The world is awash in oil and we all know what that means.
From Texas to the Dakotas and to the North Sea and everything in-between, there is oil coming out of every pore of the ground and in ways and places we never would have imagined.
Every school aged kid knows the most basic law of economics. The more they want something that isn’t so easy to get the more they’re willing to do to get it.
It works in the other direction, too.
The more you want to get rid of something the less choosy you are in what it takes to satisfy your need.
So everyone innately understands the relationship between supply and demand. They also understand that rational people do rational things in response to the supply and demand conditions they face.
Not surprisingly, commodities live and die by the precepts of supply and demand. We all know that bumper crops of corn bring lower prices, especially as there’s only so much extra corn people are willing to eat as a result of its supply driven decrease in price.
Rational farmers don’t plant more corn in response to bumper crops and rational consumers don’t buy less when supply drives prices lower.
Stocks also live by the same precepts, except that most of the time the supply of any particular stock is fixed and it’s the demand that varies. However, we’ve all seen the frenzy around an IPO when insatiable demand in the face of limited supply makes people crazy and we’ve all seen what happens when new supply of shares, such as in a secondary offering is released.
Of course, much of what gains we’ve seen in the markets over the past few years have come as a result of manipulating supply and artificially inflating the traditional earnings per share metric.
When a deep Florida freeze hits the orange crop in Florida, no one spends too much time deeply delving into the meaning of the situation. The price for oranges will simply go higher as the demand stays reasonably the same, to a point.
If, however, people’s tastes change and there is suddenly an imbalance between the supply and demand for orange juice, reasonable suppliers do the logical thing. They try to recognize whether the imbalance is due to too much supply or too little demand and seek to adjust supply.
Whatever steps they may take, the world’s economies aren’t too heavily invested in the world of oranges, no matter how important it may be to those Florida growers.
Suddenly, oil is different, even as it has long been a commodity whose supply has been manipulated more readily and for more varied reasons. than a farmer simply switching from corn to soybeans.
The price of oil still lives by supply and demand, but now thrown into the equation are very potent external and internal political considerations.
Saudi Arabia has to bribe its citizens into not overthrowing the monarchy while wanting to also inflict financial harm on anyone bringing new sources of supply into the marketplace. They don’t want to cede marketshare to its enemies across the gulf nor its allies across the ocean.
With those overhangs, sometimes irrational behavior is the result in the pursuit of what are considered to be rational objectives.
Oil is also different because the cause for the imbalance says a lot about the world. Why is there too much supply? Is it because of an economic slowdown and decreased demand or is it because of too much supply?
Stock markets, which are supposed to discount and reflect the future have usually been fairly rational when having a longer term vision, but that’s becoming a more rare phenomenon.
The very clear movement of stock markets in tandem with oil prices up or down has been consistent with a belief that the balance between supply and demand has been driven by demand.
Larry Fink, who most agree is a pretty smart guy, as the Chairman and CEO of Blackrock (BLK) was pretty clear the other day and has been consistent in the belief that the low price of oil was supply, and not demand driven. He has equally been long of the belief that lower oil prices were good for the world.
In any other time, supply driven low prices would have represented a breakdown in OPEC’s ability to hold the world’s economies hostage and would have been the catalyst for stock market celebrations.
Welcome to 2016, same as 2015.
But world markets continue to ignore that view and Fink may be coming to the realization that his voice of reason is drowned out by fear and irrational actions that only have a near term vision. That may explain why he now believes that there could be an additional 10% downside for US markets over the next 6 months, including the prospects of job layoffs.
That’s probably not something that the FOMC had high on its list of possible 2016 scenarios.
Ask John McCain how an increasing unemployment rate heading into a close election worked out for him, so you can imagine the distress that may be felt as 7 years of moderate growth may come to an end at just the wrong time for some with great political aspirations.
The only ones to be blamed if Fink’s fears are correct are those more readily associated with the existing power structure.
Just as falling stock prices in the face of supply driven falling oil prices seems unthinkable, “President Trump” doesn’t have a dulcet tone to my ears. More plausible, in the event of the unthinkable is that it probably wouldn’t take too much time for his now famous “The Apprentice” tag line to morph into “You’re impeached.”
So there’s always that as a distraction from a basic breakdown in what we knew to be an inviolate law of economics.
With 2016 already down 8% and sending us into our second correction in just 5 months so many stocks look so inviting, but until there’s some evidence that the demand to meet the preponderance of selling exists, to bite at those inviting places may be even more irrational than it would have been just a week earlier.
As usual, the week’s potential stock selections are classified as being in the Traditional, Double Dip Dividend, Momentum or “PEE” categories.
One stock that actually does look like a bargain to me reports earnings this week. Verizon (VZ) is the only stock in this week’s list that isn’t in or near bear correction territory in the past 2 months.
Even those few names that performed well in 2015 and helped to obscure the weakness in the broader market are suffering in the early stages of 2015.
Not so for Verizon, even though the shares have fallen nearly 5% from its near term resistance level on December 29, 2015, the S&P 500 fell almost 9% in that time.
While there is always added risk with earnings being reported, Verizon and some of its competitors stand to benefit from their own strategic shifts to stop subsidizing what it is that people crave. That may not be reflected in the upcoming earnings report, but if buying Verizon shares I may consider looking beyond the weekly options that I tend to favor in periods of low volatility. Although I usually am more likely to sell puts when earnings are in the equation, I’m more likely to go the buy/write route for this position.
The one advantage of the kind of market action that we’ve had recently is the increase in volatility that it brings.
When that occurs, I start looking more and more at longer term options. The volatility increase typically means higher premiums and that extends into the forward weeks. Longer term contracts during periods of higher volatility allow you to lock in higher premiums and give time for some share price recovery, as well.
Since Verizon also has a generous dividend, but won’t be ex-dividend for another 3 months, I might consider an April 2016 or later expiration date.
One of the companies that is getting a second look this week is Williams-Sonoma (WSM), which is also ex-dividend this week and only offers monthly options.
Shares are nearly 45% lower since the August 2015 correction and have not really had any perceptible attempt at recovering from those losses.
What it does offer, however. is a nice option premium, that even if shares declined by approximately 1% for the month could still deliver a 3.8% ROI in addition to the quarterly 0.7% dividend.
Literally and figuratively firing on all cylinders is General Motors (GM), but it is also figuratively being thrown out with the bath water as it has plunged alongside the S&P 500.
With earnings being reported in early February and with shares probably being ex-dividend in the final week of the March 2016 option cycle, there may be some reason to consider using a longer term option contract, perhaps even spanning 2 earnings releases and 2 ex-dividend dates, again in an attempt to take advantage of the higher volatility, by locking in on longer term contracts.
Netflix (NFLX) reports earnings this week and the one thing that’s certain is that Netflix is a highly volatile stock when reporting earnings, regardless of what the tone happens to be in the general market.
With the market so edgy at the moment, this would probably not be a good time for any company to disappoint investors.
The option market definitely demonstrates some of the uncertainty that’s associated with this coming week’s earnings, as you can get a 1% ROI even if shares drop by 22%.
As it is, shares are down nearly 20% since early December 2015, but there seem to be numerous levels of support heading toward the $81 level.
If shares do take a plunge, there would likely be a continued increase in volatility which could make it lucrative to continue rolling over puts, even if not faced with impending assignment.
Of some interest is that while call and put volumes for the upcoming weekly options were fairly closely matched, the skew was toward a significant decline in shares next week, as a large position was established at a weekly strike level $34 below Friday’s close.
Finally, last week wasn’t a very good week for the technology sector, as Intel (INTC) got things off on a sour note, which is never a good thing to do in an already battered market.
Seagate Technology (STX) wasn’t spared any pain last week, either, as it has long fallen into the same kind of commodity mindset as corn, orange juice and even oil back in the days when things made sense.
Somehow, despite having been written off as nothing more than a commodity, it has seen some good times in the past few years. That is, if you exclude 2015, as it has now fallen more than 50% since that time, but with nearly 35% of that decline having occurred in just the past 3 months.
I usually like entering a Seagate Technology position through the sale of puts, as its premium always reflects a volatile holding.
For example the sale of a weekly put at a strike price 3% below Friday’s closing price could provide a 1.9% ROI. When considering that next week is a holiday shortened week, that’s a particularly high return.
Seagate Technology is no stranger to wild intra-weekly swings. If selling puts, I prefer to try and delay assignment of shares if they fall below the strike level. Since the company reports earnings the following week, I would likely try to roll over to the week after earnings, but if then again faced with assignment, would be inclined to accept it, as shares are expected to be ex-dividend the following week.
The caveat is that those shares may be ex-dividend earlier, in which case there would be a need to keep a close eye out for the announcement in order to stand in line for the 8% dividend.
For now, Seagate does look as if it still has the ability to sustain that dividend which was increased only last quarter.
Traditional Stocks: General Motors
Momentum Stocks: Seagate Technolgy
Double-Dip Dividend: Williams-Sonoma (1/22 $0.35)
Premiums Enhanced by Earnings: Netflix (1/19 PM), Verizon (1/21 AM)
Remember, these are just guidelines for the coming week. The above selections may become actionable – most often coupling a share purchase with call option sales or the sale of covered put contracts – in adjustment to and consideration of market movements. The overriding objective is to create a healthy income stream for the week, with reduction of trading risk.