In one of the largest executive paydays in recent years, Nabors Industries Ltd. is giving its chairman $100 million in cash in a severance-style deal, even though he isn't leaving the company.
... The stock of Nabors has fallen 19% this year, and has underperformed the S&P 500-stock index for the prior one-year, five-year and 10-year periods.
I couldn't help but think of Mel Brooks when I read this article
It is certainly possible that our markets will ignore Europe as they did for much of the past year, until June. We had a year end rally last year as the situation in Europe worsened. However, it will be more difficult as a recession in Europe is all but guaranteed and the effects will be felt by US businesses.
The excess pessimism that has buffered the market is now gone. The fear of missing out on a rally has replaced the fear of losing money, although we are not yet at extreme optimism. The direction of the market is a difficult call, which is why I have reduced longs into recent strength. I prefer cheap, defensive stocks over the high beta cyclicals that have recently skyrocketed.
The economy is still likely to slow even if the stock market holds up. Spreads in peripheral Europe have not improved and they are about to undergo severe austerity measures. With Europe in recession and government spending about to decline in the US, we will be lucky to get muddle through growth.
I expect defensive value names to outperform. It is entirely possible that these wounded animals, fighting for their professional careers will continue to pile in to high beta stocks for a while, but I believe it will end in tears.
On a personal note, it feels so much better to have lowered my equity exposure. The last few months have been brutal in terms of stress and lack of sleep. Not to mention twenty trips to the bathroom a day. I wish I were exaggerating. This business is not easy, even when one is doing well.
Mark Hulbert writes that market timers have turned very bullish as well. From Marketwatch:
This water being thrown on the stock market’s parade comes from contrarian analysis. The wall of worry that existed at the correction low in early October has given way to a significant amount of enthusiasm and excitement — which does not bode well for the rally’s sustainability.
...In fact, the HNNSI is now nearly as high as where it stood in May, soon after the bull market hit what so far has been its high-water mark.
Hedge funds reduced bets that stocks will rise to almost the lowest level since 2009 this week, according to International Strategy & Investment Group.
ISI’s index of “net exposure” to stocks slipped to 44.7 yesterday, compared with its 2011 high of 54.2 in February, according to a note sent to clients. The measure climbed to 45.5 on Oct. 12 after declining to 44 on Sept. 21, the lowest level since April 2009.
If this survey is representative of hedge fund exposure and they decide to bring exposure to normal levels this rally could have a way to go.
We believe the cash generation of CA’s mainframe software and maintenance-like revenue will remain stable, and the net present value of this alone is around $33. The value of that cash flow is being discounted today, and we assume this has to do with investors’ assumptions of how that cash will be allocated.
- John Diffucci, JPMorgan Software Analyst
One of the best software analysts, John Diffucci of JPMorgan, believes that CA's mainframe business alone is worth $33. In addition, CA has $2 in net cash per share, a cloud computing business, a security business and a virtualization business. On a sum of the parts basis CA Technologies is worth over $40.
Mr. Diffucci believes that the reason CA trades at a discount is that investors fear a misallocation of capital. CA has embarked on an acquisition spree over the years that has yielded little, eroding investors confidence. What good is earnings if it is squandered away? I believe that management has found God and is finally on the right path. This should bring CA closer to its fair value over time.
At an Investors Day in late July CA management said that they were done with large acquisitions and that they will return more cash to shareholders. In the latest quarter CA Management delivered on that promise. They spent $200 million on repurchasing shares during the quarter, which works out to 8% of the shares outstanding on an annualized basis. Including the 1% dividend, they are returning cash to shareholders at a 9% annualized rate. CA announced that they repurchased nearly $50 million worth of additional shares since the quarter ended and the management once again stressed returning cash to shareholders on the conference call.
CA has been a value trap for a decade so investors are conditioned to expect little out of the stock. There has been a major change as management is now returning capital to shareholders. As long management continues to deliver on their promise the stock should go much higher.
I now believe the market is in its fair value range. We are trading at roughly 13 times next years earnings. That is on the low side but we are in a very high risk environment, so some sort of discount is justifiable.
While I believe the market is roughly fairly valued, the market often over shoots and will likely do so again. We had extreme negative sentiment a few weeks back. That is generally followed by extreme positive sentiment, which we have not seen yet. Market participants are underweight and we are headed into the strongest part of the year.
I have greatly reduced my long exposure into this 20% move but am remaining moderately long. The main reasons are that I believe there are stocks trading cheaply even though the market as a whole is not and the odds still favor more upside.
The bear case is quite simple. The bailout package is very unlikely to work in its current form because it requires trillions of dollars in funding from private investors. I don't believe they will get it. The EU will likely adjust the bailout package, but if history is a guide they will need to get hit over the head first.
The bull case is that even if this solution stops things from getting dramatically worse we should see a rally. We are entering the strongest part of the year with large investors underweight and underperforming. The recent pullback looks healthy in that it has caused much handwringing but not much damage was done.
I have decided to remain net long but am nowhere as long as I was in early October. The deciding factor in remaining long is the valuation of my longs. I am able to buy some great companies at very reasonable multiples of free cash flow, that have limited economic sensitivity.
While I still believe that hedge funds and larger investors are under-invested, I now believe that shorter term traders are long again. The latest Rydex data shows that traders have positioned themselves more aggressively.
Seasonality will be turning very positive in the coming days. With $100 in S&P 500 earnings projected for next year, current valuations (12.3 times 2012 earnings) are decent even if earnings come in slightly lower. Levels of share repurchases and cash M&A remain high. I still believe the market has more positives than negatives but I am less enthusiastic than I have been to this point.
The EU is planning to fund the leveraging of the EFSF through private investors. They refuse to allow the ECB to help in the funding. There is no way on Earth that private investors will put up a trillion Euros to fund this thing. There is a deleveraging occurring across the World, which is a large reason for the crisis in the first place. Funding the EFSF through private investors is a Catch-22.
The most likely outcome is that once EU leaders realize that the EFSF will not get funded they will find a way, which will likely include the ECB. This makes taking a stance on the market tougher. The market can be 10% higher by the time the EU figures out that the EFSF wont get funded. At which point they will likely use the ECB anyway. That said, I would feel much better if a proper mechanism was already in place. Overall, the agreement makes me slightly less bullish and I will likely reduce positions more aggressively than I was planning to.
Most hedge funds market themselves as having a value strategy when in reality they have a momentum strategy. They have "risk management" tools in place whereby they do not allow losses to grow and reduce exposure when they are losing money. In isolation this strategy works fine, but when everybody is employing the same strategy selling begets more selling. As markets move lower more hedge fund are forced to "manage risk", which causes markets to move even lower until everybody is de-risked. Once the market starts moving higher the opposite occurs, as we are currently seeing.
Many quant strategies use momentum as vital inputs. Twitter and the blogosphere are dominated by those who employ momentum strategies. With all these momentum strategies in place it is no wonder that we see these straight line movements. I have greatly adjusted my trading strategy to allow for this type of movement. As somebody who is value focused this means being more patient with both buys and sells. The good news is that for those that can keep their heads these awesome moves provide great opportunities.
This rally started with investors at very low exposure levels so they likely have plenty of room to add. Seasonality is also very supportive of the market as are the high levels of repurchases and cash M&A. However, sentiment is now on the bullish side and the easy gains have been seen. I will be looking to start reducing positions in the days ahead. Have a good night.
The chart below is from Thomson Reuters via Barrons:
Since August insiders have been "backing up the truck" but last week they began to "feed the ducks" in earnest. The CBOE equity put/call ratio dropped to 0.50 on Friday which is a level that signifies extreme call activity. This might have been expiration related but we certainly were not seeing those type of numbers a month ago on any day.
I believe that the strong seasonality and the still under invested hedge funds should keep this rally going. However, sentiment is now less of a positive for this market and gains will be harder to come by. Typically rallies that begin with extreme pessimism end with extreme optimism. By that measure we are not at the end of this rally but we are certainly closer.
News that Sarkozy is headed to Germany to try and iron out an agreement on a rescue plan has the market tanking. I remain of the belief that an agreement is too important not to happen, so it will.
On the positive side it is very likely that a deal will be reached soon regarding the EFSF. The EU is on the edge of the abyss, but I do not believe they will throw themselves in . German politicians are talking tough because Germans are against the bailouts and this is a negotiation but in the end I believe they will do what is necessary to prevent a cataclysmic event. Market participants remain underinvested as we head into the seasonally strongest part of the year. Additionally, option expiration often serves to prolong a rally and might provide a positive surprise for the bulls this week.
Rather than try to capture a couple percent in a pullback and risk losing my longs I am willing to endure this pullback.
I wrote this statement last night, feeling that playing a correction was too tricky. Timing the correction was even trickier than I imagined it would be as the market turned on a dime this morning and did not look back. I have traded my way out of too many good intermediate term moves looking for a pullback and did not want to make the same mistake again. Have a good night
- Rydex traders are still positioned slightly on the bearish side (almost neutral) but there has been a big move off of the extremes.
- Newsletter writers tracked by Hulbert are 25% long the Nasdaq, which is a neutral reading
- The AAII survey shows individuals on the bullish side.
- The option ratios are still showing a lot of activity in puts but the put activity has backed off levels we were seeing two weeks ago.
The sentiment extremes we saw a couple of weeks ago are no longer present. However, we have not yet reached bullish extremes and many intermediate term measures are still showing excess levels of bearishness.
In the EU the ECB is buying bonds, while the IMF has various lending programs. The nearly $600 billion EFSF fund has been approved and there is now talk about leveraging it 3 to 5 times via loan guarantees. While countries like Germany have talked tough regarding bailouts, when push has come to shove they have not let us fall into the abyss.
Trillions of dollars of unspent bailout funds are a kick of the can at minimum. It is highly unlikely that we will exhaust those funds in the next few months. The doom and gloomers might be proven right, but further down the road.
Rather than try to capture a couple percent in a pullback and risk losing my longs I am willing to endure this pullback. Have a good night.
A textbook scenario would be to see a strong day on Monday followed by a Turnaround Tuesday and more corrective action for the balance of the week. However, in recent years we have seen strong overbought readings like the one we are experiencing get worked off with sideways action. Additionally, the coming week is option expiration and expiration often serves to perpetuate a strong bullish trend. Regardless, the market should have a more difficult time with the upside by Tuesday.
A strong overbought reading like the one we are experiencing has bullish intermediate term implications. Even if we do correct for a few days we are likely to rally again afterwards. There is a lot of fuel for a rally as most market participants are still positioned conservatively if not outright bearishly. If market participants decide to turn bullish for some reason we will be a lot higher by Thanksgiving.
My main fundamental worry is that the ECB has been allowing Italian spreads to blow out as they have greatly reduced their bond buying. There is an Italian bond auction tomorrow. They will likely take a bigger stand if spreads blow out further but it would be nice to see them a little more proactive. I will be out until Monday. Have a great weekend.
Consider the average recommended equity exposure among those short-term market timers monitored by the Hulbert Financial Digest who focus on the Nasdaq market (as measured by the Hulbert Nasdaq Newsletter Sentiment Index, or HNNSI). This average currently stands at minus 43.8%, which means that the typical Nasdaq market timer is currently recommending that his clients allocate nearly half of their equity portfolios to going short.
That would be noteworthy at any time, since rarely has the HNNSI been this low. But it’s especially so right now, since the stock market is coming off such a strong rally. After all, from its intraday low a week ago, the S&P 500 index is now 11% higher.
There is some evidence that the bears are pulling back. Rydex data is the most up to date as it is updated every night. At Rydex the leveraged bears have largely given up in the past week. Overall positioning of Rydex traders is still on the bearish side. The put/call ratios have showed sustained put buying throughout this rally as well. The majority of the evidence points to bearish sentiment.
It seems we are gapping up again and the risks of a short term pullback are increasing. However, with so much bearishness out there and strong seasonality a couple of weeks away I believe the bulls still deserve the benefit of the doubt in the intermediate term.
While we could see some more of consolidation or even a bit of a correction the market is not yet overbought and sentiment still supports the bulls. We saw a decent amount of put activity today even though the market went sideways. Have a good night.
I prefer to measure overbought based on time rather than price. It takes about ten trading days for a strong move to exhaust itself and this move is only a little over four days old. If we continue to rally through next Tuesday we would have a good overbought reading. At that point we would be bumping up against options expiration, which can often serve to extend moves.
In the past few months rallies have been failing well before the market has become fully overbought. However, if this move is the real deal this rally can continue into next week before exhausting itself. That does not preclude corrections along the way. In the short term I don't see a high probability trade either way.
In the short run the market is once again extended and a pause or correction would not be surprising. However, equity allocations remain low and the potential for further upside is there. Have a good night.
Some homeowners are beginning to refinance their residential mortgages faster than expected in response to falling long-term interest rates, causing a chunk of the $5 trillion in mortgage-backed securities to slump in secondary markets.
Prepayments on 30-year fixed-rate loans, the return of principal when a loan is refinanced or withdrawn from the MBS, jumped nearly 30% last month, Fannie Mae and Freddie Mac said late Thursday. That was well above forecasts of a 20% rise, though was focused on newer loans with lower interest rates to borrowers with better credit, according to strategists at Morgan Stanley and Credit Suisse.
The risk to Annaly is that bonds they are holding that trade above par will be redeemed at par. From the Annaly 10-K
An increase in prepayment rates may adversely affect our profitability....when borrowers prepay their mortgage loans at rates that are faster-than-expected, this results in prepayments on mortgage-backed securities that are faster than expected. These faster than expected prepayments may adversely affect our profitability....While we seek to minimize prepayment risk to the extent practical, in selecting investments we must balance prepayment risk against other risks and the potential returns of each investment. No strategy can completely insulate us from prepayment risk.
Even with lowered estimates the S&P 500 trades at its lowest multiple to trailing twelve months and forward earnings in decades. We are currently trading at less than twelve times next year's lowered estimates. Almost every sentiment indicator is pointing to extreme pessimism. Historically, it has paid to buck the crowd when they have been this negative. Thirdly, we are entering the strongest six months of the year.
There are certainly risks as imbalances that have grown over decades are coming home to roost. However, with Lehman Brothers so fresh in the minds of policy makers it seems likely that they will kick the can at a minimum. While I respect the risks, I believe the odds favor a higher market. That said, the imbalances keep me from being as aggressive as I would like to be.
The S&P 500 (incl. dividends) is down a little over 5% for the year. The average hedge fund is down 7% to 8% depending on which hedge fund index you look at. If the S&P 500 gets closer to break even its unlikely hedge funds will catch up because they are largely risk off. This would cause a lot of anxiety. In addition, people start looking for a year end rally towards the end of October which is not that far away.
On the negative side the market has had a steep climb and sovereign spreads are blowing out again today in Europe. I am considering writing covered calls against partial positions.
I suspect that at some point the bulls will be tested. The key will be for us to see a minor correction without completely spitting the bit as we have been recently. The fear of losing money can quickly morph into the fear of missing a year end rally. I am headed out early. Have a good night.
The bulls will counter that despite this huge rally bearish sentiment is still extreme and most are still fighting this rally. In past years strong uptrends have kicked off with tremendous rallies. Most prominent is the rally that started off 666 in the S&P 500 and last Summers rally that started in late August. In both instances the rally was as sharp as this one and the market never looked back.
I see both sides of this argument which is why I am largely out of my shorter term longs but holding on to my core positions.
The QQQ has tech and biotech companies, which do a lot of their business overseas. The OEX has most of the large multinationals. There will likely be a buying opportunity further down the road as people have been piling into these names since the announcement.
We also had some positive divergences yesterday in that we made lower lows but the number of new lows on the NYSE was lower than those seen in early August. Additionally, the market is not as oversold as it was in early August. This type of action is typically seen at good lows as the downside momentum is slowing.
When we broke below 1120 on the S&P 500 I started buying on a scale lower until I was aggressively positioned. While I believe we have bottomed I am now starting to reduce my position. I f we rally through the end of the week I hope to get rid of all of my adds. That would leave me net long but not as aggressively so.
My thesis was simple. There is no reason why a portfolio of agency bonds, which have implicit government backing, should trade below book. In the meantime I was being paid nearly 20% to wait for the shares to pop back above book. I was able to execute this trade over and over during the 08' crisis. Am I not worried about the financial crisis? If we get to the point where agency securities cannot be repo'd than every bank in the World will go down.
Most of the indicators I look at are at historic extremes that almost always lead to upside. Unless we get another Lehman Brothers I believe that this will once again prove to be true. I believe the odds of another Lehman Brothers are extremely low. While officials are talking tough there are massive rescue facilities being put in place. Lehman Brothers happened over the course of a weekend with nobody prepared.
The last bit of a decline is generally the scariest and this is no different. I believe the odds of a whoosh and a rebound today are very high. it is always darkest before dawn and it is pitch black right now.
I view a systemic event as unlikely in the near term. The EFSF is 400 billion Euros or about $550 billion dollars. There are also IMF bailout funds in place as well as asset purchases by the ECB and other liquidity facilities available. At minimum, the $550 billion EFSF is a large kick of the can. I would point out that for months the market thought TARP would not be enough, yet TARP was more than enough as most of it went unused.
I believe the cycle of redemptions and liquidations is the bigger risk to the market. There are news stories of redemptions and liquidations and the price action seems to support this. Last week a group of momentum stocks fell 10% on no real news. Where there is smoke there is fire.
While it is difficult to know when this vicious cycle will end I believe that it will provide opportunity as we should see a snapback when it does. As such I will be adding exposure on a scale if we melt lower. While I have been trading around a net long position,I have held myself back from becoming aggressive on the long side. Further meltage would get me aggressive.