Weekend Update & On Friday, February 13, 2015
“STOCKS RALLY ON WALL STREET!”
STOCKS GAINED GROUND ON FRIDAY & FOR THE WEEK! Friday saw most major U.S. stock indices increase by about +0.260% to +0.75%. Volatility, as measured by the VIX imploded, and decreased by -0.65 points or -4.24% to 14.69. The DJIA +46.97 points or +0.26% to 18,019.35; The S&P500 +8.51 points or +0.41% to 2,096.99; The S&PMidCap400 +7.93 points or +0.53% to 1,502.78 (a new all time high). See the graphic below for daily and past 5 day performance of the U.S. Major Stock Indices. In fixed income Friday, long term treasuries sold off, while the entire high yield sector of U.S. Corporate and Sovereigns rallied by about +0.14 to +0.28%. See the graphic below to see how fixed income faired Monday. I continue to believe the major U.S. stock indices will soon plow through previous all time highs, by three to four percent, before taking a few steps back, before making another advance higher. I believe the only thing that could delay this would be pessimism on Greece and also on Russia’s sabre rattling against its neighbors. Germany is likely going to “bail out” Greece again; They’ve got too much to lose if they decided not to bail out Greece. If these issues can be resolved, the markets would in my view, move higher strongly. I continue to remain bullish, and I believe energy shares and crude oil will trade in a volatile range, but will trade higher given a month or two or more, which I believe will lift all major U.S. Stock Indices to new highs; as it will certainly bode well for the energy sector’s shares, which represent about ten percent of all major broad based stock indices. Lastly, I think that higher energy prices will bring “hot” (meaning higher than usual) CPI-U monthly figures over the next 12 months to 18 months, which will put upward pressure on fixed income yields across the entire yield curve in the open market, particularly in the Treasury long term and intermediate maturity sectors. I believe it’s safe to say we’re going to be in a reflationary environment in the next 12 to 24 months. The average monthly CPI monthly increase has been approximately +0.20% historically in the past; Since oil’s “demise” (of late June 2014) month to month CPI figures have been quite low, closer to zero, if not negative. As energy prices (primarily light sweet crude oil) rebounds, I’d expect the monthly CPI-U figures to come in “hot” at nearly twice to three times the historical average, at literally +0.4% to +0.6% month to month for a while. Treasuries are (by a two to three weeks) off prices of nearly unprecedented highs, due to unprecedented low yields that were struck. Thirty year zeros are down by -11.42% off their all time highs as measured by etf ZROZ, and I believe they’ll never see those highs again, or at least, for many many years. Conventional thirty year Treasury bonds are down by -7.44% off of their price peak, as measured by the etf TLT, which also may never see its highs again, or at least for a very long time. Interest rates were at historical and unprecedented low yields! Long term (and intermediate) Treasury yields have nowhere to go but upwards, which will bring Treasury prices down further, due to higher and higher yields. High yield fixed income is not at unprecedented low yields, and therefore, may not sell off as strongly as Treasuries, given equal maturities. I fear most for long term maturities and their investors, the interest rate risk is a real risk to be wary of. Higher or “hot” CPI-U monthly figures could also put pressure on the FOMC to raise rates, perhaps as early as this summer. The CPI can be greatly influenced by volatile energy (as in light sweet crude oil) prices. Higher yields at the short end (raised by the Federal Reserve) are likely to push rates up across the board, in intermediates and long term Treasury yields. I wouldn’t be surprised if long term Treasury Securities saw negative total returns over the next 36 months (until about February of 2017 to February 2018). I believe, long term maturity Treasury bond investors (and perhaps intermediate Treasury note investors) are in for “A BIG SURPRISE(!!!),” called negative total returns over the next three years, as rates begin to “normalize” in the USA. I believe investors will be totally shocked at how much can be lost in a Treasury bond as rates increase. If rates rise by 200 basis points at the long end, there could literally be 30% losses for Treasury bond investors. Additionally, there could be nearly literally 60% losses for 30 year Zeroes in the Treasury Bond market if interest rates were to increase by +200 bp. Interest rate risk is measured by duration. Swim at your own risk!
Stocks for the Week
Feb. 13, 2015, Major U.S. Stock Indices
Index PE Multiples and Index Yields
[http://finance.yahoo.com/futures Click here for an energy prices update] Today we saw USO an etf of West Texas Intermediate increase by +2.29% to 19.62; USO is now -50.25% off its peak of the past 12 months; reached in late June ’14; USO is also +20.37% off rock bottom, set on January 29th at 16.68. I believe oil will remain very volatile, perhaps an options strategy called an at-the-money straddle using two week out expirations could prove to be very lucrative; I believe oil is going a lot higher (maybe another 10% or more), and soon (over the next few weeks). I would base this estimate of mine on the oil-VIX which is very elevated right now. If the oil-VIX implodes, it will bring higher oil prices. Another strategy that could prove to be lucrative for options traders would be a long bull call ratio back spread on USO. Still another trading opportunity may be to initiate a protective married put trade on USO, selecting two weeks into the future as an expiration for the put, and purchasing a put that’s “one notch” in the money. Friday saw light sweet crude oil trade higher by 1.57 per barrel, or +3.10% to $52.78 per barrel. Higher oil likely sent the Russian stock market (as measured by the etf RSX) up by +2.21% to 18.05; RSX now stands -33.27% off its peak of the past 12 months, while also now trading at +44.40% off rock bottom. [Click here for an Oil-VIX chart & update http://data.cnbc.com/quotes/.OVX]
Select Quotes of Interest, Feb. 13, 2015
In the Fixed income markets, see the graphic above to see how Treasury etfs traded (ZROZ, TLT, IEF, TIP) and how high yield etfs traded (U.S. dollar denominated high yield sovereigns being etfs EMB and PCY; As well as high yield corporate fixed income etfs being HYG, JNK, and QLTC). The 30 year Treasury Bond yield closed at 2.63%, and the 10 year Treasury Note yield closed at 2.02% [Data from here: http://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield]. I continue to believe, and will reiterate, that as oil stabilizes and remains in a trading range, and continues to appreciate, that there will be some major opportunities in the energy sector in equities, and in the energy sector’s high yield fixed income, as well as in high yield fixed income indices; Also I continue to believe that oil as stabilized (and if it continues to appreciate) that there will be some major opportunities in high yield fixed income funds, such as the ones listed above, EMB, PCY, HYG, JNK, and QLTC. When higher energy prices materialize in the future, inflation could pick up as measured by the CPI-U, which may or could send e.g. Treasury Security yields higher, while also pressuring the FOMC to raise rates at the short end.
King Dollar has seemingly returned, which I believe will lead to a higher U.S. trade deficit, and a higher quality of living for those in the USA, as our dollar will be able to purchase more abroad, effectively “importing deflation” a disflationary pressure. The U.S. Dollar can now be exchanged for a Euro at a cost of approximately $1.1420, and also can now be exchanged for 62.4350 Rubles. [http://finance.yahoo.com/currency-investing Click here for an update on all major cross rates]
Here’s a list of all the Economic Data due for release next week
(Minutes of the FOMC, due the 18th, will be the most fun to examine)
I believe the catalyst for this week’s stock market gains involved Greece and speculation that Germany is going to bail them out, yet again; Investors are worried about a possibility of a “Grexit,” meaning that Greece may exit the Euro Union and/or the Euro Zone, and halt its use of Euros, etc. However, the European Union likely will put pressure on Greece to stay in the Euro, since its invested so much into bailing it out already. I believe that Greece will be pressured to remain in the Euro Zone and that the markets will press on higher as that news is released; Shares in Greece gained ground strongly Friday, as pessimism dissipated in anticipation of a German Bailout. An etf of Greek stocks (etf ticker GREK) increased by +5.08% to 13.65.
[Click here for updates on Futures vs. Fair value, http://www.cnbc.com/id/17689937].
The next most exciting earnings report will be PCLN, next week. Get ready, and fasten your seat belts… This stock is the epitome of HYPE! It could well move over by ±50 to ±52 dollars per share, just minutes after its eps release. I believe it could increase by 50 bucks just minutes after its eps release. Shares closed at $1,091.95 per share on Thursday, and at 1003.37 on Friday.
I believe that a married protective put trade on PCLN could prove to be very lucrative, as PCLN is trading, as of the close Friday, at 1,003.37, and the 1005 February Week 4 put is trading at 32.40! As long as PCLN trades up by more than the cost of the put (on or before expiration of February 27th), the trade would be profitable. 32.40 per share is just 3.23% of the price of the shares, and also represents the maximum loss on the trade (minus the amount that it’s already in the money, roughly 2 bucks!), if PCLN were to collapse all the way to zero. (32.40-1.63)/1003.37 is the max loss, which is 3.06% (the cost of the protective put, relative to the current share price); So long as it rises by that amount before expiration the trade here would be profitable. I continue to believe that PCLN could move up or down by roughly $51 dollars during the week of February 16, 2015. It might move more than that. It could move up all week prior to eps, and then gap open to the upside by 51 dollars the morning after eps release, and then PCLN could continue to move up for a whole extra week, or longer. It’s anyone’s best guess. I am convinced there will be an instant 51 dollar or more move the morning after eps release. I’d estimate, that it will take the whole technology sector upwards with it. GOOGL and the Nasdaq Composite (and the Nasdaq 100) could be the primary beneficiaries of a good eps report from PCLN. A married protective put trade on GOOGL could also prove to be very lucrative.
I would suggest that perhaps a long bull call ratio back spread with net credit characteristics may be lucrative; Especially if also combined with a long bear put ratio back spread with net credit characteristics on any particular “hype stock” just before eps are released; Placing the trade just a minute or two before the close (3:00PM Central Time) on its earnings release date (if it reports that day after the close, or the next morning before the opening bell). It certainly is amusing to see what happens to hype stocks just after their eps releases in the aftermarkets and on the first full day of trading post eps. Most sink fast! Some actually rise after eps reports, AAPL and some other totally Glamorized Tech Stocks are notorious for this.
“Hype stocks” to me would be e.g. GOOGL, TSLA, PCLN, FB, AAPL, LNKD, AMZN, EBAY, NFLX, TWTR, BABA, GPRO, and Z, and also what I would describe as “Big Momentum Players” such as e.g. CMG, GMCR, AZO, V, and MA etc. (a sub group of hype to me). This list of Hype and Big Momentum Players is just off the top of my head, and is in no particular order, nor is it any particular science for choosing these types of volatile securities. RSX, GREK, TUR, FXI, EWZ, and CUBA are also very volatile etfs found in places worldwide with high geopolitical risks. West Texas Intermediate matched by the etf USO is also a very volatile etf to trade as of late.
I will continue to reiterate that I’m currently bullish on the major U.S. stock indices. I believe a theme of higher crude oil prices will potentially materialize over the next few weeks, if not becoming more of a longer term theme, for the next year, if not longer. I also believe and would reiterate that the geopolitical risks involving Greece’s sovereign debt and interest payments will be resolved, and also that Russia may stop sabre rattling soon. This will bring about higher prices for stocks, and for all major U.S. stock indices, which could reach new all time highs very soon. I also think that investors may begin selling longer duration and longer maturity fixed income of all kinds, and with the proceeds they may purchase stocks, resulting in higher yields on fixed income, and also higher stock prices. I also believe investors will “go on a dividend hunt,” and/or will “go on a financials hunt” with their raised cash from any potential future fixed income selling. Higher energy prices (of light sweet crude oil and/or west Texas intermediate) may bring about higher monthly CPI-U inflation figures, resulting in a fixed income sell off, and higher interest rates, over the next 6 to 12 months, if not for the next 36 months, as rates normalize in the USA (and potentially elsewhere in other nations). Interestingly, I believe that the higher credit quality fixed income may sell off more than the lower credit quality fixed income. I would base this upon the unprecedented low sovereign yields worldwide (which in some countries are literally negative) and in the USA. Also I am estimating the USA will be entering a reflationary (meaning accelerating inflation) environment over the next 12 to 24 months. My projection of a reflationary environment will be offset by I believe a stronger dollar because I believe that “King Dollar” has returned! I’d also expect consequently a higher trade deficit, as imports become cheaper and more appealing, increasing standards of living for all U.S. Dollar denominated investors and consumers worldwide. To me, this means that Treasuries at the long end, may suffer great losses as rates “normalize.” For 2015 I am most bullish on equities and the S&PMidCap400, the S&P500, as well as the DJIA (which has the lowest PE Multiple among all the major U.S. Indices). I am also bullish on Financials, and REITs (particularly Hospital REITs such as HCP, HCN, SBRA, OHI, NHI, due to their strong dividends, and historical dividend growth), and the “Big Tobacco” (e.g MO, PM, RAI, BTI, etc., due to their strong dividends, and historical dividend growth) sectors; In fixed income I like high yield etfs e.g. EMB, PCY, JNK, HYG, and QLTC. Options can be used to “hedge” fixed income ETFs as well, in strategies such as level one covered call writing (of e.g. at-the-money monthly calls against the fixed income ETFs). Trading very deep in the money call options (with expirations two or three years into the future) on stock indices, combined with very high allocations to high yield fixed income could prove to be a great lucrative strategy if rebalanced annually; Selling weekly or monthly expiration, slightly out of the money calls by e.g. 1.5%, against the long calls, could also prove to be very lucrative; Effectively morphing the trade into a level three long diagonal bull call debit spread. If the JPM EMBI (matched by etf ticker: EMB) is good enough for the fixed income of the Yale and Harvard Endowment funds (and other large time institutional entities) then why trade Treasury Securities?! I think people (or any entity) who buy Treasuries are “ripping themselves off!” (even when rates are not forecast to increase) Treasuries, to me, generally speaking, are for short term investing, and maximum preservation of capital (I believe, this may only be achieved with short term Treasuries going forward for a year, or two, or longer- as I believe interest rates, and the CPI-U inflation figures will increase faster than expected, and faster than is the historical average going forward over the next year). I’d estimate that the CPI-U may increase by roughly +3.60% to +4.20% over the next 12 months (February 2015 to February 2016). It may be a great time to invest in TIPS (Treasury Inflation Protected Securities, at the short end) via etf ticker STIP (for maximum preservation of capital style investing; STIP (short term Treasury Inflation Protected Securities, TIPS) is the only kind of Treasury Security I’d endorse right now, and only for maximum preservation of capital style investing). Interestingly, all high yield fixed income indices (which are BB rated) have, over the long run, always closed at a new all time high every 18 rolling month period. Consequently, every or any time that high yield fixed income indices are trading well off their all time highs, I’d view it as a major buying opportunity! Happy Trading!
By Andrew G. Bernhardt
Bernhardt Capital Management LLC 