Option Investor

Daily Newsletter, Tuesday, 3/5/2019

Table of Contents

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

Market Wrap

Inflection Point

by Jim Brown

Click here to email Jim Brown

The combination of strong resistance, strong gains and strong uncertainty has created an inflection point.

Market Statistics

After a 539-point reversal on Monday the major averages were mostly flat on Tuesday. The Russell 2000 was the weakest index and led the big caps lower at the close. The opening tick saw the Russell fractionally positive but that was quickly erased never to be seen again. Resistance at 1,575 was solid and correction level support at 1,566 remains support.

In keeping with the trend for the first few days of March the volume was very low, and the range was minimal. Monday was contrary to that trend because of the China trade headlines.

The economic reports improved slightly and that took some of the negativity out of the market. The ISM Nonmanufacturing Index for February rose from 56.7 to 59.7 and erased the January decline from 58.0 in December. New orders rebounded strongly from 57.7 to 65.2 and backorders improved from 52.5 to 55.5. Business activity that accounts for 25% of the index rose from 59.7 to 64.7.

Prices paid, an evidence of future inflation, declined from 59.4 to 54.4. This is good news for service businesses. Exports rose sharply from 50.5 to 55.0. This was a good news report since service businesses account for roughly 88% of the US economy. Tariffs are still a challenge and this report will rocket higher if that problem is resolved.

New home sales rose from a revised 599,000 in November to 621,000 in December. However, that November number was revised down sharply from 657,000 to 599,000. October sales were revised lower from 562,000 to 549,000. The number of homes on the market declined to a three-month low with 6.6 months of supply. The median home price rose from $296,000 to $311,200.

Sales in the Northeast rocketed higher with a 44% spike while the Midwest fell -15.3%. The South rose +5.0% and West +1.4%. New homes listed for sale rose 3% to 344,000 and that was a 17% rise since December 2017. Home sales where the homes had not yet been built accounted for 34.3% of December sales. The rise in mortgage rates last year slowed home sales but the current return to low rates should provide a housing boom this spring.

The CoreLogic home price report for January showed prices rose 4.4% in January, the slowest growth since 2012. Vegas saw the biggest rise at 10.5%, Denver 4.8%, Miami 4.5% and Boston 4.2%. San Francisco posted the lowest gain at 1.6%.

After the bell the weekly API inventories showed a gain of 7.29 million barrels of oil. That greatly exceeded the 400,000-barrel analyst estimate. Crude prices fell about 50 cents to $56.17 on the news. Gasoline inventories fell -391,000 barrels and distillate inventories fell -3.1 million barrels. The gain in crude levels is more than likely due to increased refiner maintenance and a rebound from the multi-month low in imports last week.

The big report for Wednesday is the ADP Employment with expectations for around 200,000 jobs. The Fed Beige Book is important, but it is not expected to be a market mover unless there is a monster downturn in one of the Fed regions.

The nonfarm payrolls on Friday is expected to show a gain of 180,000 jobs. Anything around 200,000 is considered the Goldilocks level.

Earnings are really slowing down, and this is contributing to the lackluster performance in the market. Headline intensity is fading until we begin the buildup for Q1 earnings around the end of March.

The first two weeks of March are normally slow with a minimal range, but the month picks up in the last two weeks on those Q1 expectations.

Dollar Tree, Thor, Guidewire and BJ's Wholesale are the key reports for Wednesday. Prior high-profile teen retailer, Abercrombie & Fitch will report but they have fallen into the "ignore" category at $21 after trading at $80 in prior years.

There was a surge of retail earnings today led by Target (TGT). Earnings of $1.53 beat estimates for $1.52. Revenue of $22.98 billion narrowly beat estimates for $22.92 billion. Same store sales rose 5.3% and beat estimates for 5.0%. Comparable store sales rose 2.9% while online sales rose 31%. The CEO said traffic and same-store sales growth was the strongest in well over a decade. They guided for Q1 earnings of $1.32-$1.52 compared to estimates for $1.43. They guided for the full year for $5.75-$6.05 and analysts were expecting $5.61.

While I thought the earnings were ok given the minor beats, the $5.3 billion in online sales was material. They are fighting back against Amazon by allowing private sellers to put products on their Target+ website. While this may not produce a lot of profit, it makes their website a lot stickier. The company said it was gaining market share across many different areas from fashion to toys. They are capitalizing on the absence of Toys-R-Us. They are also introducing three new brands, Auden, Stars Above and Colsie, in the spring to compete with Victoria's Secret. They are going to complete remodels of 1,000+ stores by the end of 2020 and said they were gaining 2-4% in revenue on each remodeled store. Curbside delivery is now available at more than 1,000 stores and same-day delivery is now available at more than 200 stores.

Kohl's Corp (KSS) reported earnings of $2.24 and beat estimates for $2.18. Revenue fell -3.3% to $6.82 billion but still beat estimates for $6.58 billion. Same store sales rose 1.0% and beat estimates for a 0.5% decline. They guided for the full year for earnings of $5.80-$6.15 and same store sales to be flat to +2%. Analysts were expecting $5.75 and same store sales +0.9%. They raised their dividend from 61 to 67 cents payable to holders on March 20th.

The company signed a deal to display Echo dot speakers and Kindle E-readers in their stores. They also partnered with millennial-focused Popsugar to launch a new line of clothes. They are also partnered with Weight-Watchers (WTW) for lifestyle events and workshops in the stores. That is expected to sell kitchenware and cookware.

Kohls is trying to shrink its store footprint to reduce skews and duplicated space. They have agreed to lease the extra space in 10 stores to Planet Fitness. That will also bring more people in to shop.

One company having a bad day was Revlon (REV). Market data for the four weeks ended on February 23rd showed sales declined -15% after a 9% decline over the prior 12 months. Major Revlon shareholder Ron Perelman just found a buying opportunity with today's 20% decline. He owns 85% of the company and said he was planning on capping his investment at 90%. The sharp decline was accentuated by the low float of only 7 million shares out of the 53 million outstanding.

Ciena (CIEN) reported earnings of 33 cents that rose 120% and beat estimates for 31 cents. Revenue rose 21% to $778.5 million and also beat estimates for $760.6 million. Gross margins of 42.2% missed estimates for 42.5%. They guided for Q1 revenue of $815 million and 42.5% margins. Analysts were expecting $805 million and 42.9% margins. Shares spiked at the open to $45.70 but fell back during the day to close at $40.71. Apparently, investors were not that excited by the CEO comments that 2019 could see some weakness in the later half compared to 2018.

Goldman Sachs (GS) added Ingersoll Rand (IR) to their conviction buy list with a $122 price target. IR manufactures HVAC units and the demand is growing worldwide despite a slowing in the industrial sector. Buildings are rising around the world and they all need HVAC. These units also wear out and need to be periodically replaced. Barclays said the spinoff of Carrier from United Technologies could lead to another round of M&A in the sector. Goldman said higher input costs from the current trade dispute will dissipate once the trade war is over. Shares posted only a minor gain.

Tesla shares fell to a four-month low after China halted import approvals for 1,171 Model 3 cars. Later in the day, Tesla said the approvals had been held up by some incorrectly printed labels. They have reached a resolution with customs officials and the approval process will restart immediately. Tesla is currently in the process of lining up financing for a $500 million facility in Shanghai to manufacture cars. They expect to produce 10,000 per week with production starting at the end of 2019. Using the Musk calendar that probably means July of 2020. Shares closed at a four-month low and appear destined to retest $250.

This was a bad day for OPEC. Chevron (CVX) said despite a slowdown in capex spending they were going to grow production by 3-4% annually through 2023. The company said they were going to boost Permian production from 377,000 boepd (84% over the prior year levels) to 600,000 boepd by the end of 2020 and to 800,000 Boepd by the end of 2023. Chevron owns about two million acres in the Permian that it has owned for decades. As such they do not have the royalties that are being paid by newcomers. They raised their resource estimates for their Permian properties from 9 billion recoverable barrels to 16.2 billion. They plan to boost dividends in 2019 and buy back $4 billion in stock. They expect to sell between $5-$10 billion in noncore assets by the end of 2020. Annual capex in 2021-2023 is expected to be $19-$22 billion.

Continuing the theme, Exxon (XOM) said it was raising production in the Permian to 1.0 million Boepd by 2024 and that is five times their current production. Prior forecasts were for 600,000 boepd by 2025. They currently have 48 rigs working in the Permian and 30 sites under construction to handle oil and gas processing and water handling for fracking. They employ 4000-5000 workers in the basin on any given day. They have 1.6 million acres in the Permian and increased their reserves by 23% in 2018.

The Permian is expected to produce about 4.0 million Boepd this month and that will rise to 5.4 million or more by 2023. That is more than any OPEC country other than Saudi Arabia.

With the numbers being predicted by these companies plus the dozens of others producing all around the US, our total production could rise to 15.0 mmbpd, or even higher, up from the current 12.1 mmbpd by 2025.

If you can afford the new $19 million Bugatti La Voiture Noire, French for "black car" you will not have to worry about gasoline prices. This is the world's most expensive new car and is guaranteed to run away from everything but gas stations. It has a 1,500 horsepower, 16-cylinder engine. There is only one of these hand-made cars. If you want to make a statement about your wealth this is it. Of course, you could never drive it or the value would crash.


S&P futures are crashing after the close and down -7 as I type this. Asian markets opened lower on worries over the trade talks. This could all reverse by morning but given the failures at various resistance levels, the outlook is worsening.

I have warned for the last couple weeks that we would need a new catalyst to lift us over resistance and retest the prior highs. I have written repeatedly that the trade agreement could be a sell the news event and now it looks like it will be a sell before the news event.

Analysts are noting the slippage of commentary regarding the timeline for a potential photo op between Presidents Trump and Xi in Florida. Originally it was discussed as early March, them mid-March and now late March. The first time somebody says April the bottom could fall out of the market.

Analysts are also pointing out that the longer it takes, the more likely Trump will start giving up on various points in order to get a deal done before he begins campaigning for 2020. Those same analysts are already pointing out different things he will probably give up and how the agreement could end up with just some buying from China on US products.

I am not going to try and read the tea leaves on what will or will not appear in an agreement. I do believe there will be an agreement. Not to have one after all this market turmoil would further crash the markets. Trump cannot afford for that to happen.

One thing we do know is that expectations for a "deal" are already priced into the market. Expectations for various points in the deal are not. If we do get some of the most hotly contested points on intellectual property, it could provide some short-term market lift.

China may not believe there is going to be a big post term result because they announced additional stimulus in the form of tax cuts and infrastructure spending today. If they were confident they were going to get a deal they may not have gone to those extremes ahead of the agreement.

The index commentary tonight is going to be short. These are the same charts you have seen for the last two weeks only the outlook is fading. The S&P failed at 2,815 once again on Monday and there was no credible effort to rebound on Tuesday. The S&P traded in a 14-point range and closed almost exactly in the middle of that range. The index has gone sideways since February 19th. Critical support appears to be 2,765 and we have touched that level twice since the 19th with the last time on Monday.

The losing stocks in the Dow are clearly an indication of where traders are worried. Tariff sensitive stocks like MMM, BA and CAT are the biggest losers as hope over a trade agreement starts to unravel. Support at 25,800 held intraday with a drop to 25,611 on Monday for a real shock for bullish traders. Fortunately, a rebound appeared but we had a lower high today. A material decline on Wednesday could begin a major upset.

The Nasdaq remains the most bullish of the major indexes, but it cannot get over resistance at 7,600. With the 200-day at 7,478 and round number support at 7,500 the index is not making any major moves. The FAANG stocks are holding their ground but Apple cannot break free of $175 and until today, Netflix has been struggling. Facebook has surged over the last two days and Alphabet (GOOGL) over the last three days and that is the only thing keeping the Nasdaq at the high end of its range. Facebook gained $9 and Google $41.

The Russell 2000 was the weakest index on Tuesday and since the Russell normally leads both up and down, this is concerning. If the Russell breaks back below the correction territory at 1,566, we could see another leg lower and that would upset the broader market.

The Russell led the big caps higher over the last two weeks, but it has rolled over and could be preparing for leadership in the other direction.

I would recommend caution on long positions over the next couple of weeks. The China trade talks could collapse at any time or they could produce a less than desirable result. With the support of earnings now fading, the trend for early March is flat to slightly down. This normally picks up around expiration Friday as traders prepare for Q1 earnings starting in mid-April. I would recommend being patient until we have more clarity over China or until we near the middle of the month.

Enter passively, exit aggressively!

Jim Brown

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New Plays

20% Gains

by Jim Brown

Click here to email Jim Brown
Editor's Note

The major indexes are up 20% for the year with no material profit taking. All the talking heads on stock TV are trying to figure out which headline is weighting on stocks. I believe it is all of them since a 20% gain never goes unpunished. The storm cloud of the China trade agreement is holding over the market and cautious investors are taking some profits. That fact seems to have escaped those on TV.

The China meeting date now has slipped to "late March" or the "end of the month." The longer the delay the less likely a meaningful deal will be completed. The market is sensing this, and cautious investors are starting to take profits.


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


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In Play Updates and Reviews

Russell Lagging

by Jim Brown

Click here to email Jim Brown