Eureka. We made it. Technicians as well as non-technical types have been debating since October over whether or not the S&P 500 had to test the February lows. At least that singular debate is now over. On Monday afternoon the index tested and then actually created a new low for 2018. There was then, of course, an algorithmic response and a minor rally ensued that has carried domestic equity index futures through the overnight session. Time for one of my stories? Perhaps, the instance where I really had to rely the most I ever have on what I pride myself the most on, self-discipline.
It was late autumn. 1980-something. Cold and crisp. What year precisely? I have no idea. Late at night, in a sleeping bag, as were my two colleagues. No chance to get up. No time to react. Only thing to do was to play dead, and that is what we did. All three of us. Over many years, I have had too many encounters with wildlife to possibly recollect. This however, was the only one where I remained still, with my eyes closed, and simply hoped that the creature, a black bear would walk away after smelling us, and nudging us around a bit. Uncomfortable when a dog smells your face? Try a bear. The creature was not aggressive, just looking for food, and we had some. Fortunately, we were smart enough to keep our food away from our bivouac . My Ka-Bar was unsheathed. I was, though still encumbered in my bag, ready to rock, Should I strike first? That bear lost interest and left us alone. Thank goodness. This next bear will not.
A Different Bear
A new day dawns. A new bear growls. The Russell 2000, and the S&P 600, both small cap indices now reside in bear market territory. Many salaried pundits and market technicians consider a drop of 10% off of the most recent highs to be a market correction, and a 20% decline to be a bear market. Those with actual skin in the game do not live by defined standards. A bear market simply is a market where it becomes difficult to make money through the use of a conventional net-long strategy for an extended period of time. In truth, we have been in such a market since the early days of October. More than half of the S&P 500 is now more than 20% off of their most recent tops.
Monday's regular session finally pushed the Nasdaq Composite into the red for the year, the last of the broad, major market indices to get there. The Composite experienced a 2.3% drop on Monday that left it 17% off of the highs that came in late summer. The S&P 500,and the much narrower Dow Industrial Average are both now a rough 12% to 13% off of their 2018 highs, so for the powers that be to widely recognize the bear, there would still have to be some more carnage. Speaking of bears, there's WTI crude oil, and that key futures contract fell again on Monday (as did a number of dollar based commodities) despite a finally softer dollar. That my friends, is part of the future growth (or lack thereof) narrative.
The U.S. economy will see November numbers for both Housing Starts and Existing Home Sales on Tuesday and Wednesday mornings. I don't know how much of a miracle can be expected here, given that the NAHB print for December (what we in the financial industry refer to as the Homebuilder Optimism Index) printed at it's lowest levels since the spring of 2015 on Monday. Broken down by region, the headline number fell for every region in the U.S., and was downright disastrous for the northeast. Housing Starts have more or less hung in there up til now, while Existing Home Sales (easily the largest slice of the housing pie) are considerably off of 2017's pace.
That brings us to the Federal Reserve policy meeting that will spit forth a decision, as well as a few meaningless projections ahead of the all-important press conference on Wednesday afternoon. I have been beating this drum all year. Finally, it was indeed nice to see many others finally aligned. Funny, what a bear market, or a market trading at new lows can do.
We all know that the FOMC went too far by now. They know it as well. They have to. Were they compelled by some invisible master to get both short term rates and the balance sheet to a certain level by a certain date? One really has to consider as there was simply no justification for such bold aggression. Zero, for what they have done, and for the speed with which they have done it. Even the bond market has vetoed the FOMC's trajectory for monetary policy. That is why the yield curve has been within striking distance of an inversion for a month. An obvious sign of panic? On Monday, markets sold off the Utilities and the REITs harder than the other nine sectors. This despite the status of those groups as bond proxies, by virtue of dividend yield. Why? When traders were also buying Treasuries? Because, this my friends was the only place where traders had short term profits, and there was a need to protect profits. Any profits.
Let;s go long-term. We have no choice at this point. The index tested the 2018 intraday lows on Monday, and for now has passed that test. Stretching out the chart over a three year period that encompasses what I consider the start of the most recent upward leg of the now gasping bull market, illustrates possibly one last level of support should the Fed proceed with doing something stupid on Wednesday. Economic growth can die without the help of the central bank, but the FOMC does seem especially talented at forcing these unwelcome changes into the lives of hundreds of millions. All they had to do was listen, or accept help. SMH.
Overlaying a giant Fibonacci model over the entire chart allows for some help to come in just above 2500 should the 2530 level fail. Then, my good and loyal friends, it's game on, I'm afraid. Do we really go there? Quantitative easing was an experimental policy that forced risk-assets to artificially higher levels. Withdrawing that liquidity, should it continue in earnest also withdraws the standing reason for higher valuations. Should the FOMC sound dovish on future short term rates, without addressing the harm being done through balance sheet management, then they will have really done nothing to undo this series of critical errors. A subsequent rally will be ripe for trading. As for investing, I don't need to catch the bottom. If I'm wrong, I'll smile and catch up.
The White Whale
Every once in a while comes a name that ticks me off, and I just do not give up on it. A flaw in my discipline? I like to think of it as tenacity, but you may be right. General Electric (GE) , and Apache (APA) have been names that have forced upon me hardship in the past. In both of those instances, I ended up turning profits due to the wonders of net basis management over a longer time frame than was likely worthwhile. I'm human. Micron (MU) has become my latest beast in need of taming. This beauty is off a rough 15% in December alone. The name closed last night at $33.88. My net basis in $36.08. Suddenly, I am on the wrong side of the ledger. I have written positively on this name several times. I write honestly about my own trading, and if I have led you down a dark alley, then I beg your forgiveness. That said, when I find myself in a dark place, I usually find my way out of said dark alley. Follow if you want to. I am not telling you good folks to do anything. This is the story of a less than sane sea captain, and a white whale.
Micron reports their fiscal first quarter results tonight. Wall Street consensus view is for EPS of $2.96 with whispers maybe for a penny less than that. Revenue is expected to print just above $8 billion. That should be good, if realized for year over year growth of 17.9%. What do I think? I think that even with these impressive numbers probably already priced in, the shares closed last night awfully close to 52 week lows, and trade at a forward looking PE with a 3 handle. Briefly, that means that this name is grossly undervalued, or those projected earnings are wrong. There is no middle ground here. Last week, Citigroup cut estimates for MU based on lower average selling prices for both DRAM and NAND memory based on oversupply.
Still, the stock has an ally in Bank of America Merrill Lynch's Simon Woo. Woo still has a buy rating on MU, and a price target of $55, of course at least partially based on the firm's aggressive corporate repurchase program. My two cents? My belief is that the quarter being reported might not hardly matter at all. Market reaction, in my opinion will be centered around CEO Sanjay Mehrotra's guidance into and beyond the second quarter. Investors will need to be told how well the firm is countering the decline particularly in DRAM pricing as that is this firm's bread and butter. Wall Street is looking for revenue of roughly $2.44 for that quarter (reported in February). Let's say, Mehrotra can guide into the mid-$2.50's? Then I think we have a ball game. One more thing, as an Apple (AAPL) supplier, some of this stock's good fortunes are tied up in Apple hardware sales, which for the time being appear troubled.
Should the stock price approach the central trend line of this Pitchfork model ahead of earnings, I will be likely to add. If not, I'll wait until I hear the call tonight. None of the day to day indicators (RSI, MACD, Money Flow) are friendly right now, but I did not expect that they would be given MU's "December to Remember" performance so far.
Pre-Earnings Trade Idea (minimal lots)
My trades will be somewhat different, due to the fact that I am already long the equity as well as short both puts and calls. Still my general idea is to maintain a long position, while reducing net basis through the use of the options market.
-Purchase 100 shares of MU (last: $33.88)
-Sell (write) one Dec 21 (this Friday) MU $31.50 put (last: $0.64)
-Sell (write) one Dec 21 (this Friday) MU $36 call (last: $0.65)
Notes: This trader through the sale of this options strategy has reduced net basis to $32.59. A trader could push out expiration to further reduce net basis. Below $31.50 the trader is at increased equity risk at an obviously lower basis. Profit on the trade through this Friday is capped at $3.41 (or 10.5%) should the shares trade above $36 on that night's close.
Economics (All Times Eastern)
08:30 - Housing Starts (Nov): Expecting 1.227M, Last 1.228M SAAR.
08:30 - Building Permits (Nov):
Last 1.263M SAAR.
08:55 - Redbook (Weekly): Last 6.6% y/y.
16:30 - API Oil Inventories (Weekly): Last -10.18M.
Today's Earnings Highlights (Consensus EPS Expectations)