Stock Of The Day: Xerox

There are many great investors out there that I admire but whose stock picks I'm not attracted to. Seth Klarman comes to mind as I think he's likely the best value investor of our time but when scouring his 13-Fs I have never found something I wanted to own. On the other hand I have gotten a couple of ideas from David Einhorn as his common sense, value picks are right up my alley. Xerox has popped up once again on David Einhorn's 13-F. I looked at Xerox last year when it was a lot higher but decided to give it another look since the price has gone down so much.

The thing I like about technology companies is that the balance sheet is generally simple so I can focus on analyzing the business. Unfortunately, that is not the case with Xerox as they have large pension liabilities and they finance receivables. Bulls argue that one should ignore the finance related debt because the receivables are mostly short term. For the purpose of this analysis I will ignore the finance related debt but I will count the pension liabilities as debt. That gives Xerox a market cap of roughly $11 billion and an enterprise value of $16 billion. Counting the finance related debt would add $6 billion to the enterprise value.

Xerox receives 55% of its revenue from printing related hardware and the other 45% from consulting. Xerox is expected to produce $1.75 billion in free cash flow in the coming year.

What I like

  • The price to free cash flow is a very attractive 6.3 times.

  • The enterprise value to free cash flow is also decent at 9.2 times.

  • They are returning free cash flow to investors and paying down debt.

  • Some of their consulting businesses definitely deserve a higher multiple.

What I don't like

  • Printing is in a secular decline, albeit very slow. Price increases and increased market share could keep revenue steady to slightly higher at best.

  • 1/3 of their services business is printing related. A large portion of their services business is not high value, high margin business.

  • An outsized amount of revenue from services is government related. With a trillion dollar deficit and municipalities running deficits I am wary of any business that sells to government.

  • The complexity of the balance sheet is not a plus.

Its not difficult to see what David Einhorn sees in Xerox, especially because he likes owning cheap options. At 6 times free cash flow this should be a win as long as Xerox is able to keep cash flow steady or even if it declines modestly. Unfortunately, there are too many things that can go wrong here and there is a decent amount of leverage involved so I will take a pass.

The Blogger Who Cried Wolf

The turn of the month always adds an interesting dynamic to the market. It tends to have a positive bias and with the powers that be trailing the market handily year to date I would not be surprised to see them defending positions today. That said and with the risk of sounding like the boy who cried wolf, I am anecdotally seeing more and more reasons to be cautious.

  • There is now broad acceptance to the idea that the market will not pull back or that its just not worth it to try and anticipate one. The most often cited reason is that everyone else is looking for a pullback.

  • Even the bears are too scared to short. Yours truly included. If investors ever find a reason to sell there will not be much support from bears looking to cover shorts.

  • A blogpost that gently told readers they were idiots if they weren't making money in this market was widely circulated yesterday.

  • Another slew of secondaries were announced last night as bankers continue to roll out the supply

  • I almost didn't write an opener today because I fell like such a schmuck being cautious.


Random Thoughts

  • I have been toying with the idea of adding to my hedges all day but ultimately decided not to because the  turn of the month is upon us.

  • There were a slew of secondaries announced after the bell yesterday. This is the second week in a row we see bankers rolling out the supply.

  • The LinkedIn lockup ended yesterday and it seems insiders want to cash in some of their funny money for real world spending money.

  • There has been a lot of "I'm bullish cause everyone else is looking for a correction" talk recently.

  • What do readers think of the new "Stock Of the Day" feature?

  • Does the fact that I'm hesitant to add to my hedges mean that we'll finally see a pullback that lasts more than an hour?

Stocks Of The Day: Lowe's and Home Depot

Lowe's and Home Depot are the two dominant home improvement retailers. After a lovefest with Lowe's a decade ago investors have taken a liking to Home Depot in recent years. Home Depot has greatly outperformed over the past few years and investors are once again getting ahead of themselves. Home Depot is trading at a 25% premium to Lowe's based on expected 2012 free cash flow. Over the years the balance of power has see sawed between these two retailers. I don't believe that either retailer has a built in advantage that justifies such a large premium.

I believe that there is a catalyst in place that will significantly close the valuation gap. Yesterday on the Lowe's conference call Lowe's said:
Our guidance assumes approximately $4.5 billion in share repurchases for 2012, spread evenly across the 4 quarters.

The market cap of Lowe's is $34 billion, meaning that Lowe's is guiding to a repurchase that amounts to 13% of shares outstanding this year. I believe that should do the trick in closing the valuation gap. At a minimum I believe my downside is protected in that the gap should not widen given this enormous buying.

I have been long Lowe's and short Home Depot for over a half a year. I have watched a 10% profit disappear into what is now almost a 5% loss. My catalyst all along has been an aggressive Lowe's repurchase, which they have been guiding towards all along. Unfortunately, they were not following through with actual aggressive buying.  This guidance is now clear as day and has prompted me to increase my position.

The Never Ending Rally

In many ways this rally has the same feel as last year's rally at around this time. Despite many indicators flashing that have consistently led to pullbacks, the market continues to drift higher. I have seen a host of studies showing that the current rally is one of the rarest ever in that there are absolutely no pullbacks. I believe these moves that were once rare events are becoming more frequent because quants, hedge funds as a group and day traders all use momentum strategies. The question becomes how does one deal with what seems to be a change in the way market trades.

While I have not altered my longer term value strategy, I have adjusted my trading strategy to allow for these bigger moves. Recognizing the change allowed me to stay invested this year for a lot longer than I did last year even though I still sold too early. I have also avoided going net short this year, which has saved me money.

Recognizing that there has been a change in the way the market trades and making adjustments has helped me. But sticking to my basic trading strategy of buying extreme pessimism and selling extreme optimism has helped me even more. When most were puking up positions this Summer I was able to take advantage. I believe it is a mistake to completely change one's strategy even if this is a new normal. One should make certain that their strategy could withstand these types of moves but constantly changing strategies is a recipe for disaster. One must accept the fact that there is no strategy that will make money all the time.

Bought Back SPY Puts

I bought back the SPY puts I sold earlier.

Stock Of the Day: Vodafone

Vodafone is a mobile telecommunications service provider with operations across the globe. The mobile telecommunication business should grow steadily over the coming decade as smartphone penetration is still low and data usage is set to mushroom.

Vodafone trades with a 7.5% dividend yield and a greater than 10% free cash flow yield. In many ways Vodafone is similar to a utility but with better growth. It is unlikely that people will give up their cellphone service in even the worst economy as a cellphone has become a necessity rather than a luxury. Utilities currently trade at about 15 times earnings and with a 5% dividend yield. By this measure Vodafone should trade 50% higher, even ignoring the better growth it offers.

As is always is the case when a stock trades cheap analysts will offer a host of reasons why this should be the case. I want to debunk these reasons one by one. A popular way to justify the low multiple is to compare Vodafone to other European telecoms that trade at low multiples. There are a number of differences between Vodafone and other European telecom stocks. Vodafone is a pretty much a pure wireless play while most European telcos have large legacy landline businesses. The second major difference is that Vodafone is a global company that owns 45% of Verizon Wireless in the US and businesses in emerging markets such as Africa and India. Within Europe they have large businesses in Germany and the UK.

Many argue that the European wireless business will not grow due to the economy and regulation. European governments have started to restrict what service providers can charge for roaming and MTR. I view this as a one time modest decline in revenue, after which growth should resume. If all telecoms cannot make their money on roaming and MTR there will be less price competition on service. In a decade from now I expect that most Europeans will have smartphones with data plans regardless of the economy.

Every time I look at Vodafone I am shocked at the fact that I am able to get such a great business for such a low price, which is why Vodafone is my largest position. I'm getting paid a hefty 7.5% dividend while waiting for the stock to appreciate by 50%.

Hedging The Hedge

I wrote the weekly SPY 134 Puts against my SPY short. This slightly lessens my hedge.

A Change In The Supply/Demand Equation

A few weeks ago I wrote about how I measure the supply/demand of stock from corporations. At the time the equation favored the bulls. This seems to be changing. The chart below from Thomson Reuters via Barron's shows that insider selling has picked up steam recently.

According to the Wall Street Journal Markets Data section we saw $3.5 billion in secondary offerings last week, following many months with few secondaries. These are not eye popping number by any means but it shows that insiders and bankers are starting to feed the ducks. This is an incremental negative.

Don't Chase Hot Markets

I made my biggest mistake last year when the market was soaring as it is now. I could not find anything to buy that met my criteria so I lowered my standards and bought Hewlett Packard. Distressed Debt Investing wrote an excellent piece today about chasing during times when the market is hot. I found the following especially true. From Distressed Debt Investing:
The corollary to an institutional investor reaching down for yield in Klarman's quote above for an individual investor is buying a marginally cheap, marginally out of favor big cap.  Don't be tempted to settle for marginal.  Patience is the HARDEST part of allocating capital.  But those that practice it will often be rewarded when everyone else is running for cover.

Stock Of the Day: Yahoo!

Dan Loeb has gone activist on Yahoo! and is pressing them to monetize their non-core assets or sell themselves completely. A long list of activists before Dan Loeb have tried their hand on Yahoo and walked away with steep losses including Carl Icahn and David Einhorn. The difference is that Dan Loeb appears to be successful in wrestling the company away from the board. This has prompted me to take a look at Yahoo.

Yahoo is a classic sum of the parts investment. The bulls on the stock come up with a sum of the parts value in the low 20's. I prefer a more conservative estimate, especially when it comes to these sum of the parts investments and come up with a value of $18. There is decent upside risk to this estimate if all goes right.
Cash: $1.50

+Yahoo Japan: $3

+Alibaba and other Chinese assets: $5.50

+Yahoo operating company: $8

=Total company value: $18

Yahoo! seems well on its way to recognizing this value as Dan Loeb will likely be successful with his board nominations. I believe the biggest risk is the Alibaba assets. I will not mince words. The head of Alibaba, Jack Ma, is a crook. Jack Ma stole or tried to steal the Alipay business from Alibaba. The good news for Yahoo shareholders is that Jack Ma needs Yahoo's portion of Alibaba in order to do an IPO in China. An IPO in China is the way Jack Ma will be able to monetize his ownership of Alibaba.

Ultimately, I don't want to invest in something that requires me to trust a crook, even though it is in Jack Ma's best interest to buy out Yahoo!. Dan Loeb paid around $12 a share for Yahoo!, which means he received the Alibaba assets for free. If I were able to pick up the shares for closer to that price I would be more likely to purchase Yahoo!.



Blue Skies

Greece is solved, earnings were fine and the economy seems to be humming along. Add to that the fact that there appear to be no sellers in the market and this seems like the green light to take risk. Readers might be wondering what is my major malfunction and why is it that I am refusing to participate? Do I not like making money?

The price that has been paid for these blue skies is 28%. That is the amount that the S&P 500 has risen since the October lows, when the market was being priced for a repeat of 2008.  In mid-September I shared the following quote from Howard Marks:
“… most people say, ‘We’re not going to try to catch a falling knife; it’s too dangerous.’ They usually add, ‘We’re going to wait until the dust settles and the uncertainty is resolved’.

The one thing I’m sure of is that by the time the knife has stopped falling, the dust has settled and the uncertainty has been resolved, there’ll be no great bargains left. When buying something has become comfortable again, its price will no longer be so low that it’s a great bargain. Thus, a hugely profitable investment that doesn’t begin with discomfort is usually an oxymoron.”

- Howard Marks (h/t Distressed Debt Investing)

I will ask readers to think back to every crisis they have witnessed in the stock market whether it be the Asian crisis, the LTCM crisis, 9/11, Lehman brothers etc.. Eventually, all of these crises turned out to be buying opportunities. Now think back to every period like the current one where it seemed the market was bullet proof. How did they end up? Didn't it feel that way a year ago en route to a 20% collapse?  This is the reason I am cautious when everything seems great and this is the reason I was buying when it seemed the world was ending a few months ago.

I am not predicting a re-run of last year. I acknowledge the possibility of a continued grind higher as valuations are not stretched. I just don't want to pay for blue skies and am willing to accept the consequences of possibly missing out on a great party. If market participants sober up I just might buy myself a few drinks.


Stock Of The Day: Boston Scientific

I spend a good part of my day researching new ideas. I don't invest in the vast majority of the ideas I research and readers never hear about it. The market has been in a slow grind higher and there has been little new to write about. I am going to try something new and outline a stock every day regardless of whether I decide to invest in it or not.

The stock I will outline today is Boston Scientific, maker of stents and other medical devices. I decided to look at this stock because David Tepper of Appaloosa started a position in the company in the most recent quarter. From a valuation standpoint it is not difficult to figure out why Tepper took a position in the stock. The stock trades at nine times expected 2012 free cash flow and less than eight times expected 2014 free cash flow.

What I like:

  • Price to free cash flow of only 9 times.

  • Company has been returning cash to shareholders via repurchases and plans to continue to do so.

  • Nice expected free cash flow growth over the next few years.

  • Little economic sensitivity.

  • Diversified product line. Not dependent on a single product.

  • The assumptions embedded in their earnings  projections seem to be modest.

What I don't like:

  • The company is carrying quite a bit of leverage with $4.25 billion worth of debt on a market cap of $8.6 billion.

  • On an enterprise value (debt + equity) to free cash flow basis the company trades close to 14 times 2012 free cash flow estimates, which seems in the realm of appropriate.

  • The businesses they are in are very competitive and the moats are weak.

  • The biggest payers in healthcare are governments, which are in bad shape.

  • While assumptions are now modest, BSX has a history of missing.

My Conclusion:

David Tepper is likely looking at this stock as a cheap levered option, which is why he only has  a small position. I understand why people put cheap options in their portfolio. David Einhorn seems to do the same thing, with an example being Sprint. While I am attracted to these type of plays I ultimately usually take a pass and will this time as well.

Short SPY

I am adding to my hedges via a SPY short.

Closed Out MMI

I closed out my MMI position for a miniscule gain. Generally, once a deal gets US and EU approval the other approvals come quick. The fact that China has still not approved the deal is making me a bit nervous. There is no rational reason for the deal not to close but for such a small gain I no longer want to take the risk.

Buy The First Real Dip

I am not numb to the feeling that most have trading this market. It seems bullet proof. But I do not trade and invest based on my feelings. Given how long this rally has lasted without a correction and the level of complacency, the risk/reward is poor. I believe the best case scenario is that we grind out a few more percent only to see it taken away when we finally do get a correction.

The first real dip (more than 3%) will likely be bought by those who are lagging this rally and bulls who sold out their positions. It will only be on that next rally where the bears will have  a chance at a better top.  I remain hopeful that we will finally see a correction and plan to be a buyer of that dip if it ever occurs.

In Agreement

A few strategists whose opinion I value seem to be in agreement that the market is due for a rest but not a major top. Last night I posted a video of Tom Demark, who has made some pretty good against the grain calls in the past year.  He is looking for a 5% correction but not a collapse. In his latest weekly missive Jeff Saut takes a similar stance saying that he is cautious but not bearish. He says he could see a 5% correction or he could see a sideways correction but he does not see a complete collapse. Tony Dwyer of Collins Stewart is looking for a 4% correction before a larger 10% gain.

My view is similar to these strategists in that I too believe that we are unlikely to collapse but are likely to correct somewhat. There are imbalances out there and any one can creep up at anytime so I am not writing off the possibility of a bigger decline, but I don't believe one is imminent. Depending on one's time frame this can be taken in different ways. I would like to avoid a 5% decline if I could and am being more aggressive about hedging and cutting market exposure. I do consider the longer term which is why I have been reluctant to go net short. Additionally, I believe that the  market is roughly fairly valued at current levels. To an investor with a longer time horizon a 5% correction might not matter.

I would grow more bullish on the market if we did get some sort of a correction. If we traded sideways through the middle of March I would likely take some long trading positions for the seasonally strong late March to mid-April period. At current levels I believe that one risks a 5% correction and the outside possibility of a systemic event.

Tom Demark's Latest

Random Thoughts

  • Wouldn't it be ironic if the market puts in a top the day Greece is actually saved (for a few more months that is)?

  • Tom Demark is calling for a top in the next day or so. I don't know exactly what Mr. Demark does, but more often than not I am in agreement with him. I assume he uses some mean reversion strategy.

  • I respect a strategist like Mr. Demark who makes big out of consensus calls.  This is in stark contrast to most strategists who get bullish after the market is up and vice versa.

  • LinkedIn has a lockup expiration on Monday. In the glory days of the internet bubble, the lockup expiration was often the end of the line for fantasy priced companies.

  • LinkedIn reminds me of a  story back from the internet bubble. Their used to be a  stock, I think the symbol was CMRC. The company had something crazy like a $30 billion market cap but only 5% of the shares were trading. I knew it was a slam dunk short so I went in full force the day before the lockup expiration. Back then companies used to make a big press release the day of the lockup expiration so insiders can dump the stock. I shorted the stock at 470. It ran to 500 squeezed me out on its way to 530. By the end of the day it was back to 470 and then started its collapse to zero. I actually lost money shorting it.

  • I don't think LinkedIn is a zero but I think its value is closer to zero than to its current stock price.

Added To Symantec

I added to my Symantec position, making it my largest software position. It exceeds the size of my CA Technologies position, which I cut last week. With a 14% free cash flow yield Symantec is priced like CA was before the most recent rise.

Shorting Some SPY

I am shorting some SPY leaving room in case we get a blowoff this week. I would aggressively sell into a blowoff type move.

Blame The Hedge Funds

I do not like markets that move in a straight line as I am a "mean reversion" trader and investor. As a market is becoming stretched I slowly sell into it, expecting to be able to purchase my positions back at better prices when the rubber band ultimately snaps back. In recent years we have witnessed markets that go a lot further in both directions without corrective moves in between. In late July through early August we witnessed the S&P 500 fall nearly 20% in the space of three weeks, with nary a bounce in between.

I have adjusted my trading and investing to allow for these larger moves. I fought my tendencies very hard in staying invested for as long as I did, but ultimately it appears I have sold too early. Luckily, I have stayed at a small net long position rather than having gone net short. My recognition that markets have tended to move in a straight line recently played a role in this decision.

I believe hedge funds are the reason that market moves tend to persist without any corrective moves in between. As a group hedge funds employ a momentum strategy where they de-risk as the market goes down and re-risk as the market goes up. When the dominant player in the market employs a momentum strategy market moves are more likely to persist.

While adjusting my strategy, I have not abandoned it and plan to continue selling into this rally if it persists. The signs of froth continue to mount as the market becomes more stretched. While it has taken a longer time for the rubber band to snap back in recent years, it ultimately has. With a vengeance.

"bottoms scare you out, tops wear you out"

Games Sell Side Analysts Play

There is a childish game that analysts play that drives me absolutely nuts. These days when an analyst is bullish on a stock he will put a low ball earnings estimate on the stock so that the company beats it. A bearish analyst will put out high numbers so that the company misses the number. It is often the case that the most bullish analyst has the lowest estimate and the most bearish analyst has the highest estimate.

Sell side research has been under attack for the past decade and this earnings estimate game is not helping them. It is not deserving of kindergarten and makes analysts look like baboons. Whatever ounce of professionalism they may have had left is going out the window. Instead of making profitable analysis they have taken to childish games.


I have covered my SPY short from earlier for a miniscule gain. Will try it again next week if we get a "Greece is saved again" rally.  Have a great weekend

Shorting The SPY

I have shorted the SPY and am moving my portfolio closer to market neutral. I am leaving room to add to this position in case we get a celebratory rally early next week on the Greece is saved again news.

Good Old Gilead

In the Summer of 2010 I made Gilead the largest position in my portfolio. The stock was being dumped by growth obsessed investors and was easily the most hated stock in biotechnology. Gilead was trading at $32 and had about $5 in cash. They were set to earn the other $27 in less than 6 years even if they never discovered another drug. Their drugs had a long proven track record of working, as people with HIV seemingly live a full life taking their drugs. Those are the type of odds I like. To add to it they announced a $5 billion repurchase plan and started aggressively repurchasing their own shares. Nine months later in March I was able to sell the shares at close to $42. It was my biggest individual stock winner ever at the time from a dollar perspective, not percentage.

I made my mind up to repurchase Gilead one weekend this Fall, when the stock traded slightly under $40. That Monday, Gilead announced its $11 billion purchase of Pharmassett. I thought I had dodged a bullet but growth investors came roaring back into the stock and bid it up to $55. Management was selling shares aggressively as growth investors were piling back in. This morning the rug was pulled out and Gilead is down 20%.

This story reinforces my philosophy of not paying for growth. When a stock is beaten down a lot of bad news is priced in and good things tend to happen. However, when growth investors start bidding a stock up everything needs to go right. Even a small misstep like Gilead just had can cost 20%.


I remain of the, thus far wrongheaded, belief that the risk/reward in the market is poor. I am at a low net long and have a lot of dry powder in case the market ever corrects again. Have  a good night.

Change In Positioning

I have decided to reduce my gross exposure by selling some longs and removing my hedges. On net my market exposure has not changed much. The reason I did this is because some of my longs have come a long way and such a large position is no longer warranted. For instance, my position in CA has grown very large. At $27 the stock is less attractive than at $20. I cut the position nearly in half today.

Out Of BMC

For all purposes I am completely out of BMC. I prefer the risk/reward in Symantec.

Hoping For Less Froth

There is no rule saying that the market cannot continue its steep ascent, despite the many signs of frothy sentiment I have recently pointed out. My investing discipline is to pare back my risk when the crowd gets frisky. I almost always sell out too early, but rarely hold on too long. This is a tradeoff I am willing to make.

Seasonality will be neutral into mid-March when it turns very positive into mid-April, which coincidentally or not is the IRA contribution deadline. I would love to see some of the froth come off of the market before mid-March. It would set up an excellent trade into a very seasonally strong time of the year. I continue to wait for a fatter pitch before taking more risk.

What's It Going To Take

I must admit to being surprised that Apple reversed hard and the market still couldn't manage a decent down day. Sentiment is still in the danger zone but the bulls do have some important tailwinds at their back. I discussed corporate supply and demand yesterday. Many prepared for another 2008 this Fall and that has left many underinvested. I would really like to see a correction that at least takes back the gains from the jobs report day. That is the day I believe many started to get a bit ahead of themselves. Have a good night.

Welcome Back Mom and Pops

Seeing the recent move in Apple, I suspected that the retail investor was getting back in the game. All the talk about Facebook seems to have turned retail investor attention back to the market. Up until now this was a suspicion I had but ICI reported  that investors put $3.62 billion into domestic funds last week. Retail investors are notoriously bad market timers. They were removing money hand over fist late this Summer and Fall. The caveat is that after removing money for so long they still likely have some dry powder.

The Danger Zone

The Investors Intelligence poll has been a standout indicator that has not been showing extreme bullishness. That has changed as of today with 55% bulls. Bears are at 25%. We have seen the bears fall to below 20% at important tops but these numbers are now a negative for the market. We are clearly in the danger zone, looking at investor sentiment.


I wrote last night that the sideways action of the past week and a half has helped to work off the overbought reading. Unfortunately, sentiment has become more exuberant during this period and I believe that the market will have a tough time making much progress on the upside as a result. Rydex traders are now positioned about as aggressively as they have ever been. If they are at all representative of how traders are positioned, it will be difficult to find a marginal buyer.

I added to my hedges in the pre-market bringing me back to a modest net long position. When sentiment is this frothy I am happy to miss out on the upside and ensure my hard earned gains are protected.

Adding Back Hedges

I am using the pre-market strength to add back the hedges I removed yesterday.

Overbullish But No Longer Overbought

The market has now spent the seven days since the jobs report trading sideways, which has helped work off the overbought reading. Unfortunately, the sideways action did not do much to relieve the overly bullish sentiment. While I could see another push higher I don't believe it would make it very far. A pullback would be healthy but might not be in the cards yet. Have  a good night.


Removing Some Hedges

I removed the hedges I added yesterday in the pre-market for a small gain.

A Lesser Known Indicator

Most of the indicators I use are well known, but I also use a lesser known method to assess the state of market. Other than TrimTabs I don't know many who look at the supply and demand equation for stocks based on what corporations are doing. Corporations could buy stock via repurchases and cash M&A or they can sell stock via IPOs, secondaries or option exercises. When the former is greater than the latter corporations are a source of demand for stocks and vice versa.

The supply and demand equation for equities continues to be a feather in the bulls' caps. I have mentioned numerous times the recent record setting amount of share repurchases and the decent level of cash M&A. Generally, when we see a 25% runup in the market the bankers start rolling out all kinds of secondaries and IPOs. However, given the favorable environment the secondary and IPO calendar has been pretty bare. Insiders have been selling at a brisk pace but probably not brisk enough to make up for all the repurchases and cash M&A.

Tracking the supply and demand for stocks from corporations was a big reason I was confident in backing up the truck late this Summer and Fall when everything looked bleak. This indicator continues to look beneficial to the bulls and in my opinion is a large reason the market has been able to rally so strongly. This does not preclude a correction as the market is stretched but as long as this indicator stays as favorable as it is unlikely we will see a bigger decline, barring a systemic event.

Long MMI

Google just received EU antitrust clearance to buy MMI. That was the only real hurdle in my opinion, although they are waiting for a few other antitrust clearances. There is still nearly 1% in the deal spread. I have taken a long position in MMI.

The Bulls Have Some Points

I used this morning's pre-market strength to add back the hedges I removed Friday, plus a little more. Despite this I remain modestly net long. I am willing to go net short but have not done so as of yet. There are some positives that are stopping me from becoming too negative.

  • Valuations are reasonable. The market only trades at about 13 times projected earnings.

  • Corporations continue to repurchase their own shares at an aggressive pace. There is some cash M&A as well.

  • People prepared for another 2008 this Summer and Fall. That left a lot of people underexposed to the current melt up.

  • We are headed into March and April, which are seasonally strong months.

In Defense Of Contrarian and Sentiment Analysis

Bullish sentiment turned extreme the day of the jobs report last week and has stayed that way. I have read a number of critiques of sentiment and contrarian analysis in recent days because the market has yet to turn lower. Let me start by saying that there are no indicators that will give you the top and bottom of the market to the day. If that is what you are looking for you will be disappointed.

Not only will contrarian and sentiment analysis not call tops and bottoms perfectly, there are times where it will fail completely. The reason I use contrarian and sentiment analysis is to tell me approximately where we are in a rally or in a decline. When optimism is extreme I know we are likely in the latter part of the rally. This latter part of the rally can continue, but the risk/reward of being long is not very favorable. I much prefer to put my neck on the line when there is extreme pessimism.

Many people are bullish right now and are getting defensive when they are being faced with bearish facts.  When Barron's has a Dow 15,000 spread the same week Nouriel Roubini turns bullish its not likely a great sign for the market. But rather than accepting these facts many bulls would prefer to take pot shots at those pointing it out.

There are a long list of warning signs that make me believe that this is not the best time to be taking a lot of risk. We can grind higher for a while but when a correction comes it will likely take away all the gains swiftly. Its possible that my analysis is wrong this time and we go to straight to Dow 15,000. But over time investing aggressively at times of extreme pessimism and being defensive when there is extreme optimism should continue to serve me well.

Is The Correction Over

I took miniscule profits on my SPY Puts due to the spike in the VIX. Instead I sold some SPY short, but a smaller amount making me a bit longer. I am still not very bullish at current levels but believe I might get a chance to reinitiate some hedges at better levels next week as I expect Greece to fall in line. Have a great weekend.

More Evidence of Adviser Bullishness

Earlier I posted the results of the latest NAAIM survey showing advisers have turned bullish. I have come across yet another survey showing just how bullish they have become. From Financial Planning h/t @ReformedBroker:
Financial advisors have turned decidedly more optimistic about the market’s prospects for 2012, according to an SEI Quick Poll released Thursday. Nine in 10 of the advisors surveyed in early February said they expect a positive return for the S&P 500 in 2012, up 18% from a similar survey conducted in mid-January. More than six in 10, 63%, predicted gains greater than 5%, a sentiment that spread dramatically from just three weeks ago.

... The survey brimmed with additional evidence of growing optimism in the market. More than one in four advisors predicted that the “pessimism bubble” hovering over the economy will burst in 2012. Nearly one-third said that investor sentiment can best be described by the phrase, “the tide is turning.”

This level of bullishness does not necessarily mean we are at a top. But the best returns come from investing when everybody is bearish, such as late this Summer and Fall. That is the time to be aggressive.

Warren Buffet's Office Tour

How many screens does Warren Buffet have in his office? Warren Buffet gives a tour of his office to Charlie Rose:


Advisers More Bullish

The NAAIM was one of the few indicators that was bullish until last week. This week the NAAIM indicator has turned more bearish as advisors turn more bullish. This is not necessarily a great timing indicator but it tends to tell you what part of the rally we are in. Tops are made when advisers are bullish and bottoms are made when advisers are bearish but the sentiment can persist. Every top in recent years has had advisers bullish, but not every time advisers were bullish marked a top. From the NAAIM:



The dips are becoming shallower and shallower and if I had to sum up sentiment in a sentence it would be "is it even possible for this market to go down". Shorts are capitulating as are underinvested longs looking for a pullback.  I'm guessing that the monster move in Apple today means that retail investors are getting in on the act as well.

These are not the ideal conditions to be investing in. I would even argue that the risk/reward is negative. Despite my negativity I am still maintaining a small net long position. Valuations are still reasonable and people became very bearish this Summer so there is more room than usual for the market to get extended as these people come back.

While I would not be shocked to see further gains these are not the types of situations I like to invest in. If we get more extended I plan to continue selling. Have a good night.

Stubborn Like Ox

I remain wary of the overall market and am at a small net long position. Yesterday, Rydex traders moved to their largest net long position ever save for May of  last year. This was right before a 20% correction. The AAII bulls now outnumber the bears by 51.6% to 20.2%. Mark Hulbert notes in his column that insiders are selling at a pace not seen since July. This is in addition to the warning signs I pointed to yesterday.

There are some indicators that are still not lining up for a correction, even though the majority of the evidence is pointing that way. Investors Intelligence has 52% bulls and 28% bears. Normally, that would be slightly bearish but in the context of a 25% rally there should be fewer than 28% bears. The ISE equity put/call ratio is showing excessive put buying while the CBOE is showing extreme call buying. I have never seen these two option indicators diverge by so much.

There is great jubilation due to the announcement of a Greek deal. There is an old saying that goes "buy on the canons, sell on the trumpets". The market could have been bought for 25% less a few months ago when the world was ending. Now that we are going to live happily ever after you will have to pay up.



Like Flies On Symantec

Not many original ideas come from Wall Street, which likely explains the herd metaphor. If there is one thing Wall Street is good at its extrapolation. Symantec is one of three software stocks I would categorize as midcap, value. The other two are BMC and CA Technologies. CA and BMC's stock prices have taken off on plans to return capital to shareholders and I believe Symantec is not too far behind.

CA Technologies, nudged on by an activist investor, agreed to return large amounts of capital to investors. The stock shot up and is up over 30% for the year. BMC followed suit and today issued debt, likely in order to repurchase more shares. BMC shares have also performed well, extending the gains on today's news. It will not take long for investors to figure out what Symantec should do.

I predict that analysts and investors will soon be on Symantec's case like flies on excrement. I also believe that Symantec should be repurchasing shares aggressively as they are trading with a 14% free cash flow yield. I added to my Symantec position today and now own a fairly large position. Symantec already has a decent sized share repurchase plan in place and with the low valuation this should be enough for the shares to appreciate over time. But any stronger action to return cash to investors should speed up the process.

BMC Bucking The Trend

BMC is trading higher today on news of a $500 million bond issue. The company has ample US cash and the most obvious reason to issue debt is to continue their aggressive repurchase. I have sold the majority of my position but am still holding a small position. This is what the bulls want to see the company doing with its cash.

Roll Up

I have rolled up the strikes of my SPY puts that I purchased after the jobs report. This makes me slightly less net long.

Highway To The Danger Zone

In recent years momentum has carried markets further in both directions as both rallies and declines seem virtually endless. Indicators that I have been using for years to detect counter-trend moves have suddenly stopped working. While it has become more difficult to anticipate counter-trend moves I have not given up. The list of reasons to be wary of the market in the short term is growing:

  • Super-bear Nouriel Roubini turned bullish yesterday.

  • SentimenTrader basically gave up on calling a top despite many of his indicators pointing to excessive optimism.

  • On February 1 the S&P 500 closed at 1324 and the NYSE scored 302 new highs. Yesterday, the S&P 500 closed at 1347 and the NYSE scored 157 new highs. This is a negative divergence and the same can be seen at the Nasdaq.

  • I am starting to feel like an idiot being negative.

  • The 10 day moving average of the CBOE put/call is now firmly in sell territory

  • Hulbert Nasdaq newsletter writers now have their highest ever 3 week average recommended exposure.

  • Rydex traders are excessively bullish.

  • Last week was the highest week ever for junk issuance


The Difference Between Owners and CEOs

I listened to the Loews conference call yesterday, the Tisch family owned company. Loews trades at a big discount to the sum of the publicly traded parts, over 30%. In the past year, Loews has been repurchasing shares. Over time the gap should close if they continue to repurchase shares. I was listening to the conference call hoping to get a better understanding of how aggressive Loews will be on the repurchase. I was happy when an analyst asked management about the repurchase. To which James Tisch essentially answered "I'm not telling you".

I am looking to front run Loews. If I know they will be aggressive on the repurchase I will buy the shares now and sell them later when they drive the price up on their aggressive repurchase. This raises the price they need to pay to repurchase shares. James Tisch is in it for the long run so he wants Loews to get as good as price as possible on the repurchase. There is nothing for him to be gained by telling me when he is going to buy.

This is in stark contrast to what CA Technologies did. To great fanfare CA announced an accelerated repurchase plan and a dividend. The stock shot up by 20%. A long term owner would have wanted them to repurchase the shares as cheaply as possible. The accelerated repurchase plan was for $500 million. They could have quietly repurchased those shares with the stock in the low 20's but instead are paying in the high 20's. The CEO of CA Technologies incentives are different than that of  James Tisch's. The CEO of CA is judged by the stock price and is not a long term owner.

As somebody who is willing to sell my CA Technologies position I am happy to know they are in the market every day buying their own stock. I hope to eventually sell to them at higher prices. Unfortunately, I will not be able to do the same with Loews but the way they are handling it is in the better interest of long term shareholders.


The Designated Driver

Investing is  a game of probabilities. Even if one makes the higher probability bet, there is a chance the long shot will come in. However, over time if one makes the higher probability bets consistently, the chances of outperforming become much greater. I view my job as finding those higher probability bets.

Given the current state of sentiment, I view the market as offering a poor risk/reward. I might turn out to be wrong and the market can grind higher. However, if I avoid markets where there is extreme optimism(great chart from SentimenTrader via DynamicHedge) and invest in markets where there is extreme pessimism, like this Fall, I believe I will outperform. That means having to miss out once in a while there is a party going on.  I guess I'm the designated driver.

The Topping Process

The reason market tops are so difficult to identify is that topping is a process that can take a long time. There is a lot of time to second guess oneself during this process. Every dip gets bought so even the shorts are conditioned to buy the dip by the time the bottom falls out. During the topping process the first dip lower is generally bought and we saw that today. Today's action is likely to embolden the bulls and make the bears doubt themselves. That does not mean we are not forming a short term top. Have a good night.

No Deal

Reuters is reporting that the FTC is looking to block the Express Scripts / Medco merger. This deal had a greater than $11 billion cash component. This is a big negative for the overall market if it turns out to be true. For the same reason that an $11 billion cash deal is positive for the market, the cancelling of a deal is negative. If the deal is called off arbs will sell the shares they bought into the market, removing liquidity.

If the deal is called off it would be a positive for my long suffering Walgreen's position. Express Scripts has been trying to strong arm Walgreen's into accepting significantly less than they receive from other PBMs. Express Scripts bargaining power will be greatly diminished if this deal is called off.


Random Thoughts

  • I was hearing a lot of "you are an idiot if you are not bullish" talk this morning. The risk/reward is not generally great when people talk like that.

  • There is like more put activity today than the bears want to see, especially at the ISE.

  • How many bears gave up on Friday? Will be interesting to see the Investors Intelligence numbers Wednesday.

  • I get very annoyed at the cockiness of the bulls at times like this. That's fine, but I must not let it effect my trading.

  • As long as corporate profits hold up and we don't have  a systemic event we are unlikely to see anything more than a garden variety correction. Valuations are reasonable.

The Swinging Pendulum Of Market Sentiment

The movement in market sentiment is similar to that of a pendulum that swings back and forth. Market participants swing from greed at one extreme to fear at the other. The stronger the pendulum swings in one direction, the stronger it tends to swing in the other. This Summer and Fall the pendulum swung deep into fear territory, which is why it was able to swing back so hard since then.

It was an easy decision for me to get long into the extreme fear in the Fall (less easy to actually suffer through it) as I was pretty certain the pendulum would eventually swing back. However, now that we are back in greed territory it is a much tougher decision to gauge how far in we will swing.

Many of the indicators I follow are in territory that have previously led to corrections, even in the context of bull markets. The caveat is that last year these indicators did not work very well as the market stayed in a state of euphoria from late December until the March correction. All these gains were eventually erased in March but it was painful to be on the wrong side of the move until then, as I can attest to.

We are faced with market conditions that have most of the time led to fleeting gains at best. However, as last year demonstrated these conditions can last awhile. Making the decision more difficult is the fact that valuations are a lot better this year as earnings have risen but the market is in the same place. Given all these cross currents my decision to hedge and move to a modest net long stance seems appropriate.

Late Innings

I no longer get the sense that many are looking for a pullback. Today's action has  a "just get me in" feel to it. No doubt this can continue for a while, but this action typically occurs in the late innings of a rally.

While I have significantly reduced my net long exposure, I remain modestly net long. Why  am I not net short? Because even after a 25% rally the S&P 500 still only trades at a little over 13 times 2012 estimates. There are good reasons for this as the structural imbalances and excess debt in the economy are still present. That said, who says the market cannot go to 14 or 15 times. Have a great weekend.

Exuberance Thus Far

This morning I complained about the lack of uniform exuberance in the put/call ratios. Its still early but thus far we are seeing exuberance and extreme call buying at both the ISE and CBOE. I am very comfortable with my decision to reduce my long exposure.

Bought Protection

I have purchased April SPY put spreads and am now at a moderate net long.

More Mixed Signals

I continue to struggle with getting a good read on sentiment. Many of the sentiment indicators I look at are at odds with each other. People tell me that sentiment is giddy. However, my sense is that while short term sentiment is frothy in some quarters, a lot of people are worried about a pullback.

In this post I am going to highlight the put/call ratios for both the CBOE and ISE. Unfortunately, these are also at odds with each other. The chart below is the 10 day moving average of the ISE equity only put/call ratio:

This chart is giving off a buy signal as it seems retail traders are rushing to puts. This is quite difficult for me to believe, but this is what the data is saying. The chart below is the 10 day moving average of the CBOE put/call ratio:

The CBOE put/call ratios is much closer to giving off a sell signal and is in the danger zone. These are yet another pair of sentiment indicators giving off conflicting signals. At every top and bottom one can find sentiment indicators that don't confirm but they are generally in synch. The amount of conflicting sentiment indicators we are seeing is unusual. Given today's spike, the low VIX and enough concerning indicators I will likely purchase some protection today despite my confusion.

The Spike

I am using this spike in the pre-market to hedge my portfolio


One of the bullish indicators I have been pointing to has turned bearish. Here is the updated NAAIM: