One More Thing

One more thing. I sold the balance of my Amgen position and bought BMC. Will give a more detailed explanation tomorrow.

Closing Thoughts

The short term is a tough call as the S&P 500 is already up by nearly 90 points this week. That is the type of move we usually see during a quarter, not three days, making it very tough to chase. At the same time it seems that the crowd has been caught completely off guard by this move. We are not yet overbought (time wise) as the rally is only 3 days old and sentiment is not extreme.

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.

Sold 1/2 of Amgen Position

I sold half my Amgen position. I remain bullish on the name. According to Goldman Sachs research, stocks typically outperform by about 2% in the week heading into a tender offer. The Amgen tender is December 7. With this move I have roughly reduced my net long exposure back to where it was before last week.

Meaningless

I believe the coordinated action of Central Banks is meaningless in and of itself. This crisis will not end until the ECB prints money. They might print by lending to the IMF or EFSF and calling it something else, but print they must. Maybe this is a signal to the market that they will do what is necessary but the crisis is not over.

 

The Song Remains The Same

I have not posted much today because my viewpoint has not changed. I am confident that EU leaders will not allow the Armageddon scenario to occur. The only question is how long they will procrastinate. One would think they would want to have this resolved before Christmas.

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.

 

Slowly Selling

I am slowly selling down net long exposure added last week. I am remaining net long, just not as aggressively.

Buying Time

The bulls have some time due to the oversold reading and extreme negative sentiment we saw late last week. That does not mean we will not see any weakness this week, only that weakness should be limited. I would be surprised to see us fall apart the way we did last week.

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.

Shocker

It is not quite a shocker that the worst Thanksgiving week since 1932 has led to a rebound. I would be surprised if the market did not try to rally some more during the balance of the week. A deep oversold reading such as the one we just had should be good for at least a few days. If European politicians can come up with a more concrete plan that involves the ECB we should see more than just an oversold rally. Have a good night.

Nothing Has Changed

There were no ground breaking changes this weekend in Europe. The position of Germany still is that they are looking for EU governance over national budgets. Germany will need to give something in return, likely dropping their objection to ECB involvement. None of this is news.

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.

Partial Profits

I took partial profits on last weeks adds by writing naked weekly SPY Calls.

Paid To Suffer

The stock market does not trade cheaply when there are sunny skies and few worries. If one wants sunny skies one has to pay for sunny skies. The time to get bargains is when everybody is well versed in the woes of the world. The only way to make money this year has been to buy when the world was ending or short when the outlook has been sunny.

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.

 

Turkey Day

The events in the EU continue to be a disaster. There is no other way to describe it.  The good news is that we will be oversold at the end of the day on Monday. Even during these treacherous last few months oversold readings have led to rallies. Have a great weekend.

Walgreen's Is A Deal

On Wednesday, there were rumors of an Express Scripts deal with Walgreen's and Walgreen's surged.The stock is continuing higher today. While there has been no confirmation of a deal there has been no denial either.

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.

Just Print It

Everybody knows what the answer to the problem in Europe is. The ECB must print a couple of trillion Euros and purchase PIIGS debt with it. There are no other buyers for these bonds as banks are delevering and private investors have no interest. Even the Vatican made a statement saying this is the only solution.

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.

Who Wants to be Long With Europe Open

It seems nobody wants to be long heading into Thanksgiving with European markets open both tomorrow and Friday. This likely means that it will take really bad news to send us down on Friday as everybody is hunkered down. The only way to make money this year has been to buy into nastiness and its pretty nasty out there. I added quite a bit on the long side and hope I'm not the Thanksgiving turkey come Friday. Have a Happy Thanksgiving.

Walgreen's Rumors

There are rumors swirling about a Walgreen's settlement with Express Scripts. I hope its true as I have a healthy position in Walgreen's and believe the stock is worth over $40 with a settlement. CVS plunged on news of the settlement. I wrote the January $37 CVS puts as I believe CVS is worth over $37 regardless of the Walgreen's dispute. I sold my CVS position a few weeks ago when it popped above $38.

Added To Vodafone

After trimming my Vodafone position a few weeks back I have added to it today. At a greater than 8% dividend yield and greater than 10% free cash flow yield its difficult to see how one loses in the long run with this stock.

Sentiment Is Finally Extreme

Despite the huge drop in the past week many were looking for a bounce. Until this morning. Sentiment seems to have taken a turn for the worse this morning. There is heavy put buying and lots of gloom and doom. Sentiment might be extreme enough to lead to a Thanksgiving rally.

Assuming The Worst

My belief has been that when push comes to shove the EU would not allow a collapse to occur. I have clearly underestimated how bad the EU would allow the situation to get before acting. If the EU acts forcefully we will be off to the races. However, this post will look at what happens assuming they continue to twiddle their thumbs.

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 ...

 

Carl Icahn or Wall Street Analysts

Amgen and Gilead both fall into the large cap biotech value category. Recently, they have taken divergent paths as Amgen is returning capital to shareholders by initiating a dividend and a $5 billion tender offer. Gilead, on the other hand, announced an $11 billion acquisition of a company that won't show profits until 2015 and suspended share repurchases. Wall Street analysts loved Gilead's takeover and there have been too many upgrades to count. Amgen has been downgraded three times since their tender announcement.

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?

 

Set Up For A Bounce But ...

The S&P 500 is set up for a bounce after dropping by 70 points in four days. That type of decline almost always leads to a short term bounce. Unfortunately, the news coming out of Europe keeps getting worse.

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.

The Barton Biggs Indicator

The Barton Biggs buy signal just went off again. It picked the bottom this Summer and last within a couple of percent. Barton Biggs is generally bullish. When he turns bearish it usually means sentiment is at an extreme. From Bloomberg:

A Value Investors Nightmare

Gilead's $11 billion takeover of a money losing company is a value investors nightmare. Gilead had all the makings of a value investment. It was trading at less than 9 times next years earnings and management told investors they were going to return cash to shareholders via repurchases. Many of the top holders of the stock are value investors and the stock has been coming up on many value screens.

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.

Long Amgen

I have taken a long in Amgen. The stock has completely given up its gains after announcing a $5 billion tender offer for its own shares, which expires on December 7. Gilead announced an $11 billion cash acquisition in the biotech space today which should boost the sector as well.

Rydex Traders About Face

I have been mentioning the Rydex trader positioning as the most worrying indicator recently. On Thursday and Friday Rydex traders did an about face and positioned themselves much more conservatively. With permission from SentimenTrader.com the Rydex charts are shown below. While not at the levels seen this Summer Rydex traders have pulled back greatly in the past couple of days. They are now positioned quite conservatively compared where they have been the past couple of years, except for at the extremes of this Summer and last.



The chart below of traders using Rydex leveraged funds is close to where it was this Summer.



 

 

Heading Out

I am heading out for the weekend. Given that the ECB has stabilized the sovereign debt markets and that the S&P 500 has already dropped by 30 points, I would be surprised if we dropped much more today. We are likely close to our low for the week. Have a great weekend.

The Bare Minimum

At the beginning of the week I raised my long exposure for two reasons. Seasonality is strong between now and the end of the year. Next week, the week before Thanksgiving, is the seasonally strongest week of the year. The second reason I raised my long exposure was that I believed Italy would be rewarded by the ECB for passing austerity measures and appointing Mario Monti.

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.

The Excrement and The Fan

It seems that we are reaching a critical point with sovereign spreads blowing out and markets beginning to unravel. The ECB will have  a simple choice in the coming days a) buy like mad OR b) allow the system to melt down.

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.

Stuck In A Range

The indicators I look at point to a mixed picture in terms of sentiment, while seasonality is a major positive. The Investors Intelligence numbers were a positive for the bulls until now, but an increase in bulls and decrease in bears this week has turned this indicator neutral. Normally, neutral sentiment at year end is a positive but I believe the worsening situation in Europe offsets this.

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.

Print or Die

The news has been terrible for the past two days as sovereign spreads are blowing out. Safer countries like Austria and France are seeing their spreads blow out as well. Despite all this the market is hanging in and is still within spitting distance of recent highs.

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.

Lowes VS. Home Depot

Home Depot trades at a greater than 20% premium to Lowe's on both a forward free cash flow multiple and forward EV/EBITDA multiple. Home Depot has been showing same store sales 3% better than Lowe's for the past year.

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)

Psycho Killers

I thought the ECB was being calculated last week when they allowed Italian spreads to blow out. As spreads were blowing out they said they would not continue to buy bonds unless there was reform. It seemed like they were strong arming Italy into reform. They got their way as Italy passed austerity measures and PM Berlusconi handed the reins over to Mario Monti.

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.

 

Everybody Has Figured It Out

We have had a recurring pattern recently of news that "Europe Is Saved" leading to failed rallies. It seems that investors have learned their lesson and are instead selling today's "Europe Is Saved" news. We are seeing a lot of put activity as investors are betting on a return of turmoil. I believe the heavy put buying on such a small drop means that the downside is limited.

Like What I Heard

The Lowe's conference call was music to my ears:

  • 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.

Now Longer

I added to my net long position this morning . A couple of weeks ago I reduced my long positions into strength. I have used the recent weakness to add to positions.

Bulls Advantage

I learned the hard way time and time again that it rarely pays to fight the market at this time of the year. In the past 10 years the market has not been down once in the period between Veterans Day and New Years. There are some negatives but not enough to tilt the odds in favor of the bears.

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.

This Is Huge

I believe the appointment of Mario Monti is a watershed event. With Monti's appointment Italy is giving into the demands of the EU. There are no more excuses not to save Italy. I don't know if this is a kick of the can nor do I care for now. The worst case has been taken off the table for a while. This should buy the EU at least enough time for a year end rally.

Swinging

The market is providing huge swings both up and down. Many are complaining about the  market but I prefer to take advantage of these opportunities. I like to complain as well but I just complain that I'm tired at the end of the day. If the market were efficient I would not have  a job and you would not be reading this blog. Have a good night.

Covered Calls

I have written covered calls expiring next week against my adds from Wednesday. We are coming up against the top of the range.  The top of the range should be a  hard nut to crack.

Confounding Market

Last night I wrote that a down day today would set us up for a nice rally next week. Of course this market does not want to make anything easy and we are rallying this morning. I still believe the bulls have a slight edge next week given the oversold readings. Some of the excess bullish sentiment has been worked off in the past couple of days as well.Far few people are calling for a year end rally, which is a good thing.

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.

Trading The Odds

I recently came across a blog called Trading The Odds. It is a great free resource.

Nomentum

After a nasty day like yesterday there is generally a rebound, which is what we have seen today. I don't have a strong opinion about where we will go next but a down day tomorrow would set us up for a rebound next week. At the end of the day tomorrow the put/call ratio will give us an oversold reading as well.

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.

 

Still Long Lowes

I remain long Lowe's and short Home Depot based on the fact that on a forward price to free cash flow basis Lowe's is 30% cheaper. In the past two days both Bill Ackman and Barry Sternlicht revealed that they are long Lowe's at investment conferences. These are not the first value investors I have heard about that are buying into Lowe's. Both Lowe's and Home Depot report earnings next week.

The Prop Desk

Prop desks were the largest players in the merger arb world up until recently. Both in the US and Europe proprietary trading has been cut back drastically. This has left meaty spreads on larger deals where there is simply not enough money to close the spreads.

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.

More On Oversold

I received a lot of questions yesterday about the upcoming oversold reading. The reason we will be oversold at the end of the day today is because we will be dropping the last big number off of the 10 Day moving average of the NYSE Advance-Decline line. Today, we drop the big day after the European Summit, where the S&P 500 surged over 40 points. In the early part of next week we will drop some very negative numbers.

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.

 

Added Exposure

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.

Trading Places

I originally bought CVS in March when the stock traded at around $33. At the time Walgreen's traded at about $42. CVS was by far the cheaper stock but Wall Street loved Walgreen's and hated CVS. The explanation they gave was the quality of management.

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.

Added To Walgreens

I have added to Walgreen's this morning. This is both a call on the stock and the market. Walgreen's was downgraded again . I believe the Express Scripts news is baked in at this point and we are nearing some sort of a capitulation point. Additionally, as I wrote earlier we will be oversold tomorrow. I will be looking to leg into the market on weakness.

Heading Towards Oversold

Tomorrow will be the tenth day of this correction, which means we are nearing an oversold reading.  At tomorrow's close we will be oversold for the first time since early October. Typically the first oversold reading after a strong move higher is buyable. If the market were to decline through tomorrow, it would set up a decent risk/reward trade and I would likely increase my long exposure.

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.

You Know What To Do

Time to dust off last year's year end playbook. In case you forgot:

Vodafone A Long Term Value

Vodafone produced solid earnings today in a tough European environment. I believe this shows the recession resistance of the business. I don't believe people will part with their cell phones en masse no matter how bad the economy gets. A cell phone is a necessity these days and not a luxury.

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.

Italy Coming To A Head

It seems the situation in Italy is coming to a head (no pun intended Mr. Berlusconi), with the Italian 10 year at 6.77%. Italy is bankrupt at these interest rates and now needs the help of the EU. It is only under these conditions that there is a chance for reform in Italy. The stakes are high as  a move to reform will likely be greeted by a big rally. While a continued game of chicken will likely be unpleasant for markets. I believe Italy will ultimately choose reform. Hopefully, soon.

Not A Perfect World

The current setup in the market is far from perfect. There are numerous issues that are bothering me. It seems short term sentiment among traders is a little too bullish. Rydex traders added yet again to their longs yesterday and are positioned quite aggressively. Short term market timers as measured by the HNSNI are very bullish. Italy has yet to agree to the reforms that the EU is asking for. Government spending in the US  is set to decline in the coming months. I could go on but you get the picture.

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.

Lucky Break

It looks like I added to my long exposure at precisely the right time. I had no clue we were about to rip higher. I thought a decline on the seventh day of a correction was probably a decent point to start adding some long exposure. I believed we would see lower prices but prefer to leg into positions in case I'm wrong. This is a perfect example of why I leg into positions. Have a good night.

Slightly Longer

I am slightly longer now than I was coming into the day. We are now on day seven of this correction and while we could correct more I believe the bulk of the decline is now behind us. I will look to add more if we correct further this week.

Why I'm Sticking With Walgreen's

Thus far I have been dead wrong about Walgreen's. I thought they would have settled by now with Express Scripts and they have not. However, at this point I believe the stock is pricing in a worst case scenario.

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.

Sold CVS

I have sold my position in CVS as it has had quite a run but remain long Walgreen's in the drugstore sector. I covered some shorts to maintain my net long exposure

Still A Mixed Picture

The picture continues to be mixed from both a fundamental and technical standpoint. The good news is that we might get a resolution this week on both counts. Longtime readers know that I believe corrections are largely a function of time. Today is the seventh day of the correction, so if the correction continues through Thursday we will finally be oversold. If the correction continues that long we might see some of the stubborn bulls give up and relieve the overly bullish short term sentiment as well.

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.

 

Two Things That Would Make Me Bullish

One of two things need to occur in order to make me more bullish. From a fundamental perspective I would like to see Italy make reforms. If Italy were to agree to reforms than I believe the EU would come to its aid. Right now we are witnessing a high stakes game of chicken where Italy refuses reform as Italian bond yields climb. If Italy were to agree to reforms I would become very bullish.

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.

A Mixed Picture

It has been hard for me to gauge sentiment recently as indicators have been all over the place. The shorter term gauges are pointing towards investor optimism while the intermediate term gauges are pointing to more cautious investors.

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.

Option Indicators

The option indicators are not showing any signs of complacency. Even on an up day like today we are seeing a lot of put activity. The VIX remains at 30, even though the market is well off its lows of a few weeks back. There is good reason for this but its hard to argue that option indicators point to complacency.

Falling Into Place

There is both good and bad news to report. The bad news is that Rydex traders yet again increased their net long exposure yesterday and their bullishness is approaching an extreme. This would be more concerning if other indicators were at extremes, but they are not. Additionally, Italian government bond spreads continue to blow out as PM Berlusconi is unable to secure reforms.

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.

Rydex Traders Stubbornly Bullish

Now that we are getting our bounce, I wanted to focus on an item that is of some short term concern. Rydex traders have remained stubbornly bullish as the market has corrected in recent days. This data point does not argue for a quick end to the current correction.

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 Bull Case

The market has had a nasty two day spill and the odds favor some sort of a relief rally today. I have discussed the problems in Europe at length in recent days and today will instead focus on the bull case.

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.

We Should Bounce

After two nasty down days the odds now favor some sort of a bounce tomorrow. We are not yet oversold so if we do get a bounce tomorrow we are back in no mans land. The reason we are not yet oversold is because today was only the second day of the decline. Have a good night.

Italy Holds The Key

I believe that the EU can deal with whatever happens to Greece. If Greece did end up defaulting on all of its debt it would be painful but not insurmountable. I don't believe Greece will ultimately vote for drachmas over Euros but stranger things have happened.

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.

Print or Die

The spread versus bunds that the the European rescue facility, the EFSF, is borrowing at has blown out to a record 147 bps. This is all happening before the EFSF needs to borrow in order to fund Italy. It is not going to happen. The EFSF will not get funded without the ECB. The EU has a simple choice, print or die. ht @credittrader



 

A Consensus Killer

In early October bearishness hit levels not seen since the Bear Market of 2008-2009. The market proceeded to rally 20% in the span of a little over three weeks, creating great anxiety as most market participants were either run over or left behind.

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.