View From the Turret: Damned if We Do…
For the last two weeks, markets have been transfixed on the debt ceiling drama in Washington.
Equity prices sold off sharply as uncertainty increased. For the last several sessions, prices have reacted to the political wrangling, rising when it appeared a debt ceiling solution was in progress, and falling when roadblocks were hit.
This week, it appears the situation will be “resolved” with a deal to raise the ceiling, while cutting $2.5 trillion from the deficit over the next 10 years.
But even with the deal agreed to in principle, the situation may turn out to be a “damned if we do, damned if we don’t” scenario.
If the solution is pushed through Congress, the consensus appears to believe that the market will rally. After all, much of the recent weakness is attributed to the uncertainty surrounding the debt ceiling. But if a deal is reached, what will the market focus on from that point?
After a brief rally, the likelihood is that investors will once again be concerned with the mounting economic risks:
- Last week’s GDP report indicated slowing growth and revised data showed that the financial crisis represented an even deeper contraction.
- In Europe, Moody’s threatened to downgrade Spain, as the debt crisis does not appear to be contained by the latest bailout package.
- A widening gap of winners and losers from this quarter’s earnings season leaves us with fewer “leadership” stocks. It seems that for every positive reaction to an announcement, there are a handful of leadership stocks like Juniper Networks (JNPR) trading sharply lower.
Once again, we find ourselves at an important crossroads for market trends. If bullish investors are able to make a strong case for the debt ceiling agreement solving our “short-term” uncertainty issues, then the market could revert once again to a slow grind higher with overhead risks taking a back seat to growth expectations.
However, if the debt ceiling resolution does not restore confidence, we could see a very nasty reversal lower with panic-stricken managers hitting the bids at any price.
As we enter a key trading week, there are a number of both bullish and bearish opportunities we are tracking for potential trades…
Disappointing Earnings, Continuation Patterns
This has been a particularly dangerous earnings season for growth stocks. A number of high profile (and quite a few second-tier) growth names have reported solid earnings but also offered disappointing guidance. When managers of growth stocks issue anything other than a rosy outlook, momentum investors can quickly turn, and trends can be instantly reversed.
After a growth stock breaks down, bearish momentum can offer a tremendous opportunity for short sellers. But the difficult part is figuring out where to enter such a trend. There is always the risk that dip-buyers will come in and support the stock, so selling into weakness can be a good way to lose a lot of capital quickly.
If we get a brief market rally from the debt ceiling resolution, this could be the perfect opportunity to leg into some of these broken patterns. A brief respite from selling would allow us to place sell-stop entries below current market prices. Once the bearish action resumes, we are automatically stopped into our positions with a natural risk point above the recent highs.
We are building an attractive list of short candidates that fit this situation. A couple of the patterns are below, but if you want to see all of our trades setups and executions in real time, take a 14-day free trial to the Mercenary Live Feed.
Panera Bread (PNRA) traded sharply lower last Wednesday, just two weeks after making a new all-time high. The company beat estimates by a penny and raised its forecast for the year. But the positive news wasn’t enough to satisfy the street, which had already priced in robust growth expectations.
With the bullish pattern now sharply broken, any rebound this week could set up a continuation short entry. Rising food costs and decelerating profit metrics could bring down both earnings expectations as well as the price multiple investors are willing to pay. A drop to $100 would fill the gap from earlier this year, while strong support near $70 could end up being the ultimate target for this breakdown name.
Large Cap 3M Co. (MMM) had a similar experience after reporting lower than expected earnings last week.
Lower demand for the company’s products used in LCD televisions spooked investors, and the stock dropped 5.4% on the day after the report. Traders didn’t give MMM any relief as the week wore on, and the stock tacked on three additional selling days before the end of the week.
This week, it will be interesting to see if the company can attract dip buyers – and to see just how far these buyers might be able to rally the stock. A drift back above $88 or even $90 could give us an excellent opportunity to step in and short.
Given the technical damage along with the fundamental weakness, it’s difficult to determine exactly how far this institutional favorite could fall. A short position might be best managed with a combination of trailing risk points along with a half-profit target a bit above late 2010 support levels.
A growing list of breakdowns will make for an excellent profit generator if the debt ceiling optimism fades. But of course, if positive sentiment remains in play, we will continue to track some of the more stable bullish opportunities with strong fundamentals and positive chart patterns…
Positive Oil and Gas Producers
On Friday, we posted the latest Strategic Intelligence Report focusing on exploration & production (E&P) companies that made attractive takeover candidates. Of course, subscribers to the Mercenary Dispatch received the report 48 hours before it was posted on the site…
With large-cap oil companies finding it increasingly difficult to replace energy reserves, many are looking to make strategic acquisitions of companies with ample proven oil and gas reserves. Last month, BHP Billiton (BHP) offered a substantial premium to buy shares of Petrohawk Energy (HK).
E&P companies with a market cap that is small enough to be covered by a blue-chip energy company’s cash reserves make particularly appealing targets. We’re following a number of opportunities in this area that could hold up well without a strategic merger, but names that could skyrocket if a buyout deal was announced.
Brigham Exploration (BEXP) is one such company that has been increasing output quarter after quarter, as the company taps its vast supply of available well sites. The stock has recently pulled back to the 50 EMA after rallying from support near $24. If the price of oil holds up, and energy M&A activity continues, BEXP could be an attractive buy candidate once it confirms support at the 50-day average.
Gold Stocks Could Shine As Well…
In an environment where the debt ceiling is lifted, but economic challenges are still present, gold prices could continue to rise. Distrust of fiat currencies is still a major underlying theme, and the longer gold prices remain at elevated levels, the more attractive gold mining companies become.
At this point we have built a significant allocation to Precious Metal miners with a few new trades on deck. As is the case with most of our swing trades, we’re waiting for the price action to move in our favor before adding horizontal exposure to this area.
Randgold Resources (GOLD) has rebounded sharply from support in the low $70′s. The Mercenary Live Feed entered a long position on 7/13 after a mini-consolidation. Our expectation was for the stock to continue to rally after taking a few trading sessions to consolidate gains.
As GOLD continues to rise, there will likely be additional opportunities to add pyramid exposure after short-term consolidations.
In addition to gold miners, we also have a couple of buy orders in for silver miners. The silver trade has been more speculative this year, but when precious metal prices move sharply, silver has been outpacing gold, and there is opportunity to take advantage of this trend through a number of attractive silver producers.
This week promises to be volatile, with plenty of data points to keep track of. Instead of focusing too hard on the actual news items, keep your eye on the market’s reaction to the headlines.
Often the price action is a much better barometer than the actual fundamental information – as this represents actual capital flows and commitments from investors.
Manage that risk carefully and trad ‘em well this week!