Weekly issue: Downside Protection Critical Amid These Uncertain Conditions

Weekly issue: Downside Protection Critical Amid These Uncertain Conditions

Key points inside this issue

  • Ahead of the Fed’s latest dot blot, 2019 GDP expectations move lower.
  • With uncertainties again on the rise, we reiterate our Buy rating on the ProShares Short S&P 500 ETF (SH) ahead of the upcoming March quarter earnings season.

 

Weakening GDP Expectations for the Remainder of 2019

Looking back over the last few weekly issues, it would be fair to say they were a little wordy. What can I say, between the economic data and earnings season, plus thematic data points, there was a lot to share over the last few weeks. Today, however, I’m going to cut to the point with my comments, largely because all investor eyes and ears are waiting to see and hear what Fed Chair Jerome Powell has to say about the speed of the US economy as they look for signs over what is coming next out of the Fed.

We’ve talked quite a bit about the slowing speed of the global economy, and even though there have been some individual bright spots across the aggregated hard and soft economic data from both government and third-party sources, the slowing speed is hard to ignore. Based on the published data, domestic GDP hit 3.1% last year, and as we’ve shared recently we’ve started to see the expectations for 2019 move lower in recent weeks. Per the March CNBC Fed Survey of 43 economists and Fed watcher findings, GDP for 2019 is now expected to clock in around 2.3% — not quite cut in half compared to 2018, but dramatically lower and significantly lower than folks were looking for in the back half of 2018.

When the Fed issues its post FOMC meeting statement today, the focus will more than likely not be on the interest rate decision – almost no one expects a hike. Instead, rapt attention will be paid to the Fed’s updated economic dot plot, which will reveal how it sees the US economy shaping up. Let’s remember that one unofficial aspect of the Fed’s job is to be a cheerleader for the economy, so it becomes a question of “if they are cutting their GDP forecast” how deep of a cut could we really see?

Culprits of the slowing economy and these cuts include aspects of our Middle-Class Squeeze investing theme as consumers in the US grapple with debt levels that have risen precipitously over the last several years. The consumer spending tailwind associated with our Living the Life investing theme appears to be slowing some given the rising debt levels of Chinese consumers. Governments have also run up debt in recent years as the current business cycle has grown longer in the tooth. And of course, there is the impact of currency as well as political and trade uncertainties, including the pushout of US-China trade talks to June.

 

Downside Protection is Key Under These Circumstances

In a little over 10 days, we will be exiting March, entering the second quarter and beginning the earnings season dance all over again. My concern is that given the above and the several unknowns therein, we are poised to see another earnings season during which aggregate expectations will be adjusted lower. Case in point, with the  US-China trade agreement timetable slipping and slipping, it becomes rather difficult for a company to factor any resolution into its guidance, especially when the terms of the agreement are unknown.

Despite all of the above, the domestic stock market has continued to chug higher, once again approaching overbought levels, even though 2019 EPS cuts for the S&P 500 have made the market even more expensive than it was as we exited 2018.

The potential poster child for this is FedEx (FDX), which saw its shares take a fall last night after the company cut its annual profit forecast for the second time in three months due to slowing global growth, rising costs from a 2016 acquisition in Europe and questions over its ability to withstand U.S.-China trade tensions and uncertainty over the U.K.’s exit from the European Union.

Not to go all Groundhog Day on you, but this looks increasingly like the situation we saw in December when I added the ProShares Short S&P 500 ETF (SH) to the Select List. If we didn’t have those shares to offer some downside protection for what lies ahead, I would be adding them today. If you don’t have any of those shares in your holdings, my advice would be to add some. Much like insurance, you may not know exactly when you’ll need it, but you’ll be happy to have it when something goes bad.

  • With uncertainties again on the rise, we reiterate our Buy rating on the ProShares Short S&P 500 ETF (SH) ahead of the upcoming March quarter earnings season.

 

 

Weekly issue: Adding Even More Downside Protection

Weekly issue: Adding Even More Downside Protection

Key points inside this issue

  • Ahead of the Fed’s latest dot blot, 2019 GDP expectations move lower.
  • With uncertainties again on the rise, we reiterate our Buy rating on the ProShares Short S&P 500 ETF (SH) ahead of the upcoming March quarter earnings season.
  • We are issuing a Buy on and adding the ProShares Short S&P 500 ETF (SH) May 17, 2019, 29.00 calls (SH 190517C00029000) that closed last night at 0.25 to the Select List with a stop loss set at 0.15.
  • Given the drop in Del Frisco (DFRG) shares last week, following an earnings report with no new update on the potential takeout of the company, we were stopped out of our call position.
  • We will continue to hold our Nokia Corp. (NOK) December 2019 7.00 calls (NOK191220C0000700) that closed last night at 0.40, nicely in the green.

 

Weakening GDP Expectations for the Remainder of 2019

Looking back over the last few weekly issues, it would be fair to say they were a little wordy. What can I say, between the economic data and earnings season, plus thematic data points, there was a lot to share over the last few weeks. Today, however, I’m going to cut to the point with my comments, largely because all investor eyes and ears are waiting to see and hear what Fed Chair Jerome Powell has to say about the speed of the US economy as they look for signs over what is coming next out of the Fed.

We’ve talked quite a bit about the slowing speed of the global economy, and even though there have been some individual bright spots across the aggregated hard and soft economic data from both government and third-party sources, the slowing speed is hard to ignore. Based on the published data, domestic GDP hit 3.1% last year, and as we’ve shared recently we’ve started to see the expectations for 2019 move lower in recent weeks. Per the March CNBC Fed Survey of 43 economists and Fed watcher findings, GDP for 2019 is now expected to clock in around 2.3% — not quite cut in half compared to 2018, but dramatically lower and significantly lower than folks were looking for in the back half of 2018.

When the Fed issues its post FOMC meeting statement today, the focus will more than likely not be on the interest rate decision – almost no one expects a hike. Instead, rapt attention will be paid to the Fed’s updated economic dot plot, which will reveal how it sees the US economy shaping up. Let’s remember that one unofficial aspect of the Fed’s job is to be a cheerleader for the economy, so it becomes a question of “if they are cutting their GDP forecast” how deep of a cut could we really see?

Culprits of the slowing economy and these cuts include aspects of our Middle-Class Squeeze investing theme as consumers in the US grapple with debt levels that have risen precipitously over the last several years. The consumer spending tailwind associated with our Living the Life investing theme appears to be slowing some given the rising debt levels of Chinese consumers. Governments have also run up debt in recent years as the current business cycle has grown longer in the tooth. And of course, there is the impact of currency as well as political and trade uncertainties, including the pushout of US-China trade talks to June.

 

Downside Protection is Key Under These Circumstances

In a little over 10 days, we will be exiting March, entering the second quarter and beginning the earnings season dance all over again. My concern is that given the above and the several unknowns therein, we are poised to see another earnings season during which aggregate expectations will be adjusted lower. Case in point, with the  US-China trade agreement timetable slipping and slipping, it becomes rather difficult for a company to factor any resolution into its guidance, especially when the terms of the agreement are unknown.

Despite all of the above, the domestic stock market has continued to chug higher, once again approaching overbought levels, even though 2019 EPS cuts for the S&P 500 have made the market even more expensive than it was as we exited 2018.

The potential poster child for this is FedEx (FDX), which saw its shares take a fall last night after the company cut its annual profit forecast for the second time in three months due to slowing global growth, rising costs from a 2016 acquisition in Europe and questions over its ability to withstand U.S.-China trade tensions and uncertainty over the U.K.’s exit from the European Union.

Not to go all Groundhog Day on you, but this looks increasingly like the situation we saw in December when I added the ProShares Short S&P 500 ETF (SH) to the Select List. If we didn’t have those shares to offer some downside protection for what lies ahead, I would be adding them today. If you don’t have any of those shares in your holdings, my advice would be to add some. Much like insurance, you may not know exactly when you’ll need it, but you’ll be happy to have it when something goes bad.

  • With uncertainties again on the rise, we reiterate our Buy rating on the ProShares Short S&P 500 ETF (SH) ahead of the upcoming March quarter earnings season.

 

Tematica Options+

Given the above comments, I’m adding the ProShares Short S&P 500 ETF (SH) May 17, 2019, 29.00 calls (SH 190517C00029000) that closed last night at 0.25. This strike date, unlike that for the April calls, will carry us well into the March quarter earnings season and the calls are extremely liquid. As we set a stop loss at 0.15, I will share that should we get stopped out of this position in next few weeks should the market inches higher without any real resolution to the uncertainties we discussed above, I will be inclined to recommend another, similar market hedging call trade.

 

Given the drop in Del Frisco (DFRG) shares last week, following an earnings report with no new update on the potential takeout of the company, we were stopped out of our call position. We will continue to hold our Nokia Corp. (NOK) December 2019 7.00 calls (NOK191220C0000700)that closed last night at 0.40, nicely in the green.

 

Apple’s negative pre-announcement serves as a reminder to the number of risks that have accumulated

Apple’s negative pre-announcement serves as a reminder to the number of risks that have accumulated

 

We are “breaking in” to share my thoughts with you on the implications of Apple’s (AAPL) downside December quarter earnings news last night. Quickly this is exactly of what I was concerned about in early December, but rather than take a victory lap, let’s discuss what it means and what we’re going to do. 

Last night we received a negative December quarter earnings preannouncement from Apple (AAPL), which is weighing on both AAPL shares as well as the overall market. It serves as a reminder to the number of risks that have accumulated during the December quarter – the slowing global economy, including here at home; the US-China trade war; Brexit and other geopolitical uncertainty in the eurozone; the strong dollar; shrinking liquidity and a Fed that looks to remain on its rate hike path while also unwinding its balance sheet. Lenore Hawkins and I talked about these at length on the Dec. 21 podcast, which you can listen to here.

In short, a growing list of worries that are fueling uncertainty in the market and in corporate boardrooms. When the outlook is less than clear, companies tend to issue conservative guidance which may conflict with Wall Street consensus expectations. In the past when that has happened, it’s led to a re-think in growth prospects for both the economy, corporate profits and earnings, the mother’s milk for stock prices.

These factors and what they are likely to mean when companies begin issuing their December quarter results and 2019 outlooks in the coming weeks, were one of the primary reasons we added the ProShares Short S&P 500 (SH) shares to our holdings in just under a month ago. While the market fell considerably during December, our SH shares rose 5% offering some respite from the market pain. As expectations get reset, and odds are they will, we will continue to focus on the thematic tailwinds and thematic signals that have been and will remain our North Star for the Thematic Leaders and the larger Select List.

 

What did Apple have to say?

In a letter to shareholders last night, Apple CEO Tim Cook shared that revenue for the quarter would come in near $84 billion for the quarter vs. the consensus estimate of $91.5 billion and $88.3 billion, primarily due to weaker than expected iPhone sales. In the letter, which can be read here, while Apple cited several known headwinds for the quarter that it baked into its forecast such as iPhone launch timing, the dollar, supply constraints, and growing global economic weakness, it fingered stronger than expected declines in the emerging markets and China in particular.

Per the letter, most of the “revenue shortfall to our guidance, and over 100 percent of our year-over-year worldwide revenue decline occurred in Greater China across iPhone, Mac, and iPad.”

Cook went on to acknowledge the slowing China economy, which we saw evidence of in yesterday’s December Markit data for China. Per that report,

“The Caixin China General Manufacturing PMI dipped to 49.7 in December, the first time since May 2017 that the reading has been below 50, the mark that separates expansion from contraction. The sub-index for new orders slid below the breakeven point of 50 for the first time since June 2016, reflecting decreasing demand in the manufacturing sector.”

In our view here at Tematica, that fall in orders likely means China’s economy will be starting off 2019 in contraction mode. This will weigh on corporate management teams as they formulate their formal guidance to be issued during the soon to be upon us December quarter earnings season.

Also, in his letter, Cook called out the “rising trade tensions with the United States”  and the impact on iPhone demand in particular.

In typical Apple fashion, it discussed the long-term opportunities, including those in China, and other positives, citing that Services, Mac, iPad, Wearables/Home/Accessories) combined to grow almost 19% year-over-year during the quarter with records being set in a number of other countries. While this along with the $130 billion in cash that Apple has on its balance sheet exiting the December quarter, bode well for the long-term as well as its burgeoning efforts in healthcare and streaming entertainment, Apple shares came under pressure last night and today.

 

Odds are there will more negative earnings report to come

In light of the widespread holding of Apple shares across investor portfolios, both institutional and individual, as well as its percentage in the major market indices, we’re in for some renewed market pressure. There is also the reality that Apple’s decision to call out the impact of U.S.-China trade will create a major ripple effect that will lead to investors’ renewed focus on the potential trade-related downside to many companies and on the negative effect of China’s slowing economy.

In recent months we’ve heard other companies ranging from General Motors (GM) to FedEx (FDX) express concerns over the trade impact, but Apple’s clearly calling out its impact will have reverberations on companies that serve markets tied to both the smartphone and China-related demand. Overnight we saw key smartphone suppliers ranging from Skyworks Solutions (SWKS) and Qorvo (QRVO) come under pressure, and the same can be said for luxury goods companies as well. We’d note that Skyworks and Qorvo are key customers for Select List resident AXT Inc (AXTI, which means if we follow the Apple revenue cut through the supply chain, it will land on AXT and its substrate business.

All of the issues discussed above more than likely mean Apple will not be the only company to issues conservative guidance. Buckle up, it’s going to be a volatile few weeks ahead.

 

Positives to watch for in the coming weeks and months

While the near-term earnings season will likely mean additional pain, there are drivers that could lift shares higher from current levels in the coming months. These include a trade deal with China that has boasts a headline win for the US, but more importantly contains positive progress on key issues such as R&D technology theft, cybercrimes and the like – in other words, some of the meaty issues. There is also the Federal Reserve and expected monetary policy path that currently calls for two rate hikes this year. If the Fed is data dependent, then it likely knows of the negative wealth effect to be had following the drop in the stock market over the last few months.

Per Moody’s economist Mark Zandi, if stocks remained where there were as of last night’s close, it would equate to a $6 trillion drop in household wealth over the last 12-15 months. Per Zani, that would trim roughly 0.5% to 2019 GDP – again if the stock market stayed at last night’s close for the coming weeks and months. As we’re seeing today, and given my comments about the upcoming earnings season, odds are that 2019 GDP cut will be somewhat larger. That would likely be an impetus for the Fed to “slow its roll” on interest rates or at least offer dovish comments when discussing the economy.

Complicating matters is the current government shutdown, which has both the Census Bureau and Bureau of Economic Analysis closed. Even though there will be some data to be had, such as tomorrow’s December 2018 Employment Report from the Labor Department, it means the usual steady flow of economic data will not be had until the government re-opens. No data makes it rather difficult to judge the speed of the economy from all of us, including the Fed.

Given all of the above, we’ll continue to keep our more defensive positions companies like McCormick & Co. (MKC), Costco Wholesale (COST), and the ProShares Short S&P 500 shares intact. We’ll continue to watch input costs and what they mean for corporate profits at the margin – case in point is Del Frisco’s (DFRG), which is benefitting from not only falling protein costs but has been approached by an activist investor that could put the company in play. With Apple, Dycom Industries (DY), and AXT, we will see 5G networks lit this year here in the US, which will soon be followed by other such networks across the globe in the coming years. Samsung, Lenovo/Motorola and others have announced 5G smartphones will be shipping by mid-2019, and we expect Apple to once again ride that tipping point in 2020. That along with its growing Services business and other efforts to increase the stickiness of iPhone (medical, health, streaming, payments services), keeps us long-term bulls on AAPL shares.

When not if but when, the stock market finds its footing, which likely won’t be until after the December quarter earnings season at the soonest, we will look to strategically scale into a number of positions for the Thematic Leaders and the Select List.

 

Staying defensive and adding a new Thematic Leader call position

Staying defensive and adding a new Thematic Leader call position

Key points inside this issue:

 

While the market is essentially flat over the last five trading days since our last edition of Tematica Options+, it has moved tenuously higher over the last few days. Even as the S&P 500 has inched higher this week, putting some downward pressure on our  ProShares Short S&P 500 Jan 2019 30.00 (SH190118C00030000) calls over the last few days, that major market index finished well off its daily highs. What this tells us is as much as investors would like to see the market move higher, anxiety remains. As I shared in this week’s issue of Tematica Investing and as Lenore Hawkins, Tematica’s Chief Macro Strategist, shared on a recent episode of Cocktail investing there are a number of items fueling that investor anxiety.

Reports are suggesting some positive movement on the trade front between the US and China, including reduced auto tariffs on US cars in China and Chinese state-owned companies buying at least 500,000 tons of U.S. soybeans. Despite these developments, at the end of the day, the nuts and bolts of any trade deal will be what matter’s most in the eyes of the market, not a few gestures.

As we turn our gaze from across the Pacific to across the Atlantic, we’re seeing growing concerns across the eurozone. Those include escalating UK Brexit drama, France’s budget deficit, and recent downgrades for the Italian economy by both Moody’s and Fitch. On this side of the Atlantic, we are seeing investors re-assess earnings prospects for the S&P 500 in 2019, which have started to be trimmed back compared to just a few months ago amid more data pointing to a softening domestic economy.

While we the stock market is trying to find its footing, the reality is there are ample risks to be had that could pressure the market in the coming weeks. For that reason, we’ll continue to keep our SH calls in place.

 

Adding a call position on new Thematic Leader Nokia

I recently called up shares of mobile infrastructure and mobile technology IP licensing company Nokia (NOK) from the Select List to become our latest Thematic Leader, filling the Disruptive Innovator void left when we removed Universal Display (OLED) shares from that list. The rationale behind that upgrade for NOK shares can be read in full here, but the skinny version is Samsung is set to join a growing list of smartphone vendors that will begin shipping 5G smartphones in volume during 2019. Unlike Motorola and others, Samsung has committed to begin shipping its 5G smartphones during the first half of 2019.

That’s a firm line in the sand for not only that debut but for operators building out their 5G networks as well as a pick up in the RF semiconductor food chain, which will furnish the needed 5G capable chips to Samsung and others. I see this translating into a pick up for Nokia’s mobile infrastructure business in the coming quarters as well as one for its IP licensing business as smartphone vendors get their technology licensing ducks in a row before launching this new class of devices.

Weekly Issue: Investor anxiety continues

Weekly Issue: Investor anxiety continues

Key points inside this issue

  • As the investors grapple with anxiety over trade as well as the speed of economic and earnings growth, we’ll continue to hold ProShares Short S&P 500 (SH) shares.
  • Our price target on the shares of Guilty Pleasure Thematic Leader Del Frisco’s Restaurant Group (DFRG) remains $14.
  • Our price target on Middle-Class Squeeze Thematic Leader Costco Wholesale (COST) shares remains $250.
  • Our price target on Amazon (AMZN) shares remains $2,250

 

The stock market experienced another painful set of days in last week as it digested the latest set of economic data, and what it all means for the speed of the domestic and global economy. Investors also grappled with determining where the U.S. is with regard to the China trade war as well as the prospects for a deal by the end of March that would prevent the next round of tariffs on China from escalating.

There remain a number of unresolved issues between the U.S. and China, some of which have been long-standing in nature, which suggests a fix in the next 100+ days is somewhat questionable. This combination induced a fresh round of anxiety in the market, leading it to ultimately finish the week lower as the major indices sagged further quarter to date. In turn, that pushed all the major market indices into the red as of Friday’s close, most notably the small-cap heavy Russell 2000, which finished Friday down 5.7% year to date. For those keeping score, that equates to the Russell 2000 falling just under 15% quarter to date.

Last week we added downside protection to our holdings in the form of ProShares Short S&P 500 (SH) shares, and we’ll continue to hold them until signs of more stable footing for the overall market emerge. As we do this, I’ll continue to evaluate not only the thematic signals that are in and around us day-in, day-out, but also examine the potential opportunities on a risk to reward basis the market pain is creating.

 

Shares of Del Frisco’s get some activist attention

Late last week, our shares of Guilty Pleasure Thematic Leader Del Frisco’s Restaurant Group (DFRG) bucked the overall move lower in the domestic stock market following the revelation that activist hedge fund Engaged Capital has acquired a nearly 10% in the company with a plan to push the company to sell itself according to The Wall Street Journal. Given the sharp drop in DFRG shares thus far in 2018, down 52%, it’s not surprising to see this happen, and when we added the shares to our holdings, we shared the view that at some point it could be a takeout candidate as the restaurant industry continues to consolidate. In particular, Del Frisco’s presence in the higher end dining category and its efforts over the last few months to become a more focused company help explain the interest by Engaged.

In response, Del Frisco’s issued the following statement:

“Del Frisco’s is committed to maximizing long-term value for all shareholders. While we do not agree with certain characterizations of events or of our business and operations contained in the letter that we received from Engaged Capital, the Company values constructive input toward the goal of enhancing shareholder value. “

Compared to other Board responses this one is rather tame and suggests Del Frisco’s will indeed have a dialog with Engaged. Given the year to date performance in DFRG shares, odds are there are several on the Board that are frustrated either with the rate of change in the business or how that change is being viewed in the marketplace.

In terms of who might be interested in Del Frisco’s, we’ve seen a number of going private transactions in recent years led by private equity investors that re-tool a company’s strategy and execution or combine it with other entities. We’ve also seen several restaurant M&A transactions as well. Let’s remember too how on Del Frisco’s September quarter earnings conference call, the management team went out of its way to explain how the business performed during the last recession. That better than industry performance may add to the desirability of Del Frisco’s inside a platform, multi-branded restaurant company.

As much as we may agree with the logic behind Del Frisco’s being taken out, we’d remind subscribers that buying a company on takeout speculation can be dicey. In the case of Del Frisco’s, we continue to see a solid fundamental story. We are seeing deflation in food prices that bode well for Del Frisco’s margins and bottom line EPS. Over the last quarter we’ve seen prices in the protein complex – beef, pork, and chicken – move lower across the board. According to the United Nation’s Food and Agriculture Organisation’s (FAO) food price index, world food prices declined during the month of November to their lowest level in more than two years. We’re also seeing favorable restaurant spending per recent monthly Retail Sales reports, which should only improve amid year-end holiday dinners eaten by corporate diners and individuals.

We’ll continue to hold DFRG for the fundamentals, but we won’t fight any smart, strategic transaction that may emerge.

  • Our price target on the shares of Del Frisco’s Restaurant Group (DFRG) remains $14.

 

What to watch in the week ahead

As we move into the second week of the last month of the quarter, I’ll continue to examine the oncoming data to determine the vector and velocity of the domestic as well as global economy. Following Friday’s November Employment Report that saw weaker than expected job creation for the month, but year over year wage gains of 3.1% the Atlanta Fed continued to reduce its GDP forecast for the current quarter. That forecast now sits at 2.4%, down from 3.0% at the end of October.

With the sharp drove in oil prices has consumers feeling a little holiday cheer at the gas pump, odds are next week’s November inflation reports will be tame. The fact that world food prices per the Food and Agriculture Organization’s (FAO) food price index hit the lowest level since May 2016 also bodes well for a benign set of inflation data this week. Later in the week, we’ll get the November Retail Sales report, which should be very confirming for our holiday facing positions – Amazon (AMZN), United Parcel Service (UPS), McCormick & Co. (MKC) and Costco Wholesale (COST) – that given the kickoff of “seasons eatings” with Thanksgiving and the start of the holiday shopping season that clearly shifted to digital shopping.

That report will once again provide context for this shift as well as more than likely confirm yet again that Costco Wholesale (COST) continues to take consumer wallet share. Speaking of Costco, the company will report its quarterly results this  Thursday. Quarter to date, the company’s monthly same store sales reports are firm evidence it is winning consumer wallet share, and we expect it did so again in November, especially with its growing fresh foods business that keeps luring club members back. Aside from its top and bottom line results, I’ll be focused once again on its pace of new warehouse openings, a harbinger of the crucial membership fee income to be had in coming quarters.

  • Our price target on Middle-Class Squeeze Thematic Leader Costco Wholesale (COST) shares remains $250.

We’ll end the economic data stream this week with the November Industrial Production report. Given the sharp fall in heavy truck orders in November, I’ll be digging into this report with a particular eye for what it says about the domestic manufacturing economy.

As discussed above, this week Costco will report its results and joining it in that activity will be several other retailers such as Ascena Retail (ASNA), DWS (DWS), American Eagle (AEO) and Vera Bradley (VRA). Inside their comments and guidance, which will include the holiday shopping season, I’ll be assessing the degree to which they are embracing our Digital Lifestyle investing theme. We’ll also see Adobe Systems (ADBE) report its quarterly result and I’ll be digesting what it has to say about cloud adoption, pricing and prospects for 2019. As we know, that is a core driver of Amazon Web Services, one of the key profit and cash flow drivers at Amazon (AMZN).

  • Our price target on Amazon (AMZN) shares remains $2,250

 

Special Alert: Closing out our SH call position with another hefty gain

Special Alert: Closing out our SH call position with another hefty gain

Key points in this issue

Following yesterday’s tumultuous second day in the stock market that sent all the major market indices lower, I’m opting to “take the money and run” with the second half of our ProShares Short S&P500 Calls position given not only the outsized gain in a relatively quick manner, but also because we are getting favorable bank earnings from JPMorgan Chase (JPM), PNC (PNC) and others this morning. The good news is they confirm the domestic economy is on firm footing, and that is leading to a reprieve from the last few days for the stock market.

As I mentioned yesterday when I issued a sell on half of our SH calls as we enter the September quarter earnings season in force next week, we are likely to see the stock market trade day to today odds are this means our SH calls will bounce around, but the risk is they trade off from this week’s pronounced move. Let’s be prudent and book the win while we have it is my thinking. We’ll tabulate the actual exit price based on market open, but as it looks now we stand to have a blended return near 400% for this SH call option position in full. Not bad for a few weeks of work, and a solid reminder to listen to the data and our thematic lens.

 

Weekly Issue: Market Turbulence Is Good News for Our Protective Position

Weekly Issue: Market Turbulence Is Good News for Our Protective Position

Key points from this issue:

 

A few weeks ago, given the growing list of concerns that emerged during September, I added the ProShares Short S&P500 (SH) November 2018 28.00 (SH181116C00028000) calls to the Tematica Options+ Select List at 0.22. Over the last several days, those concerns — from a slowing US economy to the impact of rising Treasury yields, growing signs of inflation and more pain at the gas pump to what looks to even more escalation in tariffs between the US and China — came home to roost, leading to one of the more painful weeks in the stock market this year.

The biggest pressure was felt on growth stocks, particularly those with high valuations, but toward the end of yesterday’s 3.1%-4.1% drop in the major US stock market indices, few were left untouched. That move combined with the ones of prior days led to our being stopped out of the Universal Display (OLED) January 2019 130.00 calls (OLED190118C00130000) as well as the Amazon (AMZN) Feb 2019 2000.00 (AMZN190215C02000000) calls. The good news, if we can call it that, is our stop losses set at 7.00 for the OLED calls and 100.00 for the AMZN ones limited our losses to 20%-25%  compared to what they could have been if left unchecked as of last night’s market close.

That downward pressure in the market popped our ProShares S&P 500 (SH) calls, leaving them to close at 0.90 – up more than 300% from our 0.22 entry point. That is a heckuva move, but given my concern to be had with the upcoming earnings season we are going to do the following:

As we profit from these current tumultuous times, we will sit on the sidelines at both Tematica Investing and here at Tematica Options+ and wait as the ripple effect of the above concerns reverberates through growth expectations for the S&P 500 group of companies. The glass half full view is this will give us the opportunity to buy and trade quality companies at better prices. As Oscar Wilde said, “To do nothing at all is the most difficult thing in the world, the most difficult and the most intellectual.”

Weekly Issue: ADDING SOME DOWNSIDE PROTECTION

Weekly Issue: ADDING SOME DOWNSIDE PROTECTION

Key points from this issue:

 

Adding some downside protection 

In yesterday’s weekly issue of Tematica Investing, I shared a number of data points and surveys that raise several flags that could wind up being headwinds as get ready to enter the September quarter earnings season. Despite the usually behind the curve Federal Reserve bumping up its 2018 GDP forecast to 3.1% from the prior 2.8% yesterday following its September FOMC policy meeting, the situation I am seeing in the hard economic data points to growing inflation in the systems and rising trade concerns as the next phase of President Trump’s tariffs and China’s response take hold. From a company’s perspective, this points to rising input costs and a tinge of uncertainty that could lead to conservative guidance relative to expectations.

As we saw, EPS expectations for the back half of 2018 have already started to inch lower. Moreover, recent EPS beats from the likes of Jabil (JBL), KBHome (KBH), Nike (NKE) and others, have led to the respective shares selling off. We’d expect to see that when we get a disappointing report like the one this week from Bed, Bath & Beyond (BBBY), but when EPS beats are following by a pullback one way or another it tells us stocks are close to being priced to perfection. Not surprising given the strong run-up in the stock market this year, last year and in 2016 that has the S&P 500 up 42% since the end of 2015.

In my view, this means we should add some downside protection to our two active call option positions that are Altria (MO) January 2019 65.00 (MO190118C00065000) calls and the Universal Display (OLED) January 2019 130.00 (OLED190118C00130000) calls. In examining the timetable for September quarter earnings, I’m opting to use November dated calls for the calls for the inverse ETF of the S&P 500 that is the ProShares Short S&P 500 (SH) shares. We’ll stick with out of the money calls and that means a strike price at 28.00.

Putting it together means adding the on ProShares Short S&P500 (SH) November 2018 28.00 (SH181116C00028000) calls that closed last night at 0.22 to our holdings. As we add this protective position, we’ll also want to limit potential downside and in this case, it means setting a protective stop loss at 0.14.

  • We are issuing a Buy on ProShares Short S&P500 (SH) November 2018 28.00 (SH181116C00028000) calls that closed last night at 0.22. With this addition, we will set a protective stop loss at 0.14

 

Checking in on our Altria and Universal Display calls

As I stated above, I continue to have a Buy rating on both the Altria (MO) January 2019 65.00 (MO190118C00065000) and the Universal Display (OLED) January 2019 130.00 calls (OLED190118C00130000)calls. We’re coming up on the $0.80 per share dividend payment from Altria, it’s first at that level and if history holds that should be a positive catalyst for the underlying MO shares.

For our Universal Display calls, survey data points to solid uptake rates for Apple’s new iPhone XS and XSMax as well as the iPhone X, with the larger format XSMax being the best of the bunch. This means that half of Apple’s iPhone portfolio will have organic light emitting diode displays, up from just one model until very recently.

In just under two weeks, on Oct. 9, Alphabet/Google (GOOGL) will unveil its latest Pixel 3 smartphone, which is also expected to have that technology. In addition to smartphone models, the ZTE Axon 9 Pro, and Sony Xperia XZ23 will soon hit the market joining recent ones from Huawei, Samsung, Asus and Xiaomi — and they all will have some form of OLED display.

We are also seeing more introductions of the technology into the TV market, with products from LG, Sony, Toshiba and Philips either having already launched in some markets or poised to be launched in the coming months.

The bottom line is we are starting to see the uptake in OLED technology that was talked about earlier this year and that’s very positive for our Universal Display position, and sets the company up for what is likely to be a very positive September-quarter earnings report and favorable December quarter guidance.

WEEKLY ISSUE: Putting Some Defensive Calls in Play

WEEKLY ISSUE: Putting Some Defensive Calls in Play

Key Points From This Issue

 

Given the way the Fourth of July holiday falls this year, we strongly suspect the back of the week will be quieter than usual. For those reasons, we’re coming at you earlier than usual this week. And while we have your attention, Tematica will be dark next week as we recharge our batteries ahead of the 2Q 2018 earnings onslaught that kicks off on July 16.

 With the housekeeping stuff out of the way, let’s get to this week’s issue…

 

Putting some defensive calls in play ahead of earnings season

With trade, tariffs and uncertainty taking the pole position in investor conversation, which comes as no surprise given that more companies are sharing the negative impact that might result if these tariffs go through. I go through that in far greater detail in this week’s issue of Tematica Investing, which will be hitting your inboxes and the website later this morning.

The nutshell view is we are starting to see companies warn about the potential impact of these various tariffs and right so investors are growing increasingly uncertain about the expected rate of earnings growth to be had in the back half of 2018. With it looking like neither side is going to back down — Commerce Secretary Wilbur Ross told CNBC on Monday that there’s no level on the downside in the stock market that would alter the way President Donald Trump approaches trade – it looks like we are in for an earnings recasting lower that could make what seems like a moderately priced stock market that much more expensive.

To prepare ourselves, we’re going to add two positions to the Tematica Options+ Select List. The first one is a call option on the inverse ETF for the S&P 500 that is ProShares Short S&P500 (SH). Given the timing of the 2Q 2018 earnings season, I’m selecting the August 17 strike date, which will allow us to capture the majority of quarterly earnings reports. Based on the current share price for SH shares and my preference for out of the money calls, I’m utilizing a 30.00 strike price. In sum this means we are making the following trade:

The second trade is also a defensive one in nature, but it is also one that factors in the sweltering temperatures sweeping the country. The National Oceanic and Atmospheric Administration’s Climate Prediction Center has updated their July forecast and more heat is expected for the month ahead over most of the nation.  While some may see that as heading deeper into summer, the reality is many will be facing higher electric bills as they look to keep cool and that has me adding a Utilities SPDR ETF (XLU) call option play to the Select List.

Breaking down the selection process as I did above for the SH call trade, we’ll use the same strike date – August 17, 2018 – but given where XLU shares are trading it means selecting the 53.00 strike price. Putting it all together:

 

JPMorgan upsizes dividend and buyback program

Last week we added a call potion in JPMorgan Chase & Co. (JPM), the world’s biggest investment bank by revenue, ahead of the Fed’s annual “stress test” results for U.S.-bank holding companies. Last Thursday night, following the results of the Comprehensive Capital Analysis and Review (CCAR) that is part of the Fed’s annual financial “stress tests” JPMorgan announced it would boost its quarterly stock dividend to $0.80 per share from $0.56 cents and authorized gross common equity repurchases of up to $20.7 billion from July 1, 2018 to June 30, 2019. That dividend hike is in line with expectations for a 3.0% dividend yield at or near the current share price.

While the JPM calls have traded off with the market, we expect the company will deliver a favorable earnings report on July 13 as it discusses this latest move to return capital to its shareholders.

 

Sticking with our media call plays

Recently, Walt Disney (DIS) upped its bid for assets of Twenty-First Century Fox (FOXA) and last week the Department of Justice made its sign-off official on Disney’s $71.3 billion of those assets, which provides for the divestment of 22 Fox regional sports networks within 90 days after closing the deal. It was then announced Disney and Fox would each hold a special meeting on July 27 to hold a definitive shareholder proxy vote to approve the transaction.

I continue to think the bidding war is not yet finished, and while I see Fox’s assets offering many synergies with Disney, I will monitor how far Disney is willing to stretch to win the deal. Here’s the thing – if Disney wins the bid, it means Comcast (CMCSA) loses; if Comcast surprises with a new winning bid, it means Disney loses. Either way, the race to add content is on and it likely means additional M&A activity will soon be had. For that reason, we are keeping our AMC Networks (AMCX) and Discovery (DISCA) call options in play. I am, however, boosting our stop loss on the AMC Network call options to 2.00 from 1.25. In sum:

 

Housekeeping and adding a heavy truck supplier option play

Housekeeping and adding a heavy truck supplier option play

 

KEY POINTS FROM THIS ISSUE:

  • We are issuing a Buy on the Cummins (CMI) March 2018 170 calls (CMI180316C00170000)that closed last night at 2.15. As we add these calls, we’ll set a protective stop at 1.25, and as the calls move higher I’ll raise that stop loss level.
  • We are issuing a sell on the ProShares Short S&P500 (SH), ProShares Short Russell2000 (RWM) and ProShares Short Dow30 (DOG) ETFs.
  • Because it will cost more to trade out of the Utilities Select Sector SPDR ETF (XLU) Feb. 16, 2018, 54.00 calls (XLU180216C000540000) than subscribers will see in returned capital, subscribers should let these XLU calls expire on Friday.

 

Yesterday, I shared my initial take on how the market herd knee-jerk reacted to the January Consumer Price Index report and as the day’s trading wore on moving from losses to gain it seems the herd once again saw the light. Over the coming days, we’ll get several other economic reports, but it was this CPI report that had the stock market on pins and needles. With that report passed, the market breathed a sigh of relief as it looks like the Fed may stick with just three rate hikes this year…. At least right now.

This morning, we’ll get the January Producer Price Index, and odds are much like the January CPI report energy costs – read that as oil, gas and fuel – will have increased dramatically. As I explained this yesterday, we’re already seeing oil prices retreat as inventories build and more U.S. capacity comes on stream, and I suspect the market will see through the January PPI report.

With this behind us, we’re apt to see the market move higher albeit at a more measured pace than we’ve seen in 2017. As such, we’re going to trade out of the inverse ETF positions that we’ve held onto and served us well this month as the market gave back much of its gains.

  • We are issuing a sell on the ProShares Short S&P500 (SH), ProShares Short Russell2000 (RWM) and ProShares Short Dow30 (DOG) ETFs.
  • As we close these positions out, we’ll record a mix of meaningful short-term and long-term losses that we’ll apply to other positions on the Tematica Investing Select List as well as here at Tematica Options+

 

Adding a heavy truck supplier play to the fold

Earlier this week, I added shares of heavy truck manufacturer Paccar (PCAR) to the Tematica Investing Select List given rising freight costs due in part a national truck shortage as well as prospects for a firming domestic economy that is driving freight tonnage higher. As much as I would like to follow through with a call option recommendation to positions on the Select List, it’s not always a smart thing to do, largely due to the lack of trading volume for the corresponding options.

In the case of Paccar, the vast majority of the call options trade single digit volumes most days. That level of volume, or more correctly that lack of volume, makes it a very dicey situation to trade and tends to give rise to very wide bid-ask spreads that can make it a challenge to achieve a profitable trade. The same is true with Rush Enterprises (RUSHA), the largest dealer of commercial truck vehicles in the U.S. and one that counts Paccar as a key supplier.

This had me looking into the heavy truck industry supply chain, and one of those key suppliers is Cummins Inc. (CMI), which competes in the diesel and natural gas engines and engine-related component products for the truck markets in the U.S., China and Brazil markets as well as power generation applications. The market indigestion has weighed on CMI shares to $166 as of last night’s market close from just under $193 in late January.

Much like the PCAR share on the Tematica Investing Select List, the opportunity to be had from the mismatch between heavy truck demand and Cummins’ share price is more than favorable in my view. Unlike PCAR shares, the call options associated with CMI shares are far more liquid by comparison. Cummins reported better than expected December quarter results and guided 2018 in-line with consensus expectations even as it offered its view that domestic heavy truck engine shipments would grow 20% year over year.

In the next few weeks, the Cummins management team will present at the Barclays Industrial Select Conference 2018 and soon after we’ll get the flash heavy truck order report for February. Both events should be a positive for Cummins business, and serve as a catalyst for the currently oversold shares.

 

Housekeeping

Later this week our Utilities Select Sector SPDR ETF (XLU) Feb. 16, 2018, 54.00 calls (XLU180216C000540000) will expire – my advice is given the sharp fall and nearly zero value currently attached to them let them expire. It will cost you more to trade out of these call options than odds are the capital you will get back. Let’s be smart here and do the prudent thing.