(This article was originally published on Action Alerts OPTIONS. Survey the whole product with a free trial.)
This past week delivered some pretty stunning earnings results from some big names. On balance, the S&P 500 names that reported this past week added about $143 billion in market cap. Microsoft (MSFT) alone added almost $43 billion.
Of course the news wasn't all good. Growth-stock darling Chipotle (CMG) had a slight miss and the stock got hit as a result. Some growth stories can be priced for perfection and any misstep can cause a pullback. But in Chipotle's case the stock has pulled back sharply four of the past five quarters and three of those they actually posted earnings beats.
Another go-go growth stock, Under Armour (UA:NYSE), had a similar fate, despite a modest EPS beat, the stock lost about 1.7 billion in market cap from the prior week on a strong tape. American Express (AXP:NYSE) missed marking seven quarters in a row where the street had a tepid response to earnings whether they meet, beat or missed.
Vince Lombardi once said, "Once you learn to quit, it becomes a habit."
In business, comparing these companies the way one might compare football teams wouldn't really be fair. After all, energy, mining and many industrial companies are facing serious secular challenges and others are not. But I am interested in patterns.
Compare American Express to MasterCard (MA) or Visa (V). Here the businesses are playing the same sport, on the same field, and Amex has been losing badly. The loss of affinity card relationships like JetBlue (JBLU) and Costco (COST) are not only a black eye, but the concerns that Costco voiced regarding where Amex is accepted speak to an important issue. After all, Costco cards represented 10% of all Amex cards and, as far as Costco was concerned, they aren't accepted in enough places.
AXP used to be an AAP name and I like to keep an eye on companies whose stock prices have moved much lower as a bargain hunter, but despite a decline of 20% from the year's highs, I seriously question whether the current management can regain investor confidence.
In fact, taking a look at companies that did well, such as Microsoft, notice that they have had a change in management and, as I pointed out a couple weeks ago on "Options Action," it is a company that has changed quite a bit under the hood and is operating under new management with Bill Gates focusing on philanthropy and Steve Ballmer finding an appropriate place to scream and vent his enthusiasm courtside for his newly-acquired Clippers.
Consider this. Full-year 2015 revenues for phone will be $7.7 billion, Xbox will be $9.1 billion and advertising will be $4.6 billion. That's $21.4 billion total. That's roughly 25% greater revenue from those segments alone than all of Facebook (FB) this year. Microsoft is a new economy technology company of sorts.
This isn't about American Express or Microsoft per se, but I bring up these two examples because of something I saw in the options market this week as the VIX fell below 15 again. For years the VIX at a low level has essentially been the al- clear signal to investors that the options market isn't expecting stocks to be volatile. You could essentially buy stocks, any stocks in a set-it-and-forget-it mode and feel comfortable. As the VIX fell this past week, is this what it was signaling again? Did indications of prolonged loose monetary policy from Europe and China give us the all clear?
Let's recall what the VIX is. It is a measure of the markets anticipated volatility for the S&P 500 in the near term. The S&P 500 is an index and while generally speaking the index volatility is a function of the volatility of all the stocks it contains, the volatility of the index is also a function of the degree to which all those stocks move up or down together, or how correlated they are.
To understand this, consider if half the stocks in the index rose sharply in a given week, but the other half fell just as sharply in terms of the market cap gained by the winners vs. that lost by the stocks that fell. The index itself would not move very much. The wins would offset the losses and the index itself would remain relatively unchanged, in other words its volatility would be low, even though the volatility of all the stocks contained in the index might be quite high. For quite a while, excluding the energy space since oil began to fall, equities have been tracking quite nicely together and that is also what the options market has predicted.
We can compare the price of options on an index with that of its constituent stocks and if the implied (or expected) volatility of the single-stocks is high, while the implied volatility of the index is low, then the market's expectation of correlation is low. This is what I was looking at when I was considering the distinct performances of this past week's winners like Amazon and Microsoft vs. its losers like Under Armour, Chipotle and American Express.
The one-month implied correlation is below 30%, well below the average of over 40% we've seen over the past couple years. What that is telling us is that the options market believes we are in a stock picker's market. Rather than simply buying an index, one who chooses individual longs (and shorts, if you make bearish bets too) wisely may find the coming quarter to be more rewarding. To me it also suggests that index portfolio hedges, using things like SPY or QQQ put spreads are reasonably priced and individual stocks are likely to provide more attractive opportunities for buy-writes and naked put sales.
This is a slightly wonky subject in the world of options, so I appreciate your indulgence in allowing me to share it. We have written recently that we felt there would be better opportunities as some volatility returned for options trades and also the notion that stock selection would become increasingly important. With the VIX dropping below 15 I thought it important to provide my thoughts on why I still believe that is true.