rigs rose 1.


The markets declined last week for multiple reasons. We can blame it on Carl Icahn's "day of reckoning ahead" comments. Or, we can blame it on Apple's earnings. We could also blame a long list of tech stocks with earnings disappointments but then we would have to factor in Amazon, Baidu, Expedia and Linkedin and their huge earnings beats that were completely ignored the day after the reports. The Bank of Japan could also be a convenient scapegoat when they elected to not add further stimulus even after officials had indicated stimulus was likely. We could also blame the lackluster GDP at +0.5% growth and a two-year low.

There are lots of factors we could blame but in reality, markets do not need a reason to go down. Selling happens. When the major indexes are facing such significant resistance, I would have been more surprised to see the indexes forge ahead in light of all the events I listed above.

Resistance held and we have to deal with it. The key for us is what to expect for next week. The resistance is still there and the headline flow is going to diminish. There are plenty of earnings reports but very few high profile companies. The farther into earnings season we go the weaker the earnings will become. Misses will become more prevalent. Fortunately, those misses will not mean as much as a Microsoft or Apple because the companies are smaller. However, it should keep the downward pressure on the market.

We have talked about the very low bar for earnings estimates but we are still seeing companies miss that bar. That should remain a cloud over the market.

However, investors are supposed to buy when there is blood in the streets. This quarter could be seen as one of those events. Analysts are calling it the trough quarter for earnings. If the cycle plays out as expected with a -7.6% earnings decline and the fourth consecutive quarter of declines, that should be a signal for long term investors to buy stocks before earnings improve. While they are still expected to decline slightly in Q2 at -4.4% the Q3 and Q4 estimates are bullish at +1.6% growth and +7.5% growth respectively. We are supposed to buy in advance of the good times and sell when those good times have peaked.

I do not think investors are prepared to dive in today to capitalize on earnings nine months from now. There far too many negative headlines and we are entering the worst six months of the year for the market.

This will make the summer a buying opportunity ahead of a bullish Q4. For the next month, the markets should continue to be choppy with a downward bias. That assumes a flood of investors do not rush into the market next week still targeting those historic highs.

The events of last week may have blunted the enthusiasm investors had for a new high attempt. The S&P dipped to 2,052 on Friday and is closing in on the decent support at 2,042 followed by 2,020. Resistance remains 2,100, 2,116 and 2,128.

The Dow was crippled by Apple, Intel and Microsoft, both of which closed at a two-month low, while some of the recent reporters are going through their post earnings depression phase. The outlook for the Dow is not positive.

Dow components Pfizer and Merck report next week and they are hardly going to set the market on fire. Both reports will be ignored.

The Dow made it all the way to 18,167 the prior week and right on the verge of a breakout before losing traction. Now that more than half of the Dow components have already reported and in their depression phase it will be very difficult to regain those highs.

Support is now just over 17,500 followed by 17,400 and then a potentially long drop. Resistance remains 18,110 and 18,165.

The Nasdaq could be in trouble. The Nasdaq Composite closed at a four-week low while the Nasdaq 100 closed at a seven-week low. On the composite index, the Friday low at 4,749 is the last ditch level before a potential retest of 4,600.

On the Nasdaq 100, the index could not post a gain even after Amazon added 58 points on Friday with Priceline +26, Monster Beverage +16, Expedia +9, etc. The tech sector is reeling from a flurry of negative reports and falling guidance.

Any further decline by the Nasdaq 100 and we could be looking at a retest of 4,085.

The drop in the biotech sector is also dragging the Nasdaq lower. The biotech rebound appears to have run its course and the earnings miss by Gilead was a nail in the coffin.

The Russell 2000 had been a leading indicator for the market as the Dow tried to make new highs but the Russell failed to move over 1,150 and never even tested the stronger resistance at 1163-1165. The Russell lost more than 32 points from the Wednesday high at 1,156 to the Friday low at 1,124 or roughly -3%. Given the positive trend the prior week that could be just some needed profit taking but the weakness was pretty widespread. Real support is about 1,090 with a couple speed bumps at 1,110 and 1,100. The 200-day average at 1,126 halted the decline on Friday and it is still in play.

The event calendar is headlined by the employment reports but nobody expects any material change so they should not impact the market unless there is a big surprise. The ISM Survey is important but unless there is a large negative surprise, I would not expect that to move the market either.

The market moving events will come from the ongoing earnings cycle and the misses will be more important than the beats. The market bias has shifted to negative and given the point on the calendar it may be harder to move it back into positive as we drift towards the summer doldrums.

Warren Buffett will be cheerleading for investors all weekend in Omaha and his bullishness could be contagious for the market on Monday.

I said last week we need to avoid being too long and I think that is true for this week as well. We need to be cautious as the quarter progresses and forward estimates are revised. Despite the decline last week, the markets are still complacent.

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Random Thoughts

The current bull market just became the second longest in history. It started on March 9th, 2009 and has lasted 2,608 days through Friday's close. The now third longest started on June 14th 1949 and lasted until August 2, 1956. Bull markets do not die of old age. They die from Fed actions and economic cycles. The longest bull market started in October 1990 and lasted until March 2000 and the S&P rose 417% in that period.

The capitalist Woodstock is underway this weekend in Omaha as the Berkshire Hathaway shareholder meeting is in full bloom. Thousands of shareholders make the trip to Omaha to rub shoulders with Buffett and his team and talk first hand with some of his companies that set up booths and displays in the convention center.

Unfortunately, all the news was not good. Buffett said the railroad business had fallen off drastically and the "pain is likely to continue." He said it was off sharply in Q1 and would likely be down the rest of the year. Buffett said the BNSF railroad had let investors down but referred to the operation as its "most important non insurance business." In the preliminary earnings, the segment lost $221 million for the quarter. The insurance segment also lost $267 million because there were more catastrophe events than normal in Q1.

Buffett is known for not being tech savvy. He said we are still trying to figure out how to harness the rapid growth of online commerce, something Amazon has done very well. "We are not going to try and out-Bezos Bezos." "The internet has already disrupted plenty of people and it will disrupt more." Charlie Munger said Berkshire's business were so strong they are not particularly vulnerable to web retailers like Amazon.

Google and Amazon are in competition to build the biggest database in the world. Six years after the Flash Crash of May 2010 the Consolidated Audit Trail (CAT) project is finally showing signs of life. The CAT is supposed to contain all the identifying information for every trade across all the exchanges, including bids and offers submitted. Each transaction is going to be tagged with the identifying information showing who placed the trade/bid, through what broker, at what time, what was the market price, etc. In theory, this will allow the SEC to backtrack the next market event to determine what caused it.

The biggest problem is that capturing all that information will produce 50-100 billion records per day. That will be a massive database that will require a supercomputer to manipulate when the SEC does want to search the data.

There are three bidders. FINRA, the market regulator is teaming with Amazon Web Services. FIS is teaming up with Google and Thesys Technologies, an affiliate of Tradeworx, is going it alone. The SEC is finally done with deciding what they want to be in the database and the three bidders will decide what it will cost. The winning bidder will not be chosen until Q3 or Q4.

The next question is who will pay for it. The brokers are going to be on the hook for the eventual cost and ongoing maintenance. They will pass the costs on to their clients. Once it is built and operational, who owns the data? How will privacy be protected? Without protections, an operator could track every trade Carl Icahn has ever made including any bids and offers that did not get filled. The potential for liability is huge.

The SEC is going to produce all the rules and there will be a comment period once they are published. It will be a monumental undertaking and the volumes of data collected will be mind-boggling. Amazon may need to add an entire data center just to handle the collection and processing of the data. After this effort, putting a man on Mars will be a walk in the park.

The bulls ran for cover this week. The prior week bullish sentiment rose 5.6% but last week it declined -6%. Bearish sentiment surged 4.7%. Since the survey closes on Wednesday, the respondents reacted to the Apple earnings and the big drop on Wednesday. At the time they did not know about the coming declines on Thr/Fri. This means the survey next Wednesday could be really different as long as the market does not rebound on Monday.

An Apple employee was found in a conference room at the Infinite Loop campus with a fatal head wound and a firearm on Wednesday morning. The campus houses 16,000 Apple workers. The employee was discovered the morning after Apple reported earnings and shares crashed Wednesday morning. The death is thought to be a suicide and no names were released. You have to wonder if this had something to do with the crash in the stock. Had the individual leveraged everything in an option trade to bet on a potential rally only to be wiped out when the stock crashed instead? It would not be the first time or the last time for something like that to happen.

Amazon posted a whopping 5,421% rise in tablet sales from Q1-2015 at 40,000 to 2.2 million in Q1-2016 according to International Data Corporation (IDC). IDC said global tablet sales of all brands declined -14.7% from 46.4 million to 39.6 million in Q1. Sales of 2-in-1 tablets with a detachable keyboard saw triple digit sales increases to 4.9 million units. Microsoft was credited with creating that category but everyone is now competing in the space.

No more beer in Venezuela. The largest beer maker closed its four production plants on Friday because of inability to buy raw materials. Importers will only take dollars in exchange for their goods and the government has run out of dollars. Venezuela can print all the local currency it wants but it is worthless outside of Venezuela. In fact, it is worthless inside Venezuela. The Empresas Polar plants make 80% of the beer consumed in Venezuela. President Maduro warned Polar it would seize any plants halted by private companies and hand them over to the workers. He called it a crime against production.

However, even if he did turn them over to the workers he still does not have any dollars to pay for the raw materials to make beer. Venezuela continues to circle the drain and the citizens are reaching the point where they are going to revolt. It is only a matter of time. Analysts believe oil production will stop soon because the government cannot pay the workers or buy the materials to drill new wells or pay for the services required to keep the old wells running. Crude oil exports is the only form of cash still flowing to the government and that is about to come to an abrupt halt.


Enter passively and exit aggressively!

Jim Brown

Send Jim an email


"We aren't addicted to oil, but our cars are."

James Woolsey


New Plays

The Clouds have Parted

by Jim Brown

Click here to email Jim Brown
Editor's Note

When old problems suddenly vanish, it is as if the clouds have parted and a new day has dawned. That is the case with Navistar. They finally resolved a 4 year old problem with the SEC and the future looks bright.


NAV - Navistar - Company Profile

Navistar manufactures and sells commercial and military trucks, diesel engines, school and commercial busses and provides service on these products worldwide.

For the last several years, Navistar has been under a cloud. In 2010 the company said it had developed an advanced truck engine that would meet EPA certification requirements. In 2011 the engine failed to pass the tests for EPA certification. In 2012 after making some changes to the engine they reapplied for certification. The EPA staff objected saying there were "several serious concerns" that needed to be resolved before certification. Despite the objections the company released several statements characterizing the application as a "milestone" in development and was proceeding in a timely manner. The company planned to start production on the engine in 2012. It never happened and the SEC fined the company $7.5 million last week for improper statements in 2012. The CEO making those statements was forced to step down in 2012.

Fast forward to today and all those problems are behind the company now that the SEC finally reached a determination. Navistar is producing new state of the art trucks and engines and the stock is in rebound mode.

In their recent earnings they reported a loss of 40 cents that was significantly better than the estimate for a 77 cent loss. Revenue of $1.77 billion was short of estimates for $2.05 billion. However, the company guided for $9.0 to $9.25 billion for the full year.

Earnings June 2nd.

On Thursday, shares spiked to resistance at $16.50 and then retreated in the weak market on Friday. I believe they will break through that resistance level and test the next level at $20.

With a NAV trade at $15.40

Buy NAV shares, initial stop loss $12.95.


No New Bearish Plays

In Play Updates and Reviews

Short Covering Close

by Jim Brown

Click here to email Jim Brown

Editors Note:

The market rebounded from a very negative day as shorts covered at the close. The S&P dipped to 2,052 intraday and rebounded in the last 30 minutes to close at 2,065. Whether this rebound will stick next week is the critical question.

The majority of the large S&P 500 companies have already reported earnings. There is a deluge of small companies next week and typically their earnings are weaker than the blue chips. If the historical trend continues, we should see a lower close next Friday. However, this could always be just a profit taking dip ahead of another try to reach the prior highs.

While I do not believe we are going to be successful in reaching those highs in the near future, anything is possible. As we enter the month of May the "sell in May" mantra will be repeated every day on CNBC and Bloomberg TV and in the press. Whether the strategy works or not is immaterial since investors will assume it works and act accordingly. It creates a negative tone in the markets.

With earnings likely to be weaker than last week and the negative tone created by the sell in May bias it should turn out to be a self fulfilling prophecy.

Current Portfolio

Current Position Changes

CONN - Conn's

The long position was stopped out at $13.75.

DPLO - Diplomat Pharmacy

The long position was stopped out at $30.85.

XLF - Financial ETF

The long call position was closed at the open.

VXX - Volatility ETF

The long position was opened with a VXX trade at $16.75.

NTAP - NetApp

The short position was opened with a NTAP trade at $23.95.

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

CONN - Conns Inc - Company Profile


No specific news. Dropped with the market and stopped us out at $13.75 for a nickel loss.

Original Trade Description: April 20th.

Conn's operates as a specialty retailer of durable consumer goods and related services in the USA. The company stores offer refrigerators, freezers, washers, dryers, dishwashers, ranges, furniture, mattresses, home office products including computers, tablets, desks, printers, etc. They also sell consumer electronics including TVs, home theater equipment, etc. They operate more than 100 locations and were founded in 1890. Conn's is like a Best Buy with furniture and appliances.

Shares fell -23% after reporting earnings in late March and bottomes on April 8th. Revenue rose 7% and same store sales rose 3.6% excluding categories the company exited during the quarter. The furniture section saw same store sales rise +15.2% while electronics sales decline -13.3%. They reported earnings of 11 cents compared to estimates for 28 cents. The sharp earnings miss was caused by a major increase in loan loss reserves on their customer financing programs. The 60-day delinquency rate rose to 9.9%. Conn's finances 80% of its sales through its own in house financing plans. This is a short-term problem that will pass as they tighten up credit standards on future sales. They plan to open 10-15 new stores in 2016.

Earnings are May 31st.

An insider bought 250,000 additional shares last week for roughly $3 million. That is a huge vote of confidence.

The sell off was overdone. Shares have now rebounded above the consolidation highs for the last four weeks where the sellers were exiting. Wednesday's close was a four-week high.

I believe we can take a long position in Conn's and ride it up to the $16 level or possibly higher.

Position 4/21/16 with a CONN trade at $13.80

Closed 4/29/16: Long CONN shares @ $13.80, exit $13.75, -.05 loss

No options recommended.

DPLO - Diplomat Pharmacy - Company Profile


This kind of day really depresses me. We were up nicely with a $2 gain in the position and the market tanks and we barely escaped with a 50-cent gain on no news. The position was stopped out at $30.85 after hitting $33.40 on Thursday.

Original Trade Description: April 15th.

Diplomat Pharmacy operated as an independent specialty pharmacy in the USA. The company stocks, dispenses and distributes prescriptions for various biotechnology and specialty pharmaceutical manufacturers. A specialty pharmacy does more than just dispense pills. The provide other services for the patients like infusion, patient financial assistance, risk evaluation and medication strategies. Many of their patients are on complex programs with multiple high dollar drugs. The company has 16 locations and was founded in 1975.

DPLO had a rough six months. The Valeant problem with specialty pharmacy Philidor put a cloud over the entire sector. After DPLO reported robust earnings back in March, JP Morgan downgraded them saying they could decline 15%. The company guided below expectations but remained bullish. The analyst said he could not bridge the gap between the guidance and management bullishness. Shares dropped from $36 to $26 on the downgrade.

Fortunately, that was the bottom and shares have been moving up steadily. They accelerated last week after the company announced the availability of a new Lilly drug for Plaque Psoriasis. This confidence in DPLO by Lilly seemed to encourage investors.

Earnings are May 9th.

Shares are just over $30 with resistance at $35. With the potential for a market meltdown on Monday if the OPEC meeting in Doha does not go well, I am putting an entry trigger on the position.

Position 4/18/16 with a DPLO trade at $30.35

Exit 4/29/16: Long DPLO shares @$30.35, exit $30.85, 50 cent gain.

KKD - Krispy Kreme - Company Profile


Still holding at the highs after addition to the S&P-600. No specific news.

Original Trade Description: April 18th.

Krispy Kreme operates as a branded retailer and wholesaler of doughnuts, coffee, treats and packaged sweets. Who would have thought that Krispy Kreme Donuts would be impacted by falling oil prices and currency translation issues? They are a donut store headquartered in the USA. Unfortunately, not all their stores are in the U.S. KKD only has 297 stores in 41 states but they have more than 825 stores in 25 other countries.

There are 105 stores in Saudi Arabia, 136 in Mexico, 19 in the UAE, 14 in Kuwait and 12 in Russia. All of those countries have been impacted by the drop in oil prices and spike in the dollar.

In the last quarter sales at locations outside the U.S. fell -7.1% and expectations are for a continued decline in sales. The strong dollar caused revenue to decline -3.4% to $7.4 million in last quarter.

In late March they warned earnings would be in the range of 87-91 cents and analysts were expecting 93 cents. Shares fell -10% on the news. However, within four days the stock had rebounded to more than the level before the warning and have continued higher. Monday's close was an 8-month high.

They are running promotions to boost sales in the U.S. and they appear to be succeeding. On April 1st they gave away a free donut to anyone walking in their door, no purchase necessary. The stores were packed.

KKD only has $11 million in debt and $51 million in cash. They bought back 2.8 million shares in 2015. They have an authorized buyback for up to $144 million in shares for 2016.

Earnings are June 21st.

I am recommending we buy KKD shares with a trade at $16.50, just over today's high using a tight stop loss.

Position 4/20/16 with KKD trade at $16.50

Long KKD shares @ $17.05, see portfolio graphic for stop loss.


Closed 4/27/16: Long May $17 call @ .30, exit .65, +.35 gain

TRN - Trinity Industries - Company Profile


Minor decline in a weak market. No specific news. We have a July call option so plenty of time.

Original Trade Description: March 18th

Trinity Industries manufacturers rail cars, highway guard rails and steel beams for infrastructure projects, structural towers for wind turbines and electrical distribution grids, oil and chemical storage tanks, barges to transport grain, coal, aggregates, tank barges to transport oil, chemicals and petroleum products. The company was founded in 1933.

Shares crashed in mid February after they reported earnings that beat the street but guidance that disappointed. Earnings of $1.30 easily beat estimates for $1.07 but revenue of $1.55 billion missed estimates for $1.61 billion. They had full year earnings of $5.08 per share.

They guided for 2016 to earnings of $2.00 to $2.40 per share. The challenge is the slowdown in orders for railroad tank cars and barges to transport oil. With oil prices crashing the producers and refiners are cutting back on capex spending until prices recover. Trinity said revenue in 2016 could decline -32%. Shares declined -35% over two days on the news.

The key here is that Trinity is now trading at a PE of 3. Yes 3.74 to be exact. With earnings in the middle of their range at $2.20 and a PE of 10 that would equate to a $22 stock price.

Here is the good news. The company has $2.12 billion in cash and undrawn credit. They are not in financial trouble. They authorized a $250 million share buyback starting January 1st. They have an order backlog of $5.4 billion in orders for 48,885 railcars. They received orders for 2,455 cars in Q4 and their backlog stretches out to 2020. The barge division received orders for $190.1 million in Q4 and had a backlog of $416 million as of December 31st. The structural tower segment has $371.3 million in order backlogs.

They recognize that tankcar and barge orders are going to remain slow until oil prices recover, which should happen later this year.

This stock was extremely oversold but began recovering in early March. Trinity produces a lot of railcars for carrying all types of products other than oil. That demand is not going to disappear and they already have order backlogs stretching into 2020.

At their current valuation they could also be an acquisition candidate. This is a great business that has been overly punished by the oil crash.

Earnings April 21st.

Position 3/21/16:

Long July $20 call @ $1.50, no stop loss.

Previously Closed 4/5/16: Long TRN shares @ $19.15, exit $17.50, -1.65 loss.

VXX - VIX Futures ETF - ETF Profile


The VXX was opened with a trade at $16.75 and spiked all the way to $17.50 before the market rebound began at the close. For this position to be profitable we need the market to continue lower. Obviously that means our long plays will lose money. This is a hedge against that decline.

Original Trade Description: April 25th.

The VXX ETF tracks one-month futures contracts on the Volatility Index of $VIX. The VXX is actually less volatile than the VIX but travels in the same direction. The VXX is highly liquid with average volume of roughly 75 million shares.

The VXX or any volatility ETP or leveraged ETF should not be held for long periods of time because the futures roll over every month will reduce the value of the position. However, it is suitable for short-term tactical trades. We closed a short on the VXX a couple weeks ago for a decent profit.

With the potential for another bout of market volatility I am recommending we go long the VXX this time. Long the VXX is the equivalent of a short position since it rises with a decline in the market.

Last Tuesday the VXX declined to 15.56 and the lowest level since August 10th. We had been long the VXX and that stopped us out of the position.

Since then the market has failed at resistance and spent several days in decline. With Apple's earnings likely to disappoint, it could cement the decline and lead us into the sell in May cycle.

Keith Bliss of the Cuttone Company, said research back to 1957 showed that last week was normally the best week of the entire second quarter. After last week the markets tended to "ebb" into June as the sell in May cycle takes hold as the earnings cycle wanes.

This year we have the Brexit vote in June, a likely Fed rate hike in June, the possibility for riots at the Republican convention in July, and many other factors that could weigh on the market.

I am proposing we get long the VXX and hold it because it is only a matter of time before we see another bout of volatility that could push it back to the 26-30 level. This means we could see some short-term bouts of calm if the markets try to make a new high again. Therefore, I am putting a stop loss on the position but I plan to reenter it the instant it appears volatility is starting to heat up. Hopefully the first long will be the only long we need.

Historically, there is very little long term risk with the VXX because the market will always have volatility spikes, but because it is a futures product there is a premium bleed if the ETF is held for a long time. If it were a regular stock we could just hold it until an event occurred. Since it is futures related, we have to have a stop loss.

Position 4/29/16 with a VXX trade at 16.75

Long VXX shares @ $16.75. Initial stop loss $15.00 and a new historic low.

WIN - Windstream Holdings - Company Profile


No specific news. Another minor decline from the new 52-week high. Purely market related.

Original Trade Description: March 11th

Windstream provided network communications and technology solutions for consumers, businesses and enterprise organizations. They provide high-speed internet access, hosted web services and cable TV to a combined total of 1.6 million residential and business customers. They have more than 125,000 miles of high-speed fiber optic cable with speeds up to 500 gbps along their main corridors. They have 11 major data centers providing web hosting, cloud services, etc.

In the Q4 earnings, WIN reported adjusted earnings of $1.41 that crushed estimates for a loss of 48 cents. Revenue of $1.427 billion missed estimates slightly for $1.433 billion. The major earnings beat came from a spinoff of some of its telecom assets into a REIT. The cash received from the spinoff will allow some major network improvements in the months ahead.

The company declared a 15-cent quarterly dividend payable April 15th to holders on March 31st. That equates to a 7.3% annual yield.

WIN shares have been moving higher since they reported earnings on February 25th. Shares are at resistance at $8.25 and could breakout this week. The next resistance would be $11.85.

While we are not playing the stock for a takeover there is always the chance that somebody like Verizon or even Google could decide the $750 million market cap was chump change for 125,000 miles of high-speed fiber, cable TV and data center business.

I am going way out on the option to August because it is cheap and it will make a good lottery play even if we close the stock position early.

Position 3/11/16

Long August $9.00 call @ .38 cents.(Adjusted) NO STOP LOSS

Previously closed 3/29/16: Long WIN shares @ $8.22, exit $7.10, -1.12 loss.

XRX - Xerox - Company Profile


No specific news. Shares dipped with the market and missed our $9.50 stop by 3 cents. I am lowering the stop loss to $9.40.

Original Trade Description: March 27th

Xerox has grown into a global services company that also provided document management solutions. The services segment provides business outsourcing services, customer care, transaction processing, finance and accounting, human resources, communication and marketing, consulting and analytics. The hardware segment produces copiers and printers of all sizes, capabilities and combinations.

The company announced in January they were going to split into two companies. One would be hardware and the other business services. They did this because they were under attack by activist shareholders. Carl Icahn was awarded three seats on the board. Shares rose from the February low at $8.50 to the April high at $11.50.

When they reported earnings this week the stock crashed back to $9.50. They missed on earnings and provided weaker guidance. Earnings of 22 cents missed estimates for 23 cents. Revenue fell -4% to $4.28 billion but beat estimates for $4.24 billion. The strong dollar caused a 4% decline in revenue.

The company also reported higher costs as a result of the current restructuring. They expect the restructuring to cost $220 million but provide more robust earnings growth starting in Q2. They incurred $126 million of those costs in Q1. The CEO said they were accelerating the cost reduction efforts and would begin to see results in Q2. In light of the restructuring costs they are delaying additional stock buybacks until 2017. The company reaffirmed its full year guidance.

Shares held at the $9.75 level for three days before rising to close at $10 today and the three-day high. Normally when a company goes through this process the current holders bail on the earnings news and a new set of investors buy the dip in expectations for the improvement in earnings in future quarters plus the added incentive of the split. We see it constantly where companies report a bumpy quarter, the stock crashes and a couple days later a rebound begins that propels the stock higher than the pre earnings levels.

I think the risk has been removed from Xerox. I believe we can buy it here at $10 and ride the rebound towards the "improved" Q2 results. Because of the recent low, our risk is minimal.

Position 4/28/16

Long XRX shares @ $9.95. Initial stop loss $9.50.

BEARISH Play Updates

NTAP - NetApp - Company Profile


No news. Shares collapsed -2.75% to trigger the short entry at $23.95.

Original Trade Description: April 25th.

NetApp provides software, systems and services to manage and store computer data worldwide. Data ONTAP storage operating system that delivers integrated data protection, comprehensive data management, and built-in software for virtualized, shared infrastructures, cloud computing, and mixed workload business applications; E-Series storage systems for storage area network workloads (SAN); all-flash arrays that deliver input/output operations per second and ultralow latency to drive speed, responsiveness, and value from the applications that control key business operations; and hybrid arrays for mainstream business applications.

About two weeks ago the stock trend turned negative and has started accelerating downward after Sterne Agee and Macquarie both downgraded from neutral to sell. Sterne Agee said the downgrade came after the Q1 IT survey. The survey showed weakness in end-user budgeting for storage systems and upgrades. Spending had declined 10% year-over-year and was negatively weighted towards incumbent vendors. Agee said they did not expect revenue from ONTAP8 and SolidFire to offset enough share loss potential over the next year. The analyst said valuation appears compressed and the stock should underperform its peers.

Another analyst said deteriorating net income would keep the stock depressed.

Earnings May 25th.

Based on the chart shares may not find support until $21. The last two days shares have stalled the decline at just over $24. I am recommending we short NTAP with a trade at $23.95 and target $21 for an exit.

Position 4/29/16 with a NTAP trade at $23.95

Short NTAP shares @ $23.95, initial stop loss $24.95


Long June $24 put @ $1.17, initial stop loss $24.95.

XLF - Financial ETF - ETF Profile


Down in a weak market. This ETF reacts to the markets just as much as it does to financial news.

The long call was closed at the open for a 39 cent gain.

Original Trade Description: April 11th.

The XLF is commonly referred to as the banking ETF. However, it is actually a Financial Sector ETF. Banks account for 33% of the holdings with WFC, JPM, BAC, C, USB and GS six of the top ten holdings. Insurance, brokers, diversified financial services and REITs make up the rest of the ETF.

We are playing it to capitalize on the movements in those six top banks as they report earnings. The ETF normally moves slowly and I would not recommend it as a stock holding ahead of those earnings simply because we do not know which way it will move.

I am recommending a short-term option strategy called a strangle using very inexpensive options. We only care about catching the post earnings move in what could be a rocky quarter. Since estimates are already very low there is the potential for an upside surprise and that could cause some short squeezes with the banks.

I looked at playing the weekly puts but the premiums were in some cases higher than the May premiums so we will buy the time even though we will not use it.

Position 4/12/16

Closed 4/29/16: Long May $23 call @ 19 cents, exit .58, +.39 gain.
Long May $22 put @ 47 cents, no stop loss.
Net debit 66 cents.

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