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Toppy Tuesday – As Usual

Back to our highs, again.

And what do we do when we hit the 20% line at 3,420 from below?  NOTHING!!!  What do we do when we cross under it from above shortly after that?  We short it!  That's right, the 5% Rule™ is not very complicated.  In fact, this chart is saved in my StockCharts profile as "S&P 500 Large Cap Index ($SPX) Feb 6 2020" which means we've been using the SAME chart since before the crisis and we're STILL right where we expected to be over 6 months ago

Remember, the 5% Rule™ is not TA – it's just math!  Math is real, TA is not…  

Math told us we'd bottom out at 2,280 and we went long at 2,280 and did very well and math told us we'll top out at 3,420 and we got much more bearish last week and now we'll see how that plays out.  Hopefully, for the sake of the investors that are irrationally exuberant, we won't go down as sharply as we did in March.  In fact, we can go down 20% and still be on a bullish track – as long as our "Must Hold" levels do continue to hold.  

Unfortunately, the Must Hold levels are NOT holding on the NYSE and the Russell 2000 – our two broadest market indicators.  That's because, as I noted in yesterday's Report, this is a very narrowly focused rally led by the Tech Titans.  In the Dow 30, the Nasdaq 100 and the S&P 500, it only takes a few strong stocks to lift the entire index but in the Russell 2,000 and the NYSE (2,800) we get a much broader measure of the market and that measure is NOT GOOD.  

The NYSE was at 14,183 in January and now it's under 13,000 so about 10% down  for the year and the Russell topped out at 1,700 and is now 1,568 – also down about 10% for the year.  When you think about it, that does seem about right considering the economic mess we're in but optimists that we are, we focus on the indexes that are perfoming well and ignore the ones that are performing poorly even though, historically, the NYSE is a much better indicator of overall market direction than the smaller indexes.  

In fact, in order to keep up appearances, the Dow Jones is kicking out Exxon (XOM – $42), Pfizer (PFE – $38) and Raytheon (RTX – $62), who they only just added in April (to replace UTX) and is replacing them with much more exciting SalesForce (CRM – $208), Amgen (AMGN – $235) and, coming back from vacation (they were kicked out in 2008) – Honeywell (HON – $169).  I'm sure some of you are clever enough to see a pattern – they are replacing the stocks with much more expensive stocks and that matters a lot because the Dow is a price-weighted index so a 10% gain in XOM would be $4 x 8.5 points per $1 would add 34 Dow points but a 10% gain in AMGN would be $23 x 8.5 = 391 Dow points added.  

So you can see how these shufflings can drastically influence the index and give us a very false impression of the market's performance since, Globally, the Dow is the leading indicator for the US markets, even though it shouldn't be (see "Doubting the Dow").   On the other hand, should the market turn south, the additional weighting of these new components, which are all trading at highs, could lead to catastrophic losses in the index.  AMGN and HON are both good stocks and strong values but CRM at $208 has a $187Bn market cap after climbing 25% this year but they only generate about 125M in profits so $187Bn is 1,496 times earnings and total sales were only $17Bn last year so you're paying 11x sales for CRM – steep by any standards.  

When you invest in a Dow index fund (and almost anyone who has a retirement account does that) you are forced to buy the good with the bad and CRM is definitely the bad from a value perspective.  The Dow (/YM) is very close to 28,500 this mornng so it makes a good short and, as noted above, we short the S&P (/ES) when it crosses below 3,420 and, of course, stop out if it crosses back above.  

Be careful out there!


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  1. Good Morning.

  2. Good Morning!!

    Phil/SDS adjustment on the AUG 13th. Your adjustment was…

    Close the 200 short Jan $30 calls at 0.60 ($12,000)

    Roll the 300 Jan $15 calls at $2.35 ($70,500) to 300 2022 $15 calls at $3.70 ($111,000)

    Sell 200 Jan $22 calls for $1.10 ($22,000)

     I missed the post on the 13th, and haven’t been able to get fills even close to yours. I only managed to Roll to the $22 Short calls (from original $30s). The $15s have moved a lot and I’m seeking your advice on how to best manage these.

    If I roll now to the Jan 2022 it will cost $1.85 (mid) vs you rolled for $1.35. Would you suggest I wait for a pullback or try the JUNE2021s which will cost me 0.42c (mid) for the roll then adjust again further down the road?

    Second question. Why be 2/3 covered on this? Is it so we can profit more if a crash causes the SDS to go above $22, or to get a better price for the remaining short calls When SDS goes up?

    Thanks in advance.

  3. Good morning!

    SDS/Youngy – Well the short Jan $30 calls are now 0.54, so those were easy to close.  The Jan $15 calls are now $2.01 as SDS keeps sinking but it doesn't make sense you couldn't get $2.35 for those as it was that price still on the 17th and even on the 20th again:

    And $3.70 was easy to fill on the 2022 $15 calls too:

    The 2022 $15s are now $3.50, so cheaper but now the roll is net $1.50 and not net $1.35.  Ideally, when you are doing a roll, you want to (in this case) offer to sell 20-50 Jan $15s at $2.40 while offering to buy 20-50 2022 $15s for $3.60 and, if you get lucky, the both fill and you've rolled 20-50 for $1.20 and then you get to work on the next batch.  You WILL fill one side or the other and, having gotten a good price, you then set about rebalancing before moving on to the next set.  

    And yes, 2/3 covered to make more money as I'm more sure we're going to crash now.  Also, if we do get a spike up, it makes it easier to cash in 100 of the 2022 $15s for, let's say $5 (if SDS is over $20) and then we have knocked 0.75 off the net of the remaining 200 spreads so they are nearly free insurance for 18 months.  See – planning ahead!

  4. Phil – so do you still believe that NAK will get approval and be able to stay solvent until then?

  5. Final (ish) version of the newsletter is out.  

    • The broader market is little changed, with no sectors showing any real commitment to the upside.
    • The S&P is flat and the Nasdaq is up 0.1%.
    • The Dow, off 0.6%, is seeing more pressure after announcing it's jettisoning Exxon, Pfizer and Raytheon, all significantly lower.
    • Health Care (NYSEARCA:XLV) is the leading sector, up 0.5%. But that's feeling the Dow effect as well, getting a boost from Amgen, up 5%, which will replace Pfizer.
    • Energy (NYSEARCA:XLE) is back in the basement after leading yesterday, down 1.7%, hurt by Exxon. Crude futures are climbing, though, up 1.7%.
    • Among the Fab 5 megacaps, Facebook is seeing the biggest gains after announcing new shopping moves. Apple is down.
    • Interest rates have backed off of earlier highs. The 10-year Treasury yield is at 0.69%, up more than 4 basis points.
    • Mexico's Foreign Minister announces that it will participate in an early-stage study evaluating a COVID-19 vaccine candidate being developed in Italy by Rome-based ReiThera. The vaccine, dubbed GRAd-COV2, may be commercially available by the spring of next year if all goes well.
    • Rome's Lazzaro Spallanzani institute will conduct the trial in 90 healthy volunteers.
    • It is apparently unclear if Mexico, which signed on to provide 2,000 volunteers for studies of Russia's "Sputnik V" COVID-19 vaccine, will participate in mid- or late-stage trials.
    • Being replaced in the Dow may just amount to a bruised ego.

    Exxon Mobil (XOM-2.9%), Raytheon (RTX-3.1%) and Pfizer (PFE-1.6%) are all struggling today as the stocks were shown the door from the Dow Jones Industrial Average.

    The general thinking is that the stocks will lose the support of money indexed or benchmarked to the Dow. It’s more likely just a knee-jerk reaction to a negative headline, though. Yes, there is $28B indexed to the Dow 30. But there’s $11.2T indexed and benchmarked to the S&P, with index funds making up $4.6T.

    In fact, the effect of losing Dow status may just be hurt pride. Looking further down the road, getting jettisoned from the index doesn’t seem to have much impact on shares.

    Of the 17 stocks that have been removed from the Dow since 1999, the average one-year performance is down less than 1%, according to WSJ Market Data Group calculated in mid-2018.

    The last big Dow reshuffle in 2013 saw Alcoa (AA-1.5%), Bank of America (BAC+0.8%) and Hewlett-Packard leave. A year later, Alcoa was up 96%, BofA was up 17% and HP was up 73%.

    How did Exxon, Pfizer and Raytheon get the boot? The main reason is that S&P Dow Jones Indices wants to pivot the index more to tech and it would be losing a lot of that exposure after Apple’s stock split, since the Dow is a price-weighted index.

    Exxon has been a member of the index since 1928. But over the last 10 years, Exxon is down 28.4%, compared with fellow Dow member Chevron, up 18.2%. Looking at total return, Exxon is up just 2.3%, with Chevron up 73.7%.

    Pfizer has performed about the same as fellow component Merck (MRK-0.1%) in the last 10 years, both up about 250%. Replacement Amgen (AMGN+4%) is up 466%. But in the last five years, Merck, up 94%, has nearly doubled the performance of Pfizer, up 49%.

    Raytheon is simply not the company is was when it was just United Technologies, with much more aerospace exposure, already featuring in the index with Boeing (BA-2.8%). Honeywell (HON+3%), ousted in 2008, brings back more of the pure industrial business.

    Investors should perhaps be more concerned about the shares of new entries. According to the same data cited earlier, the 17 new entrants since 1999 fell 8% on average a year after their Dow debut. 

    Walgreens (WBA-1.4%) is down 42% since it entered the index in 2018.

    • Commercial banks and saving institutions insured by the Federal Deposit Insurance Corporation saw Q2 net income drop 70% Y/Y, according to the FDIC.
    • Still, "liquidity and capital levels remained very strong to meet loan demand and absorb any losses in the future," the agency said.
    • The net income decline is still better than in late 2008 and 2009, where the institutions, in aggregate, logged net losses.
    • Q2 net income for the group totaled $18.8B down from $43.7B a year earlier, as uncertainty surrounding the COVID-19 pandemic prompted banks and saving institutions to set aside large amount of money to cover potential credit losses.
    • Q2 provision expenses climbed to $61.9B, up $49.1B from a year ago.
    • Total loan and lease balances rose by $33.9B (0.3%) from Q1. Consumer loans, however, fell $67.1B due to reduction in credit card balances.
    • Total noncurrent loan rate (90 days or more past due or in nonaccrual status) rose by 15 basis point to 1.08% vs. Q1, and total noncurrent loans rose by $15.9B (15.5%) from the previous quarter.
    • Total net charge-off rate rose by 7 basis points to 0.57% from a year ago.
    • Slightly less than half (47.5%) of all institutions reported annual declines in net income, with the share of unprofitable institutions increasing to 5.4% from 3.9% a year earlier.
    • The Deposit Insurance Fund balance of $114.7B rose by $1.4B from Q1; however, the fund's reserve ratio declined by 9 bps from Q1 to 1.30% in Q2 due to historic insured deposit growth

    NAK/Coulter – They've been selling options to potential partners for years and they'll do so again though the stock is already hitting 0.60 as the rumors have turned against them.  You're talking about the potential to make $100Bn and it costs $60M/yr to keep the option open – they'll get the money for that because, as we've just seen, regulations can be undone after any election.

  6. Phil,

    I found a typo in the newsletter

    So in step one we’ve spent net $1,750 and, if called away at $1 in February, we 

    Called away at $2 not?

  7. Phil – misstatement in the newsletter: you said  TQQQ is "3x ultra-short ETF" and its an ultra long.

  8. Actually the $2 was a typo.  On Friday NAK was higher but, as it dropped, I switched it to the short $1 calls.  Those are still 0.30, even with the drop to 0.60 so now you net in for 0.30 ($1,500) and if you DD at 0.40, you're in for 0.35 and then, if you sell more $1 calls for 0.30, you drop your net to 0.25 on the whole thing.  That's why I like these kinds of trades.  If we have 10,000 at 0.25 next year and NAK is still in business, even if we can sell the $1 calls for 0.15, it's a 40% return.

    TQQQ/Deano – That one I missed, thanks,

  9. Phil/ WBA

    Bank of America analyst calling WBA a value trap, among her list of many such stocks.

    How well do you think she knows her companies?

  10. Hi Phil,

    In the disclaimer at the end of your newsletter, it says, "Disclosure: Neither the author nor the publisher have positions in any stocks mentioned in these pages prior to their initial recommendation and do not initiate any new positions until ten (10) business days after distribution."

    You have a position in NAK already. I don't want you to get in trouble.

  11. Well, I don't, my adult children do.  Thanks though, don't want to miss on those. 

  12. A coronavirus chart that will shock you