"When a man's knowledge is not in order, the more of it he has the greater will be his confusion."
-- Herbert Spencer
Think of the financial marketplace as where information flows are interpreted through price discovery, and are turned into something that the public (on a good day) might understand. At the current moment, there are quite a few logs in the fire. The marketplace is trying to interpret input from a central bank whose trajectory for monetary policy seems to be to get to a far tighter place than we, in this country, have seen in many, many years. The impression from this office is that there is great fear present there, either the fear of being in a more normalized spot prior to calamity, or fear of consumer-level inflation far more aggressive than the average American is mentally prepared for.
Then there is this nation's fiscal situation. Obviously irresponsible. The issuance of, and reliance upon Treasury securities by the federal government is also aggressive. Aggressively loose. The insistence of the Treasury Department on short-term issuance seems a bit bizarre, at least to this guy, from this perspective. The longer end of the curve has finally started to push out a bit. The 10-year Treasury Note actually kissed the 3% level on Tuesday. Stocks quickly turned an up-day into a rout. Overnight, while your pretty little head drifted off to the land of licorice and gummy bears, the 10-year knocked on the door again. This time the door opened, or maybe was simply kicked in. Equity index futures turned a slightly green overnight into another selloff.
But Wait, There's More
Keeping our ducks in a row. The Fed is tightening. The probability of a fourth increase for the fed funds rate in December is now being priced by futures markets in Chicago at 47%. That puts upward pressure on yields. Fiscal policy is now ultra-loose. This too brings upward pressure on yields. In addition to these forces, the coming month should be very telling as far as U.S. trade conflicts are concerned, particularly with China.
The intent of the current administration here is not misguided. Finally, someone on this side decided to actually stick up for this side. That said, the outcome of coming negotiations on this subject is undeniably inflationary. One easily spots preparation for a nasty outcome in the way equities are rotating. Tech, Materials, Staples all hit on a regular basis now by the ever present "ugly stick."
Small-cap performance is now interesting, don't you think? Unfazed for the most part by trade tensions, or dollar valuations... certainly positively impacted by tax reform, and the looser fiscal situation, the Russell 2000 as a whole has caught up to the pack year to date, and outperformed all of the major indices on selloff days. Just remember that even this group will end up divided in a decisive way. Those reliant on credit will pay more for the help, and those used to writing off their interest payments as business expenses will see less opportunity to do so.
Where To?
I would love to tell you that this news flow is over and now you may return to our normally scheduled programming. Gang, I would love to, but the fact is that the mental state (and market condition) of uncertainty is your new normal. Monetary and fiscal policy have both been perverse for so long, does anyone really think that they will know when a normalized equilibrium is reached? Is that even possible?
One thing I do know is that the S&P 500, the Dow Jones Industrial Average, and the Nasdaq Composite are all well below their individual 50-day simple moving averages (SMAs), and all three are still above their individual 200-day SMAs.
Add to that, the fact that there is likely more headline risk to our front than to our rear, and I don't care how great earnings are, there are more severe tests coming.
Hopefully most investors are at elevated cash levels by now; we have been preaching on that since January. Earnings are good, and will matter greatly once again.
My thoughts are to add in spots. I do not say that vaguely as you might see some of my colleagues do on financial television. I wrote to you here in this space that I thought Micron (MU) might be close to done with that name's April puke-athon. In the heat of the beat-down on Tuesday, I took that name from 10% of my original long position size back up to 26% (meant to go to 25%, but did the math wrong).
At nearly the precise market low, I also initiated Northrop Grumman (NOC) with a 10% increment. That stock ran into the close, but reports Wednesday morning, so we'll know shortly how smart that was. Still, defense as you know is one of my cornerstones for 2018. I will not be shaken out of these names so easily.
Let's Talk About PayPal (PYPL)
How interesting is this name? PayPal (PYPL) reports its first-quarter numbers tonight. The industry is looking for EPS of $0.54. Whispers are for roughly $0.02 more than that. Revenue projections, which are far more important these days than earnings per share, are for a consensus $3.58 billion. Is this an opportunity to score a name that gave up 3.8% just yesterday?
There certainly are positives, like a three-year average EPS growth rate of 20%, and a three-year average sales growth rate of 17%. Is most of that behind them though? Gross profit margins for fourth-quarter 2017 ran at 56%, which was slightly lower year over year. The company sports a current ratio of 1.4. Again healthy, but again lower than the previous year.
Keep in mind these guys pay you exactly zero dollars and zero cents to take on the risk of equity ownership.
Action Alerts PLUS holding PayPal is a bit expensive at 27 times forward looking earnings. The share price has seen a series of declining highs and rising lows since last December, while literally trading sideways the whole time. You market veterans know what that means. You new kids might want to know that behavior such as that often precedes extreme violence, but as an indicator is directionless.
More Information
1) I have already told you that margins could be a problem here. Investors should be aware that the payments business could be in the cross-hairs of the Death Star known as Amazon (AMZN) . That behemoth is working on a way to have its "Alexa" device take care of payments in direct response to voice commands. Yikes.
2) In late March, Bernstein analysts initiated coverage of both Visa V, and Mastercard MA as "Out-performs" and referred to both of those as the "crown jewels" of the payments business. Bernstein at the same time warned on "under appreciated business pressure" facing PayPal, as well as the firm's reliance on eBay EBAY. That eBay deal has since been extended through 2023, but the spoken reliance has not been eased.
3) In early April, the Wall Street Journal ran a story stating that PayPal was reaching out to their clientele to gauge interest in traditional banking services. The company, without a banking license, would have to make deals with smaller banks in order to offer such services, and to me, smacks a little of desperation. I mean, why not just use a bank?
Trade Ideas
My thoughts on this perplexing name are to play volatility rather than direction going into earnings. Over the past three months, the shares have traded both above $86, and below $72. I also believe that at a last sale $75.28, that an explosive move is coming for the name. How to play single stock volatility?
-- The simple, but expensive way is to simply buy an options strategy known as a Straddle. That means buying both a call option, and a put option with the same strike price and same expiration date in the hopes that the share price moves more than the combined premiums paid. At Tuesday's night's close, a $75 straddle expiring this week would cost you $4.81. That means that you would have to see prices above $80, or below $70 by week's end to make this trade worthwhile. That's up to you.
-- Another route, and maybe more economical would be the purchase of a long dated Strangle. In other words, buy an out-of-the money call, and an out-of-the money put, and push out expiration. One example I like for this name would be the purchase of a $77.50 July call and a $72.50 July put. Last night these trades would have cost you $7.40. That means that by July 20 (a week ahead of the next PYPL quarterly earnings release), you would need to see prices above $85 or below $65. In my honest opinion, this is a more likely outcome, and more time to either become right, or salvage some time premium if you change your mind.
Economics (All Times Eastern)
10:30 - Oil Inventories (Weekly): Expecting -1.429M, Last -1.071M.
10:30 - Gasoline Stocks (Weekly): Expecting -227K, Last -2.968M.
Today's Earnings Highlights (Consensus EPS Expectations)
Before the Open: (BA) (2.59), (CMCSA) (.59), (DPS) (1.06), (DTE) (1.84), (EVR) (1.53), (GD) (2.48), (GT) (.46), (HES) (-.53), (NOC) (3.63), (NSC) (1.77), (OC) (.97), (TMO) (2.41), (TWTR) (.11), (VIAB) (.79)
After the Close: (AMD) (.09), (T) (.88), (CMG) (1.57), (EBAY) (.53), (EFX) (1.37), (FFIV) (2.27), (FB) (1.34), (PYPL) (.54), (QCOM) (.71), (V) (1.01)
