Thursday Thud – First Quarter Ends With Dow Down 1,000 Points

Down 1,000 points isn't so bad.  

Well, it's bad if we consider that we were up 2,000 in January (26,600) so down 3,000 since then is 11.3% but let's say we claw back to 24,000 this morning – that would be down almost exactly 10% and you don't want the -10% line to act as resistance on the way back up – that gets very ugly, technically.  

Of course, nothing it technically uglier than failing the 200-day moving average and, so far, we have narrowly avoided that by bouncing off 23,500 but, if we call that a 2,000-point drop from the 50 dma, which was 25,500 when we were up there (since dragged lower), then we expect to see 400-point bounces to 23,900 (weak) and 24,300 (strong) – and we're a long, long way from 24,300 so it's a weak finish to Q1, at best. 

Today is the last day of the quarter because tomorrow is a holiday and Monday is spring break (I'll be in Florida) so the volume is very low and nothing the markets do today or even next week are going to matter much.  If we can't claw back over 24,300 by the end of next week – it's not going to happen.

Next week is still sleepy for earnings as well and April 13th is the official kick-off for earnings season, with CitiGroup (C), First Horizon (FHN), First Republic (FRC), JP Morgan (JPM), PNC (PNC) and Wells Fargo (boo!) all reporting that Friday the 13th morning – good luck to all of us!  We did very well shorting XLF into January earnings but, like the market, we're down 10% from there so it's a bit tricker to call now – I think we'll just wait and see if that $27 line holds but, if not, another 10% down should do the trick.

So, to decide whether or not we should be bullish, we look at our big banks and decide whether or not they are likely to rise or fall on earnings and that then will give us our premise for what is likely to happen as earnings season kicks off.  We will call that The Big Bank Theory! 

• It's early in our data-gathering cycle but C, for example, is a $175Bn bank at $68.26 and they lost $6.6Bn last year on $63Bn in revenues.  That, however, was due to a one-time $23Bn tax expense for "repatriating" the money they've been hiding overseas so now they are sitting on $413Bn in cash.  Anyway, net/net let's say they actually made $4-5Bn and let's be nice and say $16Bn and we divide 175 by 16 and that's 11 times ordinary earnings – not over priced.
• JPM did not move money around and they dropped $24.4Bn to the bottom line on $94Bn in revenues and that's AFTER paying our $58Bn in salaries and bounuses (and sales and office expenses) – it's good to be the king!  You can buy that kingdom for $368Bn at $108/share and $368/24.4 = 15x earnings, which is normal for a bank.  
• WFC (boo!) for whatever reason, only paid $5Bn in taxes despite earning the same $24Bn JP Morgan did.  Revenues were $97Bn and you can take over this criminal (allegedly) operation for $251Bn but I'm going to subtract $5Bn for tax evasion (apparently) and call earnings $19Bn and 251/19 = 13, which is in-line with their peers.  
• PNC can big put under the tree for just $70Bn at $150 per share and they had $18Bn in revenues and paid just $102M in taxes on declared income of $5.3Bn (must be nice!).  Even if we call it $4Bn without cheating, 70/4 is just 17.5 so not over-priced either.

So the financials are not likely to bring the markets lower and we'll do similar studies on all the S&P sectors to determine what we expect as Q1 earnings season begins.  We also have to think ahead as to whether rising rates are hurting their margins but, so far, it seems like we should be adding more CitiGroup to our Long-Term Portfolio!  Our current position was added on Feb 2nd and it is:

We're comfortable with the short put target at $70, so no need to change that but it would be silly to ignore the opportunity to improve our spread.  The net cash outlay for this position was just $2,150 and there's a $6,800 margin requirement on the short puts so we can certainly add some cash as follows:

• Roll the 15 2020 $72.50 calls at $7.50 ($11,250) to 25 2020 $62.50 calls at $12.50 ($31,250)
• Roll the 15 short 2020 $85 calls at $3.90 ($5,850) to 20 2020 $77.50 calls at $6 ($12,000) 
• Sell 10 May $70 calls for $2 ($2,000) 

Our net cash outlay for the roll is $11,850 plus our original $2,150 puts us in what is now a $62,500 spread for an even $14,000 so our upside potential is now $48,500 (346%) at $77.50 vs our original potential $16,600 gain.  So, what happened here?  Well this is how we structure our Long-Term Portfolio – if the stock had gone up, or even stayed flat – our initial, small entry would have made a nice return.  Since the stock went down almost 20% and we still like it, we're THRILLED to increase our allocation to $14,000, which is still only 1/4 of a full allocation block ($50,000) but call it $20,000 with the margin so we're almost half-pregnant on this one (and of course it's good as a new trade as well).

Following our strategy on this "losing" trade, we are able to drastically lower our target strike while also drastically increasing our potential reward.  Not only that but our long spread has 659 days to play out and the well-covered May calls we sold are using just 50 of those days so 12 $2,000 sales from now ($24,000) and we will have much more than paid back our $14,000 outlay.  

That's the strategy we were discussing in yesterday's Live Trading Webinar so this was a good opportunity to go over an example in detail.  With our early-round entries, we almost prefer the market takes a dip and "forces" us to build larger, lower positions as it really amplifies our returns – IF things improve down the road.  If not, the hedges are key and the hedge we added yesterday was:

As an additional hedge, at the moment, I like for the STP:

• Sell 4 WHR 2020 $125 puts for $12.50 ($5,000)
• Buy 50 SQQQ May $16 calls for $3.90 ($19,500) 
• Sell 50 SQQQ May $20 calls for $2.20 ($11,000) 

That's net $3,500 on the $20,000 spread that's almost all in the money to start and the only way to lose is if the Nas goes up quite a bit from here which, with all these headwinds, doesn't seem too likely.

That should be very easy to buy this morning as SQQQ should open lower and I don't think Whirlpool (WHR) is going anywhere.  WHR is simply a stock we'd like to own if it gets cheaper (now $151) so promising to buy 400 shares for $125 (17% discount) puts $5,000 in our pocket but it could be any stock you REALLY want to buy if it gets cheaper (see our Watch List for dozens of possibilities).  

Other than that, we expect a bit of a sell-off into the close but too tricky to bet at the moment.

Have a great holiday weekend, 

– Phil