It’s been a while since we had a flu scare.
We had avian flu a few years ago and the biotech stocks of companies that made vaccine went nuts for a while and then crashed when it turned out to be much ado about nothing. Of course before that was mad cow and that one devastated the beef and restaurant industry, especially in Europe where steak houses went bankrupt as people refused to eat meat so don’t underestimate how fast panic can spread and habits can change when people start dying. The pigs are getting a bad rap this time as this particular virus is a mix of swine, bird and human strains but logic doesn’t enter into these things and if the press is determined to label it "swine flu" then you bet that’s what the public will fixate on.
HRL is a big seller of pork products and could make a big breakdown if they can’t hold $30 but, rather than short them, I prefer to get in on a dip as these things do tend to pass. GSK makes a vaccine and is an obvious upside choice and they’ve been trading well off their highs so make a nice play either way. The June $30 puts can be sold naked for $2.17 and that’s a nice way to enter the stock (or get paid $2 NOT to buy it). Also buying the stock at $29.34 (which pays a 5.6% dividend) and selling the June $30 calls for $1.10 and the June $27.50 puts for $1.05 drops the net entry to $27.19 and an average entry of $27.35 if put to you, a nice discount to the current price (see "How to Buy a Stock for a 15-20% Discount" for details on this strategy). GSK 2011 $25 calls are also pretty cheap at $6.15 ($2 in premium) and we can sell calls against them on a nice run up, perhaps a 1/2 sale of June $30s at $2+ (now $1.10).
NVAX already got a huge pop on Friday when this story first spread and should continue to fly but that’s one of the ones we’re more likely to short as they get overextended. I think my other favorite upside play is MMM, who don’t make a vaccine but do make those blue masks that governments love to give out to make people feel like they’re doing something. It’s hard to get US citizens to go for them but in Asia they love the things and 3M is a great company anyway who held onto half their profits in the last earnings report and are quite the bargain at $57. Jan $50 calls are $9.85 and a 1/2 sale of the June $55s for $4 or more puts you in a $5 spread at $7.85, fairly well covered (and you can always sell the other half) with plenty of time to adjust.
In Chinese, the symbol for crisis is made up of two elements that signify danger and opportunity (more accurately, a time of change). Preparation is a pre-requisite for taking advantage of an opportunity or all you have is a dangerous crisis. Although the danger may be high, opportunities present themselves to those who are prepared – that’s what we try to do here at PSW, prepare ourselves for market contingencies and be ready to act, turning danger into opportunity whenever possible but never forgetting that the danger is there! Remembering the danger that lies in the opportunities and hedging for both is the yin/yang of trading….
As is usual in any kind of global scare, gold is running up, going as high as $920 in overnight trading and this is good news for the IMF, who are the world’s third largest holder of gold and are looking to sell 12.9M ounces (12% of their reserves) for, they hope, close to $12Bn while they wait for $500Bn in checks to clear from the pledges made by G20 nations at the last conference. We’ve been bullish on gold for quite some time but I urge caution here as a combination of IMF sales forcing the ETF GLD to begin selling their stash could cause a fairly sharp correction along the way. We covered our hedging strategy on that in "Spinning Straw Trades Into Gold" back on March 22nd, when we hit a perfect bearish entry right at $925 and flipped bullish at $875 – this strategy may be setting up to work again so we’ll keep an eye on it!
China, with 1.4Bn people, hates epidemics of any kind and the Hang Seng fell 2.74% this morning (418 points) so congrats to all our FXP players as that cover pays off in spades today. Tourism stocks led the declines but the market was due for a pullback anyway and this is just a good excuse to take a little off the table after a huge run although it is a little disturbing to see the 15,000 line fall so easily as we practically gapped below it at the open. The Shanghai Composite took a similar fall but the Nikkei got a 75-point "stick save" into the close that kept them positive (up 18) and painted a nice technical picture above the 8,650 line despite the government’s forecast of a record 3.3% economic contraction, a severe revision from flat forecasts in December.
The government on Monday also finalized a supplementary budget bill to fund the fourth stimulus package since last summer, which includes ¥15.4 trillion in fresh fiscal spending. It will submit the bill to parliament for approval. "It is very unusual to submit an extra budget as early as April, the first month of a fiscal year," a Finance Ministry official said. "We can’t imagine what lies ahead now; let’s just hope that the announced measures will save the economy." One thing I often say to members is: Hope is NOT a strategy, but it seems to be what Japan is counting on as they once again roll the stimulus dice. Japan’s GDP contracted at an annualized pace of 12.1% during the October-December period, and the Cabinet Office said it may shrink by about 14% — the worst pace on record — during the January-March period. "We are also worried about a return of severe deflation," the Cabinet Office official said, because it will make the recession more severe by damping consumer spending.
Europe is down about a point ahead of our open and hoping they can pull our markets up rather than us dragging them down as the EU markets clearly outperformed us last week. Airlines and other travel stocks led the downturn in Europe as well and that should finally get PCLN to break lower here (see Weekend Wrap-Up) although not for the reason we expected. Iceland swung sharply to the left in this weekend’s elections (European nations have elections on Saturday’s because they actually WANT their citizens to vote) with the Social Democratic Alliance and their coalition partners in the Left-Green Movement taking majority control of Parliament. Why does this matter? Well Iceland was not in the EU and ran a very US-style economy dominated by banking and it destroyed the country. The Social Democrats want to join the EU and the EU is controlled by votes and this will push the EU further down the path to regulate and reign in capitalism. Doesn’t that sound like it matters?
Speaking of capitalism not working – GM is diluting down common shareholders roughly 100 to 1 by paying off everyone in stock, cutting deals with bondholders and the UAW in order to save the company. For some amazing reason, this is not tanking the stock pre-market, which I find amazing as I didn’t want to own 1/300 Millionth of GM for $1.69 last week and I sure don’t want to own 1/30 Billionth of it for the same price today!
We are, to say the least, relieved that we took a bearish stance into the weekend but we will try not to over-think the market and stick to watching our key levels, which remain Dow 7,900, S&P 833, Nasdaq 1,580, NYSE 5,225 and Russell 444 below which we have at least a 2.5% air pocket that will provide little support. On the upside, we need to take out last week’s highs of DIA 8,130, S&P 870, Nas 1,700, NYSE 5,500 and RUT 480, which should NOT be difficult as the dollar is off 2.5% from last week’s open (raising the relative value of equities). The energy sector and perhaps the miners will pull us down early on and I don’t really see a horse to jump to other than biotech/pharma but that’s based on the flu event and not a reason to rally the markets so we’re going to strap ourselves in and ride this puppy down and see where the bottom is today – hopefully we find it early on but, fortunately, we are prepared for anything.
Be careful out there!
