The Bull Case

There are plenty of  things that can go wrong with the global economy. I am not going to go over all the imbalances even though I acknowledge that they will eventually need to be dealt with. However, its also possible that we kick the can a little further down the road. One must recognize the bull case even if  one doesn't believe it. The bull case is simple right now. The economy is doing fine, valuations are fine and we just had a correction.

Why I'm Pounding The Table On Symantec

Symantec trades at a greater than 15% free cash flow yield (FCF/EV) or roughly 6.5 times free cash flow. I cannot recall ever seeing a liquid, large cap stock with fairly good earnings visibility trade at such a low multiple in a time with little market stress. Even during times of market stress few stocks of this kind ever trade so cheaply.

Symantec's earnings visibility is a function of its large recurring revenue stream. While Symantec is best known for its Norton anti-virus product, consumer sales make up less than a third of Symantec's revenue. Symantec's corporate security and compliance combined with storage and server management make up nearly 2/3 of Symantec's revenue. Of these revenues over 60%  are recurring.

Software investors are growth oriented and few are value oriented. This is the reason I believe this bargain is being made available.  I believe that an aggressive share repurchase could serve as a catalyst for shares to achieve a more reasonable valuation. Currently, Symantec is repurchasing shares at a pace of $800 million a year or a little less than 8% of enterprise value. They are likely to increase the pace of their share repurchases after the most recent decline in the stock.

CA Technologies traded at a 14.5% free cash flow yield this Summer and looked very similar to the way Symantec does now. Both are steady technology companies, with little of the growth that technology investors desire.  An activist stepped in and helped nudge the company into returning more cash to shareholders, which led to a nearly 40% rise from the lows.  Symantec trades at a cheaper valuation than CA did at its low point.

Back To A Steady Grind?

After months of the market steadily grinding higher we finally had a pullback that lasted more than two days. That pullback is over but I don't believe this means that we are back to a steady grind.  There should be two way action even in the case where the market manages to work its way higher over time.

There are major differences between the market environment coming into the year and current environment. Coming into the year market participants were positioned in a "risk off" manner. Every pullback was bought by underinvested market participants. While investors have turned cautious in recent weeks they are not in "risk off" mode and there will not be the same demand there on every dip. The first few months of the year are seasonally strong while we are now entering more neutral seasonality. Europe was not an issue earlier in the year as LTRO kept sovereign spreads in check. This is no longer the case.

I believe this means that we will see a two way market where one can sell overbought and buy oversold. Currently we are very short term overbought but would get a better overbought reading if the market is strong  this week. A better overbought reading would arrive at the end of this week or early next week if the market remains strong.

Still No Big Advantage

I keep a large spreadsheet of market statistics and went through it to see if I can find a hint of which way the market is likely to go. The statistics are mixed and are not pointing to extreme bullishness or extreme bearishness, nor a market that is oversold or overbought. There are some statistics pointing to too much bullishness, but there are roughly just as many pointing to too much bearishness. Seasonality is now mixed as well.

It seems as if the market wants to test the high end of its range after rejecting the lower end last week. At the same time the situation in Europe seems to be worsening with spreads at their widest since the Fall and economic data pointing to a slower economy than just a few months ago. I continue to believe that the best course of action is to wait for the bulls or bears to push things too far and fade them.

On a side note, late yesterday it felt as if market participants began to get a little giddy. I am starting to hear chatter of a win/win market because Bernanke has the market's back. Bernanke always had the markets back, including 2008, last Summer and the Summer before that but it didn't help prevent steep declines. If the bulls manage to push the market to a marginal new high I believe it could likely be faded but will withhold judgement until I see how market participants react.

The Hits Keep Coming

This past weekend I was thinking that the current year is going so well that it was a matter of time before  a safe falls on my head. This week more than one did. To start the week my second largest holding, Symantec, blew up and fell 11% in a single day. Today, Wellpoint took a hit right after I increased my position yesterday.

I plan on sticking with both positions and increased both of them. Warren Buffet speaks of adding to losing positions as a gift from Mr. Market. It certainly does not feel like a gift at the time. I hope these are the last gifts I will be receiving in the next few weeks. Have a good night.

 

Mixed Feelings

My knee jerk reaction to yesterday's big up day was to want to get bearish. Big up days on Federal Reserve news and Apple earnings have a tendency to mean revert. However, when I looked at the data there was little supporting evidence for much more than a small move lower.

The market has been choppy for weeks so one big up day does not make it overbought. As I have recently outlined sentiment is cautious. One day is not likely to change sentiment all that much. The bears have some positives going for them. Seasonality is neutral for the next few months after being very favorable for half a year.  We still haven't seen a swing to extreme pessimism after 6 months of optimism.

Yesterday's trading does not change my outlook all that much. I still don't see any great advantages, long or short. I believe its better to wait for the bulls or bears to push this too far in either direction.

Adding and Subtracting

I added to my Wellpoint position after earnings came out roughly inline with estimates. The company trades at nine times expected earnings and is repurchasing roughly 3% of shares outstanding each quarter. After adding to Symantec yesterday and Wellpoint today, I shorted the QQQ to hedge out my market exposure. I believe tech will underperform in the coming months, as it is the most loved sector out there and due for a rest.

Neither Here Nor There

The market is rallying this morning following Apple's earnings. After the big decrease in bullishness in recent weeks it is hard to make a case that sentiment is overly bullish. I see sentiment as mixed, just as we head into a period of mixed seasonality. Overall, I don't see a big advantage either way. I think both the bulls and bears can be faded if they try to push things too far in either direction.

Symantec Kaboom

Symantec pre-released  earnings today that were lower than expectations. Bookings were inline but revenues and earnings disappointed. The difference between the inline bookings and lower revenues was that a larger portion of bookings were recognized as deferred revenue. Free cash flow was roughly inline.  It seems like  the coming quarter will look like the past quarter as well with more revenue being booked as deferred revenue. This will create lower earnings but free cash flow should be closer to estimates.

Symantec did not release full earnings results but the company did give enough information to make some estimates. Symantec is now trading with an enterprise value of roughly $10.4 billion. The free cash flow for the year that just ended was roughly $1.63 billion dollars. The stock is trading at about 6.4 times free cash flow.

The drop in Symantec seems like an over reaction to me given that free cash flow was inline and will likely stay strong. This is about as cheap as I have ever seen a large cap stock trade that that did not have existential issues. I have greatly increased my position in Symantec today.

Insiders No Longer Selling

After selling for weeks while investors were optimistic, insiders have turned bullish into the recent selling. I would somewhat discount this as many insiders are in a lockup period surrounding earnings. However, this is yet another piece of evidence that investor sentiment is back in neutral territory as insiders generally sell into optimism and buy into pessimism. I don't think we are seeing the extreme pessimism that is seen at good bottoms but I believe we are heading in the right direction. From Thomson Reuters via Barron's:

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Europe Woes

The crisis in Europe continues to worsen, which is the reason for this morning's weakness. We are seeing a repeat of last year where Eurpean authorities are ignoring the problems, wishing them away. It is likely that there will eventually be  a rescue but only when there are no other options. This does not necessarily mean that the market will play out in the same way. There are differences in market participants positioning from last year. In addition, many panicked out at the worst time last year causing them to underperform.

Last year heading into May market participants were extremely bullish. We now find ourselves with market participants that are cautious. It is likely that their positioning is more conservative than last year. Last year market participants prepared for another 2008, going full "risk off". This caused them to greatly underperform. It is unlikely that they react to the same extreme on the same news.

I believe it is very possible that we see lower prices but I don't believe that it will be to the same extent that we saw last year. I believe that sentiment is now in neutral territory. If we get extreme pessimism and fear in the coming days I plan to add on the long side. I was able to add some hedges when we rallied in the middle of last week. I was hoping for more of a rally to further reduce my net long but it did not materialize. This still leaves me with plenty of room to add if the bears push this too far.

Some Improvements

By the end of the day on Tuesday the market will no longer be oversold and we will be entering neutral seasonality. There is still a window for a rally but as that window gets smaller I will no longer be buying dips. Instead, I will be looking to decrease exposure if we do rally.

There has been a very large improvement in sentiment in recent weeks. Market participants have gone from being excessively bullish to being cautious. The NAAIM investment manager survey is showing the least bullishness since early January. The Investor Intelligence bulls have dropped to 44% from 55% a few weeks ago. Additionally, the AAII bears have exceeded the bulls for two weeks in a row. The sentiment indicators are now in neutral territory whereas a few weeks ago they were clear negatives. The chart below is from the NAAIM:

The NAAIM Survey of Manager Sentiment

There are some negatives that could crop up in the coming weeks. The crisis in Europe is worsening and authorities are doing nothing about it. Unless it gets better on its own it is likely to get worse. Market darlings like Apple have started to wobble. I believe it is likely that the bulls will be in for a bigger gut check in the coming weeks. In the intermediate term the market is still somewhat extended.

A few weeks ago I imagined myself getting pretty bearish at the end of April. However, the drop off in sentiment combined with the correction we have seen have made me more neutral. I will be looking to fade both the bulls and bears if they try to push the market too far in either direction.

Bad News

I believe the market is in a position to rally but the news flow has not been helping. We had a miss in unemployment claims, European sovereign spreads going the wrong way and lukewarm earnings from most of the large cap tech darlings.  There is still time for a rally in the next few days but that window is closing. I view the EU crisis as the biggest obstacle as nothing is being done in response and it is hard to imagine it getting better on its own.

Technology Overowned

I believe the technology sector is over owned. In every investor and portfolio manager survey I have come across recently technology is the most overweighted sector. I believe that the sector will underperform in the coming months as a result.

Many of my longs are in the tech sector. I believe my names will outperform the rest of technology because they are among the least loved names in tech. However, they will likely be dragged down somewhat. I plan to move some of my hedges to the Nasdaq 100 in order to try and mitigate this.

When Will We Be Overbought

As I wrote yesterday I believe we are in a trading market, where one can buy oversold and sell  overbought. The market will not be overbought until the  end of the day on Tuesday. This also happens to roughly coincide with the end of strong seasonality. If we rallied through that period  it would likely be a decent place to make some sales.

After adding hedges into yesterday's strength, my plan is to addlong exposure if we see considerable weakness today. I think the market should head higher over the coming days. I will look to lighten up if we rally into expiration and will take further steps if we rally into the middle of next week.

Putting Some Hedges Back On

While I believe the market is likely to end the week higher than where it is now, I have put back on the hedges I removed yesterday. I am sticking with my other trading longs.

A Trading Market

Coming into April I envisioned a rally into expiration that led to extreme bullish sentiment. Following that rally I thought we would see a meaty correction. Instead we saw a correction during this normally seasonally strong period that has turned sentiment negative. As a result I believe that we will now see a two way market.

I am a big fan of two way market as I prefer to buy weakness and sell strength. I believe this will be a good strategy for the next few months. Right now we are closer to being oversold so I am positioned on the long side. As the market becomes overbought I plan to trim positions.

Looking For A Rally

I am looking for a rally this week for a number of reasons:

  • If we are down tomorrow we will have  a decent oversold reading

  • We are seeing a lot of put buying today and it seems that market participants are getting a little too negative in the short term.

  • The hiding spots are getting hit today (AAPL, PCLN,GOOG, MA). This tend to happen towards the end of a decline.

  • The current week is still seasonally strong.


As a result I have removed half my hedges today. Have a good night.

Removed Some Hedges

I removed some hedges as I believe we should see a bounce sometime this week. As I wrote in my opener, we are getting oversold and seasonality is very strong this week.

Why Steve Romick Owns Wellpoint

My stock of the week is up at MarketFolly. Why Steve Romick owns Wellpoint:
Hedge funds as a group have struggled performance-wise in recent years. However, there is one sector which has treated them very well: the HMO's. In 2010, at the height of uncertainty surrounding Obamacare, many hedge funds took positions in HMOs such as UnitedHealth (UNH), Cigna (CI) and WellPoint (WLP).

Since then, most of the stocks in the group are up by 50%, with some nearly doubling. Even after this large rise, many stocks in the the group are still cheap. Currently, Farallon Capital Management and Steve Romick of FPA Crescent hold positions in WellPoint. Continue Reading...

 

A Game Of Chess

We came into the seasonally strongest three weeks of the year, starting two weeks ago, with the market stretched after rallying for months on end. Sentiment was excessively bullish as one would expect after such a long rally. Most times when the market is extended and we enter very strong seasonal periods we see the market become even more extended and a correction waits until after the seasonally strong period is over.

I came into this seasonally strong period long but with put spreads for protection as I recognized how extended the market was. My plan was to try and benefit from this seasonally strong period and flip short once it was over. The market laughed at my plans as troubles in Europe started to emerge. At that point I tightened up my hedges with straight shorts, although still net long. As the market fell further and was becoming oversold I started to remove hedges and even added to longs. When we bounced on Thursday I started hedging again, still remaining net long. After which the market nosedived again on Friday and here we stand.

In the intermediate term the market and sentiment are still stretched. However, in the short term the market is becoming oversold and the coming week is very seasonally strong. As such I believe that a drop early in the week is buyable for another bounce. After this week the market becomes  a lot more tricky.

Hedging A Bit

I am hedging a bit here.  I am still bullish but don't want to be a pig after a nice rally in the past two days.

Odds Favor Bulls Moderately

We are seeing a decline in bullishness to match the 60 point decline in the S&P 500. We saw a lot of put buying yesterday and the AAII survey is now showing 30% bulls and 41% bears. While Rydex bulls have come down, they are still at lofty levels. We are coming off of a long period of bullishness so it is possible for this bearishness to persist, as investors likely have supply to sell.

This is by no means an easy buy opportunity like the one we saw in the Fall where every indicator was lining up short and intermediate term. We have a few short term indicators lining up for a rally and some strong seasonality starting tomorrow. I remain positioned for a rally over the coming week.

Sentiment Moving In Place

One thing that bugged me yesterday was that there was a lot of talk about how oversold we were. Negative sentiment was a missing ingredient as few were calling for a lower market. That completely changed today as we saw put buying all day and I'm hearing a lot of talk about lower prices. I believe this is a step in the right direction and remain constructive over the next week or so.

2 Reasons Apple Will Underperform

I believe that Apple will underperform following option expiration for 2 reasons:

  1. I believe we are nearing an NDX rebalancing, which would result in a lot of Apple to sell. Apple is now nearly 20% of the NDX. The rule is that Apple cannot be greater than 24% the weight of the NDX but last year's rebalancing happened when Apple was 20.5% of the NDX.

  2. Apple is very extended and in need of a correction. We are currently in a period where people are putting their tax refunds and IRA contributions into the market. I believe a lot of that money is finding its way into Apple as it is the most loved stock out there. That period will soon be over.


If Apple rallies into option expiration I will strongly consider bearish risk reversals.

A Short Term Low

We are seeing a rebound this morning from yesterday's oversold condition. I believe we have seen the low for the next couple of weeks. The very strong seasonality begins this Friday and combined with the oversold condition I expect an upward bias into expiration. We will likely see a lot of chopiness due to the rumblings out of Europe, which remains a big wild card.

If we get a rally into option expiration I plan on taking a  more cautious stance. The past two Summers have seen very nasty corrections and we are coming off a big rally in the past half a year. The imbalances that have caused crisis after crisis in recent years remain and valuations seem fair to high all things considered.

Works Both Ways

For the first three months of the year the market went straight up without any corrections. We are now seeing the mirror image as the market is cascading lower, snapping any tree branches in its way. This is not the type of market I prefer as I generally buy and sell on a scale. My strategy benefits when there is two way volatility. However, this is the hand I have been dealt and I am playing it. I have added to the long side today and am positioned for a rally to start within the next few days. Have a good night.

Bought SPY Calls

I am finally seeing the fear I was hoping to see. Funny how I now want it to go away. I have purchased April SPY 139 Calls.

Writing Naked Puts

I am writing naked puts for April expiration on some stocks I would not mind owning. As I wrote this morning I believe the odds of a rally are improving.

Decent Odds

I believe we are approaching a decent long trade. The market is becoming oversold and very strong seasonality starts this Friday. The reason it is only a decent opportunity is because sentiment is still not where I would like it to be, but there is still some time for that to change.  There has definitely been an improvement in sentiment from a short week ago, but anecdotally it seems that most are still clinging to the bull camp.

It seems like we are seeing a repeat of last year as the EU ignores credit spreads blowing out, hoping that it will improve on its own. This too will be an impediment to a short term rally. I believe the logical thing to do would be for the ECB to buy Italian bonds. I understand that they likely want to wring out concessions from Spain before bailing them out but there is no reason to allow this to spread to other countries. Unfortunately, trying to apply logic to the reaction of EU authorities has been a fruitless endeavour until this point.

The Real Challenge

Tomorrow morning the bulls will be faced with a bigger challenge as European markets will be open for business. I think a good scare tomorrow will set us up for a rally later in the week. I would likely add to some long if we finally see some fear tomorrow. Have a good night.

Removing Some Hedges

I am using this morning's weakness to remove some hedges. We are now getting oversold and heading into some very strong seasonality later this week. That combination should be enough to keep the market from collapsing at a minimum. I am tempted to completely remove my hedges but I am worried about further deterioration in Europe. If it were solely an issue of a bad employment report I would be less cautious.

Sentiment is still an issue as I remain of the belief that the long side is crowded and is in need of a shake up. Rydex traders are long to a near record degree and the Investors Intelligence bears are too low. If we do see a rally related to the strong seasonality and the oversold condition I would likely quickly re-hedge as I don't believe the market will be able to do much more.

Shifting Positioning

I have decided to tighten up my hedges by moving from long SPY Puts to short SPY stock. This was a tough decision because we are slightly oversold and the period starting late next week is very strong seasonally. I originally planned to remain a little more aggressive through this period. However, with most people being positioned on the long side and shots being fired in Europe I don't want to get too cute after the market is already up over 30%. Happy Holidays.

Caught With Pants Down

European sovereign spreads are moving the wrong way once again this morning. Spain's budget deficit is spinning out of control. Even if the EU or ECB steps in to help Spain they will likely want to wrestle out some reforms first. This is unlikely to go away quickly and will probably get worse before it gets better.

We have seen two Summers in a row when market participants were fooled out of their positions due to European sovereign fears only to find themselves chasing stocks at higher prices. While I am skeptical that we will see the exact same thing play out I do believe that these sovereign fears will be enough to wipe out the excess fluff in the market. This should lead to at least a meaty correction at some point. The only question is when.

Most sentiment indicators are pointing to market participants being long and there being few bears. This sudden flare up has caught most investors with their pants down, myself included to some extent. I have been expecting this correction but did not think it would occur during the three seasonally strongest weeks of the year. Normally, I would have rolled up the strikes on my SPY puts  when we rallied late last week and early this week. But I decided to wait.

The Danger Zone

The Investor's Intelligence bears have dropped into the danger zone of 21.5%. The last 2 years we have seen this indicator bottom under 20%, but this is too close for comfort for me. This increases my desire to get better hedges in place if and when we get rally in the next few weeks.

Looking At Sectors

It has been very important the past few years to get sector selection right, as it could be the difference between feast and famine. Investors in miners have gotten smoked this year while technology investors are having a spectacular year. I believe that the outperformance of technology will take a break at minimum. I expect to see a sharp correction in technology some time in the next few months and am looking to move some hedges to the Nasdaq 100 within the next few weeks.

A lot of the IRA and tax refund money will likely find its way into technology because it is the hottest sector. The same investors that likely would have put GLD in their IRA a year ago will now put Apple in. That might help technology extend its performance for a few more weeks, but I believe that the sector's days of outperformance are numbered.

Rumblings In Europe

Spanish and Italian bond spreads are widening in Europe this morning. After spending most of March under 5%, Italian 10 year bond yields are 5.3% this morning. Its starting to look like we could see a third year in a row of drama in Europe during the Summer.  The market has basically gone up in a straight line for months and will likely use this as an excuse to correct at some point.

My thinking has been that a correction was likely to start somewhere between April option expiration and the Facebook IPO in May. We are seeing weakness this morning continuing from yesterday, partially as a result of European headlines and partially because the market is so extended. The reason I kept put spreads in place was because I recognize the possibility that a correction starts earlier than I am planning for. I still think its unlikely we see significant weakness before April option expiration, but with protection cheap it still makes sense to play it safe.

 

Seasonality Vs Exuberance

We have seen only a modest gain over the past two days even though seasonality was very strong. The market had a difficult time making much progress as it was extended coming into this period. By late next week seasonality will turn positive again but for the next few days its neutral. I was hoping for strength today in order to tighten up my hedges but we did not get it. I am targeting options expiration as a point in time where I want to be fully hedged. Have a good night.

Untangling Comverse's Quarter

I recently posted on MarketFolly my explanation for purchasing Comverse Technology. I will not rehash my entire argument but at the current market price of $6.45, the underlying Comverse business trades at $140 million or less than .25 times its $700 million in revenue. The reason the value has gone down, even though Comverse stock has gone up is that the value of their stake in Verint has increased.

Since I wrote up Comverse there have been some important developments. Convergys sold a business similar to Comverse's to NEC for nearly 1.4 times revenue. At that price the Comverse business would be worth nearly $1 billion versus the current valuation of $140 million. Comverse's largest competitor, Amdocs, trades at 1.5 times revenue so this seems like a reasonable price for an acquirer. Management has indicated they are reviewing all strategic alternatives so a sale is very possible.  However, in order for a sale to occur Comverse must first spin off its Comverse unit, which its in the process of doing, and then wait 6 months for a sale to be tax free. Those hoping for a sale are likely looking at waiting at least a year. I am buying this business for peanuts so the wait seems worth it to me.

My biggest fear has been that Comverse will burn cash between now and the time they could sell their business. Today's earnings announcement has gone a long way in allaying my fears. The Comverse business generated nearly $17 million in cash this quarter. They spent $18 million settling a shareholder lawsuit, which is now behind them. They spent an additional $20 million on restructuring and getting their financials in order. These costs are set to dramatically decline and eventually disappear. There is an end in sight to these extraordinary costs and burning cash is now much less of a worry for me.

Investors are dumping Comverse today on a disappointment in new orders. I believe it is much more important that Comverse finally has its cost structure in line and is able to generate cash. Comverse is on track to release its financials for the spin off in the next month or so. In order to make good money on Comverse at the current price one does not need a beat and a raise. All one needs is stabilization, which is what I believe we have seen. I was holding a small position in Comverse but have turned it into a significant position today.

Abra Cadabra

It seems that the early April hocus pocus is working thus far. There is actually a perfectly reasonable explanation for the seasonal strength in April. It is the height of tax refund season, some of which finds its way into the market, and it is the IRA/pension contribution deadline. Tomorrow is another seasonally strong day, after which seasonality turns neutral for a few days. We then get another burst of strong seasonality mid-month.

If we get another strong day tomorrow I will consider rolling up the strikes on my SPY Puts or writing covered calls against longs. I would not get too excited about the market as I believe things will get a lot rockier by next month. For now I'm staying at the party with an eye on the door. Have a good night.

Why David Einhorn Owns Dell

My stock of the week column is posted up at MarketFolly. This week I discuss Dell and my very difficult decision making process in deciding whether to invest in Dell.

Hocus Pocus

Many view seasonality as hocus pocus. As long as it keeps working more times than not I don't care what people call it. The first few days of April are very seasonally strong. Unfortunately, we are entering this seasonally strong period with extreme bullish sentiment and a market that has not had a real gut check in months.

I have found that strong seasonality helps extreme bullish sentiment persist more times than not. That is why I used last week's weakness to position myself more bullishly. I left put spreads for protection in place because they are very cheap right now and because the extreme bullish sentiment is a risk. We have also seen rumblings from Europe in recent weeks as the sovereign crisis threatens to worsen.