I have moved this week from being positioned aggressively long at the beginning of the week to having a medium amount of market exposure now. I would really like to see a more definitive plan out of Europe given how far we have come. Have a good night.
I reduced my net long exposure in case there needs to be another scare to get EU leaders moving. I still have a healthy net long exposure. Seasonality and the oversold reading are short term positives. Now we need to see some real progress and fewer statements and meetings. Have a good night.
Tactically, I will look to ratchet back my net long exposure into strength (after raising it last week) as long as there is no progress in Europe. I believe that ultimately Europe will do whatever it takes but there does not seem to be a sense of urgency. It might require another scare in order to get the EU to act. As such, once we are no longer oversold there is little justification for being aggressively long.
Thankfully, Angela Merkel has not held a press conference yet today telling everybody to go to hell. But other than that all that has changed is the mood. Sentiment became too negative last week and we are oversold. These excesses now being relieved. If we do not see real progress in Europe than I will likely look to reduce positions later this week. By progress I mean a plan that involves the ECB.
My philosophy towards the stock market is that I get paid to suffer, both in my market timing and individual stock selection. I generally buy stocks that people hate, especially Wall Street analysts. I generally buy during times when the market outlook is dark. Most of the time my positions start out a loss for me as I buy into negative momentum.
I don't believe that I get paid to be comfortable. I get paid to suffer. Last week, I added quite a few positions into the carnage. There was no reason to buy and nary an uptick. It was not comfortable as I felt exhausted and sick at the end of each day even though I sit at a desk. This morning it appears as if I will be looking at a profit on even my worst buy from last week.
My experience from last week typifies my experience in the stock market in general, although to an exaggerated degree. Many say that trading is easy. Just follow the trend and cut your losses quickly. I could never figure out how to do that. The only way I know to make money usually involves a lot of suffering.
Walgreen's is an important position for me as I own both stock and calls. There has been relentless selling in the stock as it has absorbed brokerage downgrade after downgrade. A former bull called the stock uninvestable. I find that statement incomprehensible. In a worst case scenario where Walgreen's does not make amends with Express Scripts the company should earn $2.75 next year. Trading at twelve times a worst case scenario and a nearly 3% dividend seems very investable to me.
A deal makes sense for both Express Scripts and Walgreen's and I believe this is the most likely outcome. Walgreen's is the most successful pharmacy in the US and Express Scripts is the most successful PBM. They did not become that way by cutting their noses off to spite their face. I still see a deal as the most likely outcome, but even without a deal Walgreen's has a margin of safety.
Yesterday, at a press conference Angela Merkel offered no remedies to the crisis but made certain to shoot down every possible solution. The most astonishing part was that Sarkozy and Monti stood by in agreement. I might believe that Merkel is this clueless but to believe that Sarkozy and Monti are as clueless is impossible. The most likely explanation is that they are playing along with Merkel until she can convince her supporters that she has tried every other route.
The choice is simple, print money or allow the Eurozone to break up. I have a hard time believing that the Europeans will give up on the Eurozone without even trying. The only question is how much more blood needs to flow first.
Even during the worst crises there are rallies. The market typically needs to get maximum oversold for a rally to occur during market turmoil. That will occur at the end of the day on Monday. We could be looking at another three down days before a rally by that measure. That said, it is fairly unusual not to see a bounce before we reach maximum oversold. We have yet to see a bounce during this decline so a bounce is not out of the question before reaching maximum oversold.
I have clearly been wrong by buying into this decline way too early. My plan is to tough it out until we get a bounce at which point I will likely cut positions if the EU still has their thumb up their ...
Gilead started aggressively repurchasing shares last Summer at $32. Analysts hated the stock and the downgrade parade began. Since then the stock jumped to over $40, outperforming both the market and its biotech peers by a wide margin. Yesterday, Gilead reversed its strategy and the stock gave up nearly half its gains since last Summer. Analysts loved the move and the upgrade parade began.
Carl Icahn recently won a board seat at Amgen. His fingerprints are all over this tender offer as it is the same strategy that Biogen underwent, another Icahn investment. Amgen will trade at a little over 9 times forward estimates after the repurchase. Analysts hate the strategy and are downgrading the stock to no end. They believe Amgen should make large acquisitions rather than returning cash to shareholders.
Carl Icahn's motivation is to make a profit on his investment. Analysts motivations are questionable as i-banking does not make money when cash is returned to shareholders but makes a fortune on takeovers. Who do you trust, Carl Icahn who made a fortune over the course of his life or Wall Street analysts who never managed money and are conflicted?
At current borrowing rates half the countries in the Eurozone are insolvent. Instead of trying to solve the problem, German officials make inflammatory statements on an hourly basis. I have been of the opinion that it will likely take a crisis but ultimately EU officials will act. The crisis is here and thus far we are not seeing any action. The longer they wait, the greater the action that will be required.
Gilead's $11 billion takeover will not allow them to repurchase shares any longer. Even though the stock now trades at less than eight times next year's earnings who is to say that management won't do the same thing again. Value investing is not as simple as finding cheap companies. One must also be confident management will not squander the money.
Normally I look for companies whose plan it is to return cash to shareholders. The tricky part of Gilead is that this was management's stated plan. I was actually considering buying Gilead this weekend based on Amgen's tender in two weeks. I decided to buy Amgen this morning based on the fact that Carl Icahn is on the board and it is likely the safest way ensure against dumb takeovers.
The chart below of traders using Rydex leveraged funds is close to where it was this Summer.
I was clearly wrong in assuming that the ECB and Germany would soften their stance after Italy did exactly what was asked of them. This morning, the ECB is once again doing the bare minimum as Italian ten year rates are only slightly lower than yesterday after blowing out the first half of the week.
I realized yesterday that the ECB was dithering and could have exited my new longs at a small gain. I told myself I would exit at the end of the day as I wanted a little more. We now sit nearly 30 S&P points lower and I now have a lot less.
At this point we are near the bottom of the recent range and I am not going to compound my mistake by selling here. I will look to use strength in the coming days to dispose of the longs I recently added. I plan to remain moderately long but unless the ECB acts more forcefully a more aggressive stance is uncalled for.
I believe the ECB will choose to buy like mad. Italy heeded the ECB by passing austerity measures and putting Mario Monti in charge. Greece passed austerity measures and backed off their referendum. Everybody did what was asked of them. The ECB has no excuse not to step in. Have a good night.
The S&P 500 has been stuck in a range for the past few weeks between 1220 and 1290. I believe it will be very difficult for the bulls to break out of this range without some sort of a resolution in Europe. I also believe it will be difficult to break down because when push comes to shove the EU will intervene.
My plan is to trim positions towards the top of the range and add closer to the bottom, while maintaining a net long position. The reason I want to maintain a net long position is because ultimately I believe there will be a rescue. Just don't hold your breath.
The market clearly wants to go higher but there is a limit to what it can do with the news so negative. We are nearing the point where the ECB will have to choose between printing or letting the EU disintegrate. There are clearly no buyers for sovereign debt and the problem will not get better by wishing upon a star. I believe they will choose to print but call it something else. Have a good night.
For the coming quarter Home Depot is guiding to same store sales less than 1% better than Lowe's. It seems the companies are beginning to perform more inline. In addition, Home Depot is slowing down its repurchase while Lowe's is accelerating its repurchase. Here is a link to Bill Ackman's slides on Lowe's. (hat tip Barbarian Capital)
I expected the ECB to defend spreads this week as a reward for reforms but spreads continue to blow out and the ECB continues to be reactive. I have come to realize that there is no method to their madness. They are simply waiting until Europe is on the edge of the abyss to react at which point they do the minimum to save it. The ECB, especially hawks in Germany, do not understand a simple concept. If banks try to delever and sell trillions of dollars of debt somebody needs to buy that debt. All the reform in the World will not buy that debt.
There are some pieces of good news in this. It is unlikely that Europe will be allowed to fall into the abyss at this point. The other piece of good news is that we are once again nearing a crisis point so this will likely spur the EU and ECB into action very soon.
- Sales seem to have stabilized.
- They are slowing down expansion and focusing on improving current stores.
- They are returning more cash to shareholders via repurchases.
I believe management at Lowe's are taking the right steps and have faith that the valuation gap between Lowe's and Home Depot will continue to close. The valuation gap has shrunk by over 7% since I put the trade on. I am pressing my bet and believe there is at least 20% more.
There are some worrying signs in sentiment such as Rydex trader positioning and the AAII survey, which are showing high levels of bullishness. However, more broadly the sentiment indicators are not showing excessive bullish sentiment. The 10 day moving averages of the put/call ratio's are showing high levels of puts.
We have seen higher levels of insider selling, IPO's and secondaries in recent weeks. This supply of new stock does not help the market but is pretty typical after a strong rebound. High levels of share repurchases and cash M&A help offset this supply.
I believe the appointment of Mario Monti as Italian Prime Minister takes the worst case scenario in Europe off the table for now. This should appease the hawks in Europe and buys Italy time. I believe the path of least resistance and maximum frustration is higher.
If we rally next week towards the upper half of the range I believe the odds would shift back to neutral. I would want to assess sentiment at that point to see where we stand to ultimately make a decision.
The sub-story today has been the complete carnage in many momentum favorites. The 39% drop in Green Mountain Coffee carried over to many other momentum names. Growth managers are having a very difficult year and there is a danger of a puke-fest. Have a good night.
The Goodrich deal offers a 4% spread and the deal is very likely to go through. In years past this deal might have been going at a 1%-2% spread. I am long Goodrich.
The oversold reading is not registering big on the charts, largely because a lot of the downside was seen in a small number of days. If breadth is flat today the reading would be -200, which doesn't seem very oversold for a 50 point decline in the S&P 500.
The reason I believe the oversold indicator works is that after 10 days of the market mainly going down many give up hope. I saw a big change in sentiment yesterday. I have been saying we would be oversold today for a week now. Yet, after a huge drop yesterday suddenly many took issue with this. While the oversold reading is not great, it is oversold no less.
I added some more long exposure late in the day as we will be oversold at the close tomorrow. My plan has been to slowly add exposure as we approach the oversold reading, which is exactly what I have been doing.
Unfortunately, the only way anything gets done in Europe is when they are looking into the abyss. Ultimately they are unlikely to allow the system to implode but that doesn't mean markets won't need to freak out first. Have a good night.
Fast forward to today and the stocks have traded places. Now Wall Street loves CVS and hates Walgreen's. I am once again focusing on the valuations and taking the other side of Wall Street.
If there were any doubt yesterday about Italy needing help from the EU, that doubt is gone today as Italian bond yields are trading well above 7%. It was a matter of time before we reached this point. We are now likely to see the EU demand reforms in exchange for a bailout. There is likely to be a song and dance but at the end Italy has little choice.
Vodafone trades at a 10% free cash flow yield and at almost an 8% dividend yield despite the durability of the business. I am not selling any of my position and will look to add on weakness.
There are many issues that bother me. With that said, I believe the market is more likely to head higher than lower into year end. Seasonality is strong at this time of year. While that may seem simplistic, seasonality works more often than it doesn't. Hedge funds are under invested, underperforming and my sense is that they are getting very anxious and are about to chase. Corporate profits are holding up and corporations are repurchasing stock and engaging in cash takeovers. Amgen initiated a $5 billion tender offer for its own shares yesterday.
The economic outlook is scary. But the stock market is not the economy and at the present I believe they are headed in opposite directions. I remain bullish and worried.
The street low estimate for next fiscal year (August 2013) earnings is $2.88. Before the Express Scripts dispute analysts were expecting $3.50. Even if this worst case scenario comes to pass the stock is now trading at a 12 multiple to a worst case scenario. Walgreen's also pay a 2.7% dividend.
Before the dispute Walgreen's traded as high as the the mid forties. The stock is now at a reasonable multiple to worst case scenario earnings, with a free call option embedded in the case where the dispute is settled. I still expect the dispute to be settled.
Spreads in Italy are blowing out again this morning and we are nearing the point where Italy will not be able to access capital markets. While this might seem like bad news, it is only under these conditions that I believe reforms will be passed. I believe that if Italy passes reforms, the EU will support Italy and the crisis will largely be over.
The seconds thing that would make me more bullish is if the market declined a bit next week and shook off some of the excess optimism we have seen build up recently. I want to get more bullish as this is generally a very good time of the year for the market. But the combination of excess optimism and a standstill in Europe are stopping me. Have a great weekend.
I have cited Rydex traders as showing too much optimism in recent days but it also seems that short term newsletter writers have turned optimistic, especially on the Nasdaq. From Marketwatch:
According to the Hulbert Financial Digest, the average recommended exposure levels among these timers is now 106 percentage points higher than where it stood a month ago. This is 12 percentage points higher than the week-ago level, even though the Nasdaq Composite Index is lower today than then.
Many of the intermediate term indicators are still stuck in neutral. The Investors Intelligence numbers are showing low levels of bullishness, as are positioning surveys such as the ISI survey. Hedge fund letters seem to confirm the high levels of caution.
All in all sentiment is painting a mixed picture. I would normally put more weight on the intermediate term sentiment but it is difficult to imagine hedge funds buying into the market in a big way without a resolution in Europe. I would feel more comfortable about increasing exposure if we would get a decline that would temper the optimism from short term traders.
The good news is that the Greek's bluff was called and it now appears that they are falling into place. The remaining hurdle is getting Italy to reform, which I believe they eventually will. We are now roughly half way through this correction in terms of time. If we can get another decline early next week, we will be set up to rally again.
Ideally what I would like to see is some sideways movement and possibly a test of yesterdays lows. This would achieve two things. Some newfound bulls will get shaken out and more time will pass. A correction is both a function of time and price and this correction is only 3 or 4 days old, depending where you start to count. We have had a correction in price, now it would be nice if some time passed.
Tactically, I remain net long but would like to see how the correction progresses before adding back the positions I shed into last week's strength.
The best thing the bulls have going for them is that earnings have held up despite the economic weakness. Corporations have been using much of the cash they earn to repurchase shares and for cash takeovers, which helps markets. As long as this continues it is unlikely the market will see much downside and this could spark a year end rally. We have been seeing earnings reductions from the more cyclical companies, but overall earnings are holding up well, for now.
The other factors that favor the market are seasonality and investor positioning. We are headed into the strongest months of the year. Despite the fact that everybody knows about seasonality and markets are supposed to be efficient, seasonality continues to work more often than not. While investors have recently increased equity allocations evidence suggests that investors are still positioned conservatively. The NAAIM survey, Investors Intelligence, AAII and ISI surveys all show equity allocations below average.
Unlike the Greek issue, a solution to Italy's borrowing problems must be found. Reading between the lines, the EU is demanding reforms out of Italy in exchange for a bailout. These reforms are bitter pills to swallow politically. The EU is asking that Italy raise the retirement age. Older people tend to vote so passing this will not be popular. They are asking to reduce the number of politicians so essentially the politicians are being asked to vote their jobs away. They are also asking that lifetime employment rules be abolished, which will anger unions.
These reforms need to be done but are likely to cost the politicians who pass them their jobs. If Italy ultimately lives up to its end of the bargain I believe the EU will live up to its end of the bargain, even if it means using the ECB. Ultimately this is the way I believe it is most likely to play out. But it will be a bumpy road and it is not a sure thing.
During the entire run up the majority of market participants were fighting the rally. By late last week it seemed the majority of market participants had finally embraced the rally. Rydex traders were positioned aggressively, the AAII survey showed individuals as optimistic as they have been all year and talk of a year end rally with new highs grew loud.
We find ourselves this morning with the market down nearly 6% from its highs on Thursday, with the consensus once again caught leaning the wrong way. This market has absolutely brutalized the consensus.
Sentiment analysis has been the only way to catch the twists and turns in the market. Right now it seems the crowd is caught bullish. From a pure sentiment standpoint it is likely too early to try and catch a bottom, although 70 S&P 500 points in less than 3 days could lead to a bounce.