As The Federal Reserve’s policy of “Quantitative Easing” comes to an end the next phase considered should perhaps be one of instituting some form of “Quantitative Muzzling.”
Given comments contained in this past week’s FOMC statement had recognized global economic concerns, perhaps the Federal Reserve should consider expanding its dual mandate and reaching across the ocean to affix, adjust and tighten the right remedy.
As most of us learned sometime in childhood, words have consequences. However, we tend not to mind when the consequences are positive for us or when what we all know is left unsaid and ignored.
In each of the past two weeks words from the European Central Bank’s President Mario Draghi have had adverse impacts on global markets. While no one is overtly suggesting that ECB President’s should be seen and not heard, undoubtedly at least one person is thinking that, having applied a sloppy test of correlation to the market’s moves and Draghi’s words.
Such sloppy tests may have at least as much validity as the much discussed “key reversal” seen as trading closed on Wednesday and said to presage a bullish turnaround to the downtrend.
How did that work out for most people?
This week Draghi told us what everyone knows to be the truth, but what no one wants to hear. He simply said that there can be no growth in the European economies without economic reform.
That’s not different from what he said the previous week, as he pointed out that political solutions were necessary to deal with economic woes.
We also all know if it we have to rely on politicians to do the right thing, or make the difficult decisions, we’re not going to fare terribly well, hence the sell-offs. Why the Europeans can’t simply kick things down the road and then forget about it is a question that needs to be asked.
Compare the response to Draghi’s comments to the absolutely effusive response to this past week’s FOMC statement that simply said nothing and ignored answering the question that everyone wanted to ignore.
Despite everyone knowing what Draghi has been saying to be true, having had the same scolding take place in the U.S. just two years ago, no one with an investment portfolio wants to hear of such a thing, especially when it’s followed up with downgrades of Finland’s and France’s credit ratings.
Add to the mix the International Monetary Fund’s cut to its global growth forecast and you have spoken volumes to an already wary US market that was now eagerly eying any breach of the 200 day S&P 500 moving average (dma), as that had taken the place of the “key reversal” in the hearts and minds of technicians and foisted upon investors as being the gateway to what awaits.
Unfortunately, the message being sent with that technical indicator is a bearish one. While it has been breached on numerous occasions in the past 5 years, the most pronounced and prolonged stay below the 200 dma came in the latter half of 2011, a period when triple digit daily moves were commonplace and volatility was more than double the now nearly 2 year high level.
I miss those days.
As usual, the week’s potential stock selections are classified as being in Traditional, Double Dip Dividend, Momentum or “PEE” categories.
When I first started thinking about a theme for this week’s article I decided to focus on stocks that had already undergone their own personal 10% correction.
That list grew substantially by the time the week came to its close following a brief FOMC induced rally mid-week and that thesis was abandoned.
As trading in the coming week opens at a DJIA level lower than where it began the year, there’s not much reason to start the week with any sense of confidence.
While the S&P 500 is only 5.2% below its recent high, putting it on par with numerous “mini-corrections” over the past two years, you don’t have to do a quantitative assessment to know that this decline feels differently from the others, as volatility is at a two year high point. The sudden appearance of triple digit moves have now gone from the mundane 100 point variety and have added 200 and 300 point ones into the arsenal.
For me, this week may be a little different. Heading into the week I have less cash reserves than I would like and less confidence than I would ordinarily need to dwindle it down further.
While it appears as if there are so many values to be had I would prefer to see some sign of stability before committing resources in my usual buy/write manner. Instead, I may be more likely to add new positions through the sale of out of the money puts, unless there is a dividend involved.
Additionally, while individual stocks may have compelling reasons to consider their purchases, this week I’m less focused on those specific reasons rather than the nature of their recent price declines and the ability to capitalize on the heightened option premiums associated with their recent volatility.
One of the benefits of this rising volatility environment is that option premiums grow as does the uncertainty. The sale of puts and anticipation of the need to rollover those puts in the event of further price erosion may be better suited to an environment of continuing price declines, rather than utilizing a traditional buy/write strategy.
Furthermore, as the premiums become more and more attractive, I find myself more inclined to attempt to rollover positions that might otherwise be assigned, as the accumulation of premiums can offer significant downside protection and reduces the need to find alternative investment candidates.
If you’re looking for a sector that is screaming “correction” you really don’t have to look beyond the Energy Sector. Hearing so many analysts calling for continued decline in oil prices may be reason enough to begin considering adding positions.
Over the years I’ve lost track of how many times I’ve owned Halliburton (HAL), but other than during the 2008-2009 market crash, the time of the Deepwater Horizon disaster and during the tumultuous market of 2011, there haven’t been such precipitous declines in its price, as it has just plunged below its own 200 dma.
Although Halliburton doesn’t report earnings until the following week, next week’s premiums are reflective of the volatility anticipated. For anyone considering this position through a buy/write one factor to keep in mind is that it will be imperative to rollover the contract if expiration looks likely. That is the case because earnings are reported on the following Monday morning before trading opens so there won’t be a chance to create a hedging position unless done the previous week.
I have been waiting for an opportunity to repurchase shares of Anadarko Petroleum (APC) ever since a bankruptcy judge approved a pollution related settlement, that was part of its years earlier purchase of Kerr-McGee. Like Halliburton, it is now trading below its 200 dma, but it doesn’t report earnings until a week after Halliburton. However, it also offers exceptionally high option premiums as the perceived risk remains heightened in anticipation of further sector weakness.
Owing to its drops the final two days of the previous week, Dow Chemical (DOW) is now also trading below its 200 dma. It, too, is demonstrating an option premium that is substantially higher than has been the case recently, although the risk appears to be considered less than that seen for both Halliburton and Anadarko. With the exception of having received an “outperform” rating those past two days, Dow Chemical appears to have just been caught up in the market’s downturn.
Fastenal (FAST) has traded below its 200 dma since its last earnings report in July 2014 and was not helped by its latest report this past Friday. That was the case despite generally good revenues, but with softer margins that were expected to continue. Unlike the preceding stocks the option premiums are not expanded in reflection of heightened risk. In the event that this position is initiated with a put sale that is likely to be assigned, I would consider taking possession of shares rather than rolling over the puts, as shares go ex-dividend during the November 2014 option cycle.
For a stock whose price hasn’t done very much, eBay (EBAY) has been getting lots and lots of attention and perhaps it is that attention which has prompted it to finally decide to do what so many have suggested, by releasing plans to spin off its PayPal unit. eBay reports earnings this week and is always a prospect to exhibit a sizeable move. It is currently trading below the point that consider the mid-point of the price range that I like to see when considering a new position. As with some other potential earnings trades, it is a candidate for out of the money put sales before earnings or for those more cautious the sale of puts after earnings in the event of a large price drop upon earnings having been released.
Intel (INTC) reports earnings this week after having already been brutalized this past week along with the rest of the chip sector. Most recently I discussed some hesitancy regarding a position in Intel because it had two price gaps higher in the past few months. However, thanks to the past week it has now erased one of those price gaps that represented additional risk. As with Fastenal there is an upcoming ex-dividend date that may be a consideration in any potential trade.
Following YUM Brands’ (YUM) earnings report last week, many over-reacted during after hours trading and shares quickly recovered to end the following day higher, perhaps buoyed by the enthusiasm following the FOMC Statement. Shares did trend lower the rest of the week, but fared much better than the overall market. This coming week YUM Brands is ex-dividend and based upon its option premium is a veritable sea of calm, although it too is demonstrating growth in premiums as risk is generally heightened.
Finally, Best Buy (BBY) is one of those stocks that has seen its own personal correction, having fallen nearly 13% since the market high just 3 weeks ago. With so much attention having been placed on European concerns it’s hard to think of too many stocks that are so well shielded from some of those perceived risks. Although it doesn’t report earnings for more than a month, this is a position that I would like to maintain for an extended period of time, particularly with its currently bloated option premiums, heading into earnings, which I believe will reflect an improving discretionary spending environment, to Best Buy’s benefit.
Unless of course the muzzle falls off, in which case all bets are off for this week.
Traditional Stocks: Anadarko Petroleum, Dow Chemical, Fastenal, Halliburton
Momentum: Best Buy
Double Dip Dividend: YUM Brands (10/15)
Premiums Enhanced by Earnings: eBay (10/15 AM), Intel (10/14 PM)
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.