JS Trading Notes

Flotek (FTK) provides oilfield chemicals, logistics, and downhole drilling and production equipment to the oil and gas industry. The key growth driver is their technology, primarily chemicals and equipment, for removing oil and gas from shale rock. The company ran into financial trouble in 2009, but they have since turned around, ramping up sales and earnings and paying down debt. In their recent quarter, the company reported earnings of $0.20 per share (vs. a loss in 2010), beating estimates by $0.05; revenues rose 57.7% year/year to $74.9 mln vs. the $76.34 mln consensus. In strong demand by institutional money, the number of mutual funds owning the stock has increased dramatically over the past year: Mar-2011 — 66, Jun-2011 — 112, Sep-2011 — 127, Dec-11 — 156. The stock appears inexpensive with a forward P/E under 15 and year over year earnings growth forecast at 59%, giving it a PEG of 0.25.

Today the stock is clearing resistance in an 8-week consolidation on strong volume, a good place to add shares.

(see chart at my WordPress blog -- the link is listed at the outset of this journal)

 

Up 5% in nine trading days, the S&P500 index sits over its upper Bollinger band, typically a risky place to add shares and generally a good set-up for a sharp pull-back. The relative strength index also sits in overbought territory.

(see chart at my WordPress blog -- the link is listed at the outset of this journal)

Tomorrow is turn-around-Tuesday, the first Tuesday following a Friday triple-witching day. I wouldn't be surprised to see the beginning of a correction tomorrow or soon thereafter as the market seems to have forgotten what down feels like. There is no need to anticipate a down move (a mistake in a strong uptrend), but I'm ready with some hedges (TVIX, TZA) if the market continues with its rally but then suddenly reverses and makes a new intraday low within the next few trading sessions. It feels like there is an avalanche of new money hitting the market as big money rotates out of treasuries and into stocks. I'm keenly aware that this is a central bank-induced liquidity rally in the stock market, with immense inflationary implications. The market may get really silly on the upside this year before inflation fears put an end to the optimism.

Trading tip: trade individual stocks on the merit of their own stock charts and ignore the overall market direction.

 

Becton Dickinson (BDX) is a major global medical technology company that provides devices, instruments, and reagents used by healthcare institutions. The company consistently grows earnings year after year and has a long history of regular dividend hikes. The stock currently yields 2.3%. While the company represents a conservative income play, a higher income may be found by selling the May 19, 2012 75 strike puts, currently bid at $1.1. Every contract sold puts $110 in your pocket. Should the stock close under 75 on May 19, 2012, you would own 100 shares for every contract sold and your cost basis would be 73.9, a few bucks off the panic market low of 69.59 set on October 2011. If you end up owning shares in this conservative company, you can easily sell calls on it to generate some more income and lower your cost basis even further.

 

VF Corp (VFC), a major global supplier of branded fashion, manufactures jeanswear, outdoor apparel, sportswear, athletic apparel, and occupational apparel. Generally regarded as a well-managed enterprise, the company generates margins higher than many of its competitors and a 21% return on equity in the latest fiscal year. In its latest quarter, the company reported earnings rose by 30% year/year to $2.32 per share, $0.01 higher than estimates, and revenues rose 36.9% year/year to $2.91 billion, in-line with estimates. Analysts see 16% earnings growth in the coming year, resulting in a forward P/E of 16 and PEG ratio of 1.

The stock chart for VFC has been tightly consolidating for four weeks and looks good for another leg higher once it clears 150 with some above average trading volume. (see a chart at my WordPres blog -- the link is listed at the outset of this journal).

On the downside, the stock has a history of whippy action so I would not be surprised by some back and forth action around 150. I’d enter the position with a 4% stop loss and a 12% price target.

 

Visa Inc., the well-known provider of global payment solutions, provides credit and debit programs for financial institutions. The company itself does not assume the credit risk of individual users of its services; rather it takes a fee on each transaction. Accordingly, the company’s earnings are sensitive to the general level of global economic activity and the secular trend of adopting paperless financial transaction methods. Interestingly, the company offers a unique hedge against inflation since higher purchase prices translate directly into higher transaction fees.

In it latest quarter, the company reported earnings per share grew by 21% year/year to $1.49, $0.04 better that analyst estimates. Sales grew by 14% year/year to $2.55 billion, better than $2.47 billion estimates. On valuation, the stock holds a forward P/E of 20 on 2012 earnings estimates of $5.96 per share, a 19% year/year increase in earnings. This gives the company a PEG (price to earnings ratio over growth) of roughly 1 — a low valuation given the company’s unique global franchise.

The stock chart shows an abundance of demand for the stock and a lack of sellers, with recent trading forming a tight price consolidation following an up-gap after the February 2012 earnings report.

(For a chart of Visa, see my blog at WordPress -- the link is listed at the outset of this journal).

Trading rules dictate to enter the stock when it summits the 120 area on an increase in trading volume. On such an event, the stock may be good for 15-20% within a few weeks using a 5% initial stop loss.

 

A bear market may be some distance off. Probably the most important element supporting a sustainable rally in the U.S. stock market is the availability of credit. When credit is getting cheaper, it becomes easier and cheaper to apply leverage for the purchase of stocks, and it becomes easier and cheaper for corporate America to borrow and invest to boost earnings power.

Guess what? Credit is becoming easier and cheaper to get. The chart below shows the BofA Merrill Lynch U.S. High Yield BB Spread over U.S. Treasuries for the past 10 years. I use the BB-spread as it serves as a sensitive proxy for credit availability across the American economy. When the spread declines, credit availability is improving.

(See charts at my WordPress blog. The link is listed at the outset of this journal).

The next chart illustrates how stocks perform relative to the availability of credit. The chart shows the percentage performance, year over year, in the S&P 500 stock index versus the percentage performance, year over year, in the spread index just described. When credit availability improves, the stock market rises.

Three more things add to the bullish picture: 1. the stock market looks undervalued (according to the Fed Model), 2. money flows into stock mutual funds switched from negative to positive within the past few months, 3. central banks worldwide have primed the asset-bubble pump with trillions of dollars. Eventually, central bank funny-money printing will catch up to us and inflation in the general economy will accelerate, undermining economic progress; but right now, take advantage of a robust environment for stocks.

 

Chart Industries (GTLS) currently trades tightly over its 20 ema (daily exponential moving average) as it digests its recent three-week up move and sets up for another possible leg higher.

(see chart at my WordPress blog. The link is listed at the outset of this journal).

As a leading supplier of cryogenic distribution and storage equipment, the company provides the backbone for building out the natural gas fueling stations set to populate the United States (see Clean Energy Fuels (CLNE)) over the next ten years. More and more trucking companies are replacing their diesel engines with natural gas engines (see Westport Innovations (WPRT)) since the conversion pays for itself in six months with the savings from using cheap natural gas versus diesel. Thousands of new natural gas fueling stations are planned to meet the growing demand by truckers.

 

No indicator works all the time in predicting stock market corrections. But some work better than others, and this obscure indicator from Yong Pan at www.cobrasmarketview.com has a high percentage success rate. The indicator is the Percentage Price Oscillator (PPO) of the relative movement of the equal-weighted S&P500 index (normally the S&P 500 index is a market-capitalization weighted average) versus the Chicago Board Options Exchange (CBOE) options equity put/call ratio.

(see the chart of the indicator at my WordPress blog. The link is listed at the outset of this journal).

In the chart above, when the blue indicator line crosses below the zero boundary, a sell signal is generated.

Intuitively, the indicator makes sense. First of all, the put/call ratio serves as a reasonable real-time measure of complacency and fear in the market. When investors are fearful, they load up on put options for protection, sending the put/call ratio higher, and when they are complacent, they buy less puts and the put/call ratio drops. The indicator line displays the PPO (a measure similar to the rate of change) of the relative movement of the equal-weighted S&P 500 index (the numerator) and the put/call ratio (denominator). When the market begins a new downtrend, the numerator falls and the denominator rises, so the PPO heads down. The interesting point is that the indicator has worked for a long time through various market environments. The data I have starts in 2004, so it has worked for at least eight years.

 

There are several long-term cross currents in the current U.S. stock market environment. On the negative side, measures of volume and participation of “smart-money” have been woefully lacking since the October 2011 bottom, and really since the March 2009 bottom. In his weekly column in FuturesMag.com, technical analyst Robert McCurtain maintains close tabs on several market indicators including cumulative volume, most actives advance/decline line, and the call/put dollar value flow line. His indicators do not support the long-term sustainability of these market levels and suggest some future massive bear market.

Shorter-term, there is no arguing the fact the market needs a rest after the S&P 500 index has run nearly straight up 18% from its mid-December bottom. The number of stocks participating in the rally has fallen off since early February, clearly evident in the performance of the broad Russell 2000 index verses the S&P 100 index.

Investor’s Business Daily notes the rally is under pressure following a recent cluster of high volume down days and stalling days in the major averages. From a fundamental standpoint, short-term weakness is also supported by recent declines in the Citigroup Economic Surprise Index, which shows economists became too optimistic into January and February and are now tempering their GDP growth views. A decline in this index often precedes a decline in the market. On a short-term basis, traders are well-advised to take some profits off the table at this juncture.

On the long-term positive side, four fundamental items support robust prices: the U.S. treasury yield curve is positive, the U.S. leading indicators index is sloping upwards, equity prices are somewhat undervalued looking at historic earnings multiples of the S&P500 and deeply undervalued using the Fed Model, and the availability of cheap credit is improving (see my recent blog “Is A Bear Market Around The Corner?“). Looking at sector leadership, the aggressive sectors — technology (XLK), consumer discretionary (XLY), and financial (XLF) – are leading the market higher and show little sign of rolling over. The chart below illustrates the strength in these sectors versus the S&P500. This is a sign of market strength and trend sustainability.

(See the chart at my wordpress blog. The link is listed on the first day of this journal)

The early 1950s also offer some precedent: when long-dated Treasury yields started to rise in that era, stocks surged as investors fled falling bond prices for equities. The same may happen today.

While a focus on the chart behavior of individual securities leads to trading success, my current thinking is that aggressive positioning in new plays could pay off once the market consolidates its recent 14-week run. When the general positive factors discussed above degenerate (perhaps by the end 2012), I’d expect another generational bear market. After all, the federal reserve is out of bullets — they cannot lower short-term rates any further to help in the next (and inevitable) economic downturn.

 

While the stock of Johnson & Johnson (JNJ) has the same value it had ten years ago, the company has doubled sales and increased earnings per share 116% over the same time period. Perhaps more importantly, they have increased their dividend by 221%, boosting it every year; the stock now yields 3.5%.

The stock has traded very tightly since December 2011 and looks ready to clear resistance in the 66 area. The healthcare sector also looks strong recently on a relative strength basis.

A riskier way to play JNJ is with call options. The deep-in-the-money January 19, 2013 50-strike call options have hardly any premium in them and offer a leveraged way to participate in JNJ price appreciation, albeit with no dividends.