Weekend Update – November 8, 2015

For a very brief period of time before October’s release of the Employment Situation Report and for about 90 minutes afterward, the stock market had started doing something we hadn’t seen for quite a while.

Surprisingly, traders had been interpreting economic news in a rational sort of way. Normally, you wouldn’t have to use the word "surprisingly" to describe that kind of behavior, but for the preceding few years the market was focused on just how great the Federal Reserve’s monetary policy was for equity investors and expressed fear at anything that would take away their easy access to cheap money or would make alternative investments more competitive.

The greatest increment of growth in our stock market over the past few years occurred when bad news was considered good and good news was considered good.

To be more precise, however, that greatest increment of growth occurred when there was the absence of good economic news in the United States and the presence of good economic news in China.

What that meant was that good economic news in the United States was most often greeted as being a threat. Meanwhile back in the good old days when China was reporting one unbelievable quarter after another, their good economic news fueled the fortunes of many US companies doing business there.

Then the news from China began to falter and we were at a very odd intersection when the market was achieving new highs even as so many companies were in correction mode as a Chinese slowdown and supremacy of American currency conspired to offset the continuing gift from the FOMC.

At the time of the release of October’s Employment Situation Report the market initially took the stunningly low number and downward revisions to previous months as reflecting a sputtering economy and added to the losses that started some 6 weeks earlier and that had finally taken the market into a long overdue correction.

90 minutes later came an end to rational behavior and the market rallied in the belief that the bad news on employment could only mean a continuation of low interest rates.

In other words, stock market investors, particularly the institutions that drive the trends were of the belief that fewer people going back to work was something that was good for those in a position to put money to work in the stock market.

Of course, they would never come right out and say that. Instead, there was surely some proprietary algorithm at work that set up a cascading avalanche of buy orders or some technical factors that conveniently removed all human emotion and empathy from the equation.

As bad as the employment numbers seemed, the real surprise came a few weeks later as the FOMC emerged from its meeting and despite not raising rates indicated that employment gains at barely above the same level everyone had taken to be disappointing would actually be sufficient to justify an interest rate increase.

The same kind of reversal that had been seen earlier in the month after the Employment Situation Report was digested was also seen after the most recent FOMC Statement release had started settling into the minds of traders. However, instead of taking the market off in an inappropriate direction, there came the realization that an increase in interest rates can only mean that the economy is improving and that can only be a good thing.

Fast forward a couple of weeks to this past week and with the uncertainty of the week ending release of the Employment Situation Report the market went nicely higher to open the first 2 days of trading.

There seemed to be a message being sent that the market was ready to once again accept an imminent interest rate increase, just as it had done a few months prior.

That seemed like a very adult-like sort of thing to do.

The real surprise came when the number of new jobs was reported to be nearly double that of the previous month and was coupled with reports of the lowest unemployment rate in almost 8 years and with a large increase in wages.

Most any other day over the past few years and that combination of news would have sent the market swooning enough to make even the fattest finger proud.

With all of those people now heading back to work and being in a position to begin spending their money in a long overdue return to conspicuous consumption, this coming week’s slew of national retailers reporting earnings may provide some real insight into the true health of the economy.

While the results of the past quarter may not yet fully reflect the improving fortunes of the workforce, I’m more inclined to listen closely to the forecasting abilities of Terry Lundgren, CEO of Macy’s (M) and his fellow retail chieftains than to most any nation’s official data set.

Hopefully, the good employment news of last week will be one of many more good pieces to come and will continue to be accepted for what they truly represent.

While the cycle of increasing workforce participation, rising wages and increased discretionary spending may stop being a virtuous one at some point, that point appears to be far off into the future and for now, I would trade off the high volatility that I usually crave for some sustained move higher that reflects some real heat in the economy.

As usual, the week’s potential stock selections are classified as being in the Traditional, Double Dip Dividend, Momentum or "PEE" categories.

What better paired trade could there be than Aetna (AET) and Altria (MO)?

I don’t mean that in terms of making the concurrent trades by taking a long position in one and a short position in the other, but rather on the basis of their respective businesses.

In the long term, Altria products will likely hasten your death while still making lots of money in the process and Aetna’s products will begrudgingly try to delay your death, being now forced to do so even when the costs of doing so will exceed the premiums being paid.

Either way, you lose, although there may be some room for a winner or two in either or both of these positions as they both had bad weeks even as the broader market finished higher for the 6th consecutive week.

Both have, in fact, badly trailed the S&P 500 since it started its rally after the October Employment Situation Report.

Aetna, although still sporting a low "beta," a measure of volatility, has been quite volatile of late and its option premium is reflecting that recent volatility even as overall volatility has returned to its historically low levels for the broader market.

With Aetna having recently reported earnings and doing what so many have done, that is beating on earnings, but missing on revenues, it had suffered a nearly 8% decline from its spike upon earnings.

That seems like a reasonable place to consider wading in, particularly with optimistic forward guidance projections and a very nice selection of option premiums.

Walgreens Boots Alliance (WBA) is ex-dividend this week. Although its dividend is well below that of dividend paying stocks in the S&P 500 its recent proposal to buy competitor Rite Aid (RAD) has increased its volatility and made it more appealing of a dividend related trade.

With some displeasure already being expressed over the buyout, Walgreens Boots Alliance will surely do the expected and sell or close some existing stores of both brands and move on with things. But until then, the premiums will likely continue somewhat elevated as Walgreens seeks to further spread its footprint across the globe.

With about a 10% drop since reporting earnings at the end of October there isn’t too much reason to suspect that it will be single out from the broader market to go much lower, unless some very significant and loud opposition to its expansion plans surfaces. With the Thanksgiving holiday rapidly approaching, I don’t think that those objections are going to be voiced in the next week or two.

International Paper (IP) is also ex-dividend this coming week and I think that I’m ready to finally add some shares to an existing lot. Like many other stocks in the past year, it’s road to recovery has been unusually slow and it is a stock that has been among those falling on hard times even as the market rallied to its highs.

While it has recovered quite a bit from its recent low, International Paper has given back some of that gain since reporting earnings last week.

Its price is now near, although still lower than the range at which I like to consider buying or adding shares. The impending dividend is often a catalyst for considering a purchase and that is definitely the case as it goes ex-dividend in a few days.

Its premium is not overly generous, as the option market isn’t perceiving too much uncertainty in the coming week, but the stock does offer a very nice dividend and I may consider using an extended option to try and make it easier to recoup the share price drop due to its dividend distribution. 

Macy’s reports earnings this week and it has had a rough ride after each of its last two earnings reports. When Macy’s is the one reporting store closures, you know that something is a miss in retail or at least some real sea change is occurring.

The fact that the sea change is now showing profits at Amazon (AMZN) for a second consecutive quarter may spell bad things for Macy’s.

The options market must see things precisely that way, because it is implying a 9.2% move in Macy’s next week, which is unusually large for it, although no doubt having taken those past two quarters into account.

Normally, I look for opportunities to sell puts on those companies reporting earnings when I can achieve a 1% ROI on that sale by selecting a strike price outside of the range implied by the option market.

In this case that’s possible, although utilizing a strike that’s 10% below Friday’s close doesn’t offer too large of a margin for error.

However, I think that CEO Lundgren is going to breathe some life into shares with his guidance. I think he understands the consumer as well as anyone, just as he had some keen insight long before anyone else, when explaining why the energy and gas price dividend being received by consumers wasn’t finding its way to retailers, nearly a year ago.

Finally, the most interesting trade of the week may be Target (TGT).

Actually, it may be a trade that takes 2 weeks to play out as the stock is ex-dividend on Monday of the following week and then reports earnings two days later.

Being ex-dividend on a Monday means that if assigned early it would have to occur by Friday of this coming week. However, due to earnings being released the following week the option premiums are significantly enhanced.

What that offers is the opportunity to consider buying shares and selling an extended weekly, deep in the money call with the aim of seeing the shares assigned early.

For example, at Friday’s close of $77.21, the sale of a November 20, 2015 $75.50 call would provide a premium of $2.60.

That would leave a net of $0.89 if shares were assigned early, or an ROI of 1.15% for the 5 day holding, with shares more likely to be assigned early the more Target closes above $76.06 by the close of Friday’s trading.

However, if not assigned early that ROI could climb to 1.9% for the 2 week holding period even if Target shares fall by as much as 2.2% upon earnings.

So maybe it’s not always a misplaced sense of logic to consider bad news as being a source for good things to come.

 

Traditional Stocks: Aetna, Altria

Momentum Stocks: none

Double-Dip Dividend: International Paper (11/12 $0.44), Target (11/16 $0.56), Walgreens Boots Alliance (11/12 $0.36)

Premiums Enhanced by Earnings: Macy’s (11/11 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.