Gaming a Pairs Play

 | Jan 30, 2012 | 12:30 PM EST  | Comments
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Stock quotes in this article:

ttwo

,

thqi

In investing, creating pairs is called "pair trading," and this strategy is the most exciting during earnings season, given the probability of large pops and drops as the market does its best to interpret the next few years of earnings from a single trading session. In addition, when the underlying fundamentals of the broad market appear poised to shift -- as they appear now -- knowing which names to pair up to go long or short is a useful tool. Don't forget, successful pair trading could mean looking at two companies that are due to report earnings on a given day and deciding to make a bet on one, but avoid the other.

First, below is some information about the broader market to lay the groundwork for my pairs play.

Economic Data

  • I was more concerned with real final sales softness in the fourth quarter than in the inventory talking-points hoopla that broke out. The not-so-publicized consumer spending revival of 2011 was basically done via accessing savings since personal income growth was substandard, inflation elevated and the employment outlook forever swinging about. I'm a bit concerned about the fourth-quarter GDP report regarding consumer spending in the first quarter, especially in light of continued price pressures on the wallet.
  • The National Association of Realtors (NAR) loves to say that now is the best time to own a home; in fact, I think that was the pickup line uttered from 2005-2007. Nonetheless, improvement in housing data had been a key to greasing the market's gears dating back to October. So a very disappointing new home sales report last week and resurfaced musings of another foreclosure wave are serving to depress home values and has created a red flag for the rally.

Takeaway: The bullish undertones of the macro data are going a touch quiet.

Earnings Season

  • Number of companies that have surprised on earnings, thus far: 59%
  • Number of companies that surprised on earnings from when the economic recovery commenced: 70%-plus
  • More companies are curtailing their outlooks rather than raising them.

Takeaway: The market has hung on to the view that "corporate earnings are strong and valuations are attractive." If outlooks are being lowered, what is the message that is being sent regarding valuations?

Pairs Play

  • Short: Take-Two Interactive (TTWO)
  • Avoid like the plague: THQ Inc. (THQI)

The upward bias in TTWO following its mega-earnings warning in mid-January is befuddling. In addition, NPD industry data for December stunk, and Take-Two's holiday product line-up was a major yawn outside of NBA2k12.

The market has started to price in the earnings benefit of a potential Grand Theft Auto release later this year, but is this title as relevant as the market expects? The game has taken forever to develop, and Call of Duty and most games for the iPad are kicking butt. However, Take-Two's fiscal year has two more quarters,  and it is unlikely that the company will produce anything stellar in this time. Weak titles, high development costs and a challenging marketplace point to at least another poor outlook from the company when it reports its earnings this week.

As for THQ, I simply ask: How does CEO Brian Farrell still have keys to the joint? He has been at the helm since 1995 (a long time in video-game land), and the stock is interestingly nearing the level it was at when Farrell took over. If he were to exit now, he would leave with the knowledge that the stock was basically flat after 17 years.

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