Once again, everything is proceeding exactly as I have foreseen.
On Monday afternoon, I said: "S&P must hold 900 of course, no sense in making a play to the upside as the danger of gapping below 900 and triggering a massive sell-off looms for tomorrow. Since we’re 300 points away from getting back to today’s open, there’s not much of a sense of urgency to reposition here" and our bearish outlook has served us well the past two days as we did indeed fail to hold 900 on Tuesday's close and we did indeed gap down into a huge sell-off, heading for our 840 target test along with the Dow 8,200 line I said would be our BUYBUYBUY point.
With Monday's DXD Dec $65s at $19.70 (up 67%) it's mission accomplished on the short side and we looked to rebalance to 50/50 in yesterday's sell-off and discussed the idea of moving to (dare I say it?) 60:40 bullish if we hold 8,200. To that end, I listed 22 hedged plays for members in yesterday's post based on yesterday's very important educational post: "How to Buy Stocks for a 15-20% Discount." Of the group of diversified dividend payers, that includes, MSFT, WMT, KMP, PRU, KFT and even the horribly performing GE – the dog of the day was and is INTC, who warned last night that revenues will be 14% below expectations for Q4.
14%?!? Shocking! Still, if you do the math that's 14% less than $10.35Bn expected, which is still about $9Bn. This makes sense with CC shutting down (no new orders for the holidays) and everyone else looking to burn off inventory even if they could use their credit lines to make new orders. Consumers don’t want what’s new this year – just what’s cheap and corporations aren’t even having Christmas parties so Q4 IT spending has got to be cut to the bone. So INTC will "only" sell $9Bn worth of chips in Q4 vs last Q4 where they sold $10.1Bn and profit margins will fall 5% so let’s say 2.7Bn in profits is knocked down 20% overall…. Last Q4, INTC was $27, now it’s $13 – that is ridiculous! Even if orders fall another 15% and another 15% and they still can’t get margins under control (in a deflationary environment), they are still worth more than $13!
But we're not going to buy INTC for $13 are we? We're going to buy INTC for $13 and then we're going to sell the Dec $12 puts and calls for $3, which will give us a net entry of $10 and a 20% profit if called away at $12 on Dec 21st and an average entry of $11 if a second round is put to us if the stock finishes the option period lower than $12. We may be a little nervous buying INTC at $13 but we sure as hell want to own it for $11. As of yesterday's close, I can sell the Jan $15 call for $2.75, that's a 25% annual return on my $11 investment. It doesn't matter if the price of a share of Intel is $5 or $25, I'll still get 25% back on my $11 investment this year. As long as you believe in a company and are willing to ride out the recession, whatever that may be – then deals like this and the dozens of other we're featuring this week may be once in a lifetime opportunities.
I think that a 40% drop in the markets is already pricing in a long recession. The US GDP is $13Bn. Let’s assume it drops 5% to $12.35Bn this year and another 5% to $11.74Bn and then we have a third year of negative 5% growth (this has never happened in history) to $11.15Bn – That would still be a bigger GDP than we had in 2004. Companies like INTC are already trading well below 2004 prices, the Dow was at 10,000 in 2004 and the S&P was at 1,100. These prices are way too low for any reasonable projection of the economic activity of this country. Then you have to factor in that, if you stay out of the housing, banking and commodity sectors, which were already bubbling in 2004 – that the remaining segments of the economy have lower borrowing costs, lower materials costs, lower shipping fees, lower energy costs and a pool of readily available labor – these are the classic ingredients for a booming recovery!
I'm certainly not saying we are going to turn up right away but, for the kind of companies we're selecting for the long-term, it’s simply not as bad as is reflected in the the current prices. We may have a couple of bad quarters or a couple of bad years but, if you plan on owning IBM for 20 years, it’s like valuaing them now based a snapshot of the 9/11 quarter or the 1987 recession – that’s what the go-forward valuations are like, as if we are NEVER going to recover. This isn’t nuclear war, it’s an economic recession….
Our major fears remain (in order of likelihood): a GM bankruptcy, a major bank failure or a major country failure (not Iceland). Any of those could spark a much worse liquidity crisis than we have now. It is far more likely that GM will be bailed out, the banks will continue to be bailed out and the IMF will support the troubled nations and we will move through this crisis and things will, eventually, get back to normal. It may be a while but we know how to get paid to wait – even the people who held onto their stocks in 1929 and never sold finally got their money back in 1954. Since we know how to generate 10-20% annual incomes while we wait, that's just not a scary prospect for option players.
Keep in mind we're not 100% bullish either but I feel good about moving to 60% bullish positions IF we can hold 8,200 for the week. We often look at the S&P priced in Euros to get an idea of how our markets look to the rest of the world and it's a lot easier to see here that we're actually holding up fairly well in the face of a rising dollar. Your IBM stoc k may have dropped from $120 in July to $80 but in July, that $120 could have bought you just 9 tenths of a barrel of oil but today $80 buys you 1.4 barrels, a 50% relative increase!
Fear was running rampant in Asia this morning with the Hang Seng and the Nikkei following US equities down 5% but the Shanghai bucked the trend and GAINED 4%, refusing to lose the 70% off line, which is I have pointed out is our opportunity to get into Chinese stocks just 30% away from zero! We've been playing both the FXI and the FXP, depending on our mood lately but the FXI's are long-term holds for us from our $23 entry while the FXPs are momentum plays we've been using to great advantage. We'll be watching both $23 and $85 with great interest as those are our targets on the two ETFs before the turn.
It wasn't official when I told you yesterday but today it's officially official that we are in a global recession according to the OECD. In its latest economic forecasts, the Paris-based agency said gross domestic product was likely to fall by 0.3% in 2009 for its 30 member countries, representing democracies with market economies. The OECD said the U.S. economy would contract by 0.9%, Japan's by 0.1% and the euro zone by 0.5%. Oh my gosh – that's almost 1% contraction – I guess we'd better knock 40-50% off the markets! (end extreme sarcasm font).
"The OECD area economy appears to have entered recession," said Jorgen Elmeskov, director of the policy studies branch and the OECD's economics department. He said that while the picture was uncertain, "projections point to a protracted downturn" with recovery not likely before the second half of next year, with the U.S. leading the way out of recession. Key risks include a longer-than-anticipated return to normal in financial markets, which have fallen sharply. The OECD's projections assume that the financial stress since the banking crisis exploded in mid-September will prove to be "short-lived" but followed by an "extended period of financial headwinds" through the end of next year, with conditions then returning to near normal.
I'm not sure what "normal" is after seeing the markets nearly double from 2003 to 2007 and then seeing them cut in half 12 months later – it can't be weirder than this, so let's look forward to it! Europe is holding it together ahead of our open with a slightly negative morning but improving from the open. Germany is officially in a recession (also old news to us) and SI (Europe's GE) had a big loss but it was expected and shouldn't hurt them too much, especially as they are already trading 60% off their highs and European investors are known to be 10% more rational than US investors so SI should do at least 10% better than GE on similar earnings…
Jobless claims were, of course a disaster with 516,000 people filing for the week, the most since Sept 29th, 2001. The four-week average of new claims, which aims to smooth volatility in the data, rose 13,250 to 491,000, the highest since 1991 and well above recessionary levels typically associated with further increases in the unemployment rate. Meanwhile the tally of continuing claims, those drawn by workers collecting benefits for more than one week in the week ended Nov. 1, inched closer to the four-million mark, rising 65,000 to 3,897,000. That's the highest level since January 1983, suggesting it is taking the unemployed much longer to find new work.
Both imports and exports dropped but energy tipped the balance in our favor and our trade deficit shrank to $56.47Bn, almost half of last year so that's a good thing. We imported over 1Mbd less oil than last September so keep that in mind when you see today's inventory report that they are already shorting us 10Mb per week on those numbers in order to hide the tremendous level of demand destruction. People are simply not driving and even giving up extra cars – this isn't just saving a few gallons by switching to higher mileage vehicles but we are actually reducing the amount of cars on the road by 10% – these are huge, immediate cut-backs in fuel consumption.
Sub $60 oil is something we haven't seen since 2005, when the global economy was overheating and, if it stays down at these levels and we can start planning our years around that price, outlooks for Transports and the industrials can change rapidly. We were watching the TRANQ as our lead indicator yesterday and their failure at 1,750 was exactly what tipped the market over the edge. While we are cautiously optimistic – we're not going to go too crazy until we see those levels (see Big Chart) starting to be taken back.
QLD is still my favorite upside play and good old Intel has whacked them all the way down to $26 so it's hardly worth using options at that price. Still, you can't argue with the tremendous leverage of the Dec $23s at $5.80, you can set a stop at $5 or sell the Nov $28s for $1.50 if the Qs can't hold 28.50 but I like them for the month. UWM is also a great way to go at $18.40, we can sell calls against them later but this is a long-term investment in Main Street – let's hope they survive!
