View From the Turret: Tis the Season
As traders sit down to their desks this week, holiday distractions are likely to play a role in both liquidity and volatility. Typically, the two weeks surrounding Christmas are great environments for research and planning.
From a trading perspective, opportunities are likely to be weighted toward the early part of the week with volume drying up substantially by Thursday and Friday. When it comes to institutional desks, we’re dealing with the second string managers (at best) and so the price and volume signals become less reliable.
This doesn’t mean that we shut down our trading operations entirely, but it does warrant an attitude of caution as the price movement includes more noise, and lower levels of liquidity make it more difficult to efficiently enter and exit positions.
The Mercenary Trader book enters the week with a fairly heavy short bias. China represents a significant portion of our short exposure as the leader of emerging markets fights inflation and may disappoint global growth investors who still appear to be overweight this vulnerable area. At the same time, several domestic (US) momentum names are beginning to show signs of topping out, and we’ve already begun building exposure with risk points tightening and profits accumulating.
Working with a balanced book is always an objective to pursue, and we are continually stalking long opportunities to help counterbalance our bearish exposure.
In practice, this often means using stop / limit orders to buy attractive names should the market begin to rally. So while the actual exposure in our trading book remains heavily bearish, there are a number of bullish opportunities that remain on our radar and will likely trigger buy orders should the price action begin to improve.
So with that backdrop, let’s step in and look at a few charts for this holiday week.
I had to smile a bit when I read Whitney Tilson’s excellent fundamental review of Netflix Inc. (NFLX). The article begins with the statement “We’ve lost a lot of money betting against Netflix…” and then goes on to explain why Tilson believes Netflix is over-priced and vulnerable.
While we agree with most of the bearish elements of the article (and have been shaking our heads at the rise in the stock for months now,) I’m happy to report that we have NOT lost a lot of money betting against Netflix.
Whenever a momentum stock appears to dislocate itself from any rational fundamental price range, value short traders are often the first to step onto the battlefield and begin to fade the momentum. But the problem is, when a stock is disconnected from rationality, there’s really no reason to believe that it will re-connect in a short amount of time.
If a stock priced at $100 makes absolutely no fundamental sense, why couldn’t it trade to $200 just as easily??
And so for Netflix, (along with other momentum generals) we have taken a few shots at bearish trades along the way – but only when the price action shows that there is a good reward-to-risk opportunity. Our trades always have a well-defined risk point and if that level is hit, we’re out – no questions asked!
In the case of Netflix, we noted “three strikes and you’re out” last week – and we have built a short position based on 1) internal business turbulence, 2) a major price failure at the key $200 level and 3) a failure to hold the bullish “index effect” after the stock was added to the S&P 500.
The stock faces a key test at the current juncture with the 50 EMA just below – a level that has offered support several times on the way up. If this area is broken, it could give us yet another chance to pyramid our exposure and pour on the nitro for the ride lower.
As far as new setups are concerned, we’re keeping it relatively light this week given the liquidity and volatility issues at hand.
Fertilizer / Agflation
The agflation theme has taken a bit of a back seat over recent weeks as European concerns have captured traders’ attention. But after taking some time to consolidate recent gains, fertilizer stocks could offer an attractive bullish trade as they begin another leg higher.
It’s interesting to note that even after the Potash Corp. (POT) takeover deal was killed by the Canadian government, the stock still remains well above the level it sat at before the hostile bid. This evidence of demand for the stock leads to great opportunities for a few of the competing firms…
We have a pending trade in Agrium, Inc. (AGU) which has found support near the $80 level. If AGU begins to move higher, we will take on long exposure which helps to offset our bearish bent, and also offers us a great reward to risk setup with a few bips at risk and significant upside potential if AGU pushes to new highs.
Fellow fertilizer stock Mosaic Co. (MOS) has a similar pattern as the stock has taken a few weeks to consolidate tremendous summer gains. Fundamentally, the fertilizer demand picture still looks very bullish with emerging market population growth (along with a higher standard of living) drives both quantity and price levels for stockpiles of potash, phosphates, and nitrogen-based fertilizers.
Jack has been picking academic arguments left and right with his discussion of Modern Monetary Theory (MMT) as well as through his discussion of The Von Mises Prophecy. I use the term “academic arguments” because the majority of rebuttals come from theorists sticking to hypothetical models. But our position as real-economy market participants has us much more interested in making money – versus being “right” – and at this point we’re seeing yet another opportunity to leg into additional precious metals exposure.
Our current position in Silver Wheaton (SLW) has us sitting with partial profits booked, a tightened risk point that protects profits on the second half of the position, and an opportunity to pyramid back into some additional exposure should the name find support and begin to trade higher once again.
The company is one of our three favorite silver plays, and Silver Wheaton has a very unique approach to the business. Instead of developing its own mines, SLW enters purchase agreements with an assortment of silver miners – thereby reducing its operational risk but still allowing the company to participate profitably as the price of silver advances.
Entering the week, we have an additional silver setup pending. The ProShares Ultra Silver (AGQ) offers a leveraged play on the spot price of silver, and its recent pullback to the 20 EMA may very well offer an attractive entry point.
With currency concerns still a major factor in today’s market, precious metals continue to be seen as an attractive alternative to owning Dollars, Euros, Yen or other currencies. Additionally, speculative traders are actively involved creating demand and sending prices sharply higher.
We continue to hold our bearish China exposure with short positions in broad indices like the iShares China 25 (FXI) as well as the PowerShares USX China (PGJ).
Baidu Inc. (BIDU) offered us an exceptional opportunity to take on bearish China exposure when the stock broke down last week. BIDU had been trading in a tight range near its peak, and our pending short trade was hit as the stock broke through the support levels.
Now BIDU is back below the key $100 level which could give traders another reason to dump their exposure, adding more pressure to this expensive and vulnerable Chinese stock.
Shortly before the open, the futures show modestly positive action with no major surprises.
Trade ‘em carefully this week,