Further Analysis of QE3

I hadn’t considered the effect of QE3 on oil, but inflation in the dollar will be a positive for oil, priced in dollars. American oil companies should benefit.

However, the entry of Russia into the WTO cannot be ignored. It is hard to tell which force will be greater.

Negative bets on U.S. Treasuries have hit an all-time high in the face of QE3. What Bernanke really wished was that Congress would release a stimulus. However, QE3 has, in effect, dampened the ability of Congress to do so. As investors sell treasuries, the interest rates will rise, increasing the load of U.S. debt and making stimulus action more and more expensive.

Admittedly, this effect would not be felt unless it were to continue past the current deleveraging. Deleveraging is causing the deflationary effects we are seeing, and until demand for debt increases, interest rates will not substantially rise.

In the shorter term, the low interest rates will continue to have a positive impact on stocks. This is bad news for my short of SPY. SPY has not approached my stop limit, so I am sitting tight on it, however. If headlines begin to turn more positive on the U.S. market, I may have to reconsider my position.

In my loose prediction of the future, I would guess that stocks will fall in the short term on renewed European concerns. Then we will get a post-election rally, as investors become more certain of the future and the housing rebound takes full swing on the back of QE3. Finally, in the spring, the massive decrease in government spending should cause the markets to fall substantially. I don’t expect Congress to actually decrease spending and let tax cuts expire simultaneously. However, I do expect Congress to put it off until the last minute, and U.S. stocks will not like this.

That is mere speculation, in the loosest sense of the word. Too much time and too many game-changing factors will occur between now and next spring to have a good idea of what will happen, on a macro-level, beyond the next month.

 

Disclosure: I am short SPY.

The near future for oil

I have entered my short SPY trade as described previously. However, the global recession is causing a necessary pullback in oil prices that have gotten ahead of themselves, and I am suddenly realizing that I am far too exposed.

Oil prices have been running up, I believe, in a correlation with markets, for two main reasons: Asia, and Southeast Asia in particular, has not been as affected by the slowdown as investors are expecting – they have generated enough capital on their own to become more immune to international financing problems – and because Saudi Arabian oil production was decreased in June/July.

But now several factors are converging to hit oil prices at the same time.

Russia’s entry into the WTO, which has been well signaled for over a year, will continue to have further negative impact on oil prices, as the Russian oil will be available to more nations and more markets, increasing the worldwide supply.

In addition, Israel has publicly announced that it will not go to war with Iran. In fact, Israeli officials seem satisfied with the current level of international pressure on Iran. This removes the impetus for speculators to bet on further instability in the Middle East. Though there have been minor skirmishes related to an American video released, it is too early to tell if this will be a significant new outbreak of violence.

Without the speculative aspect, Brent Crude cannot sustain a level much higher than $100.

This is OPEC’s intended target, and they have wisely recognized that more oil is coming online and are not increasing production yet. This is one positive in the near term, however with more countries receiving Russian oil, and the possibility of Iranian oil being removed from the market being removed from the table, will provide enough negative force to push Brent to $100 or below.

The effect on WTI is less clear – the pipelines to the Gulf of Mexico have been okay-ed by President Obama, which will allow American oil to reach the world markets. However, the effects of this project will not be felt for the near future. I would expect WTI to trade roughly in correlation to Brent, though the supply/demand characteristics are completely different.

Supply in America is continuing to increase as a result of exploration and production companies concentrating on Shale oil, rather than gas. Though this will change as natural gas prices increase this winter, the glut in supply is likely to overwhelm demand in the near term, especially as unemployment remains disappointingly high.

What does this mean for my stocks?

As far as the companies themselves, I don’t expect C&J energy services or Halliburton to experience severe negative impact to earnings – exploration and production companies tend to plan on a much longer term than daily market movements. In addition, rising natural gas prices should juice earnings as exploration and production companies will likely increase their production this winter.

However, the stock prices themselves will likely be hit by the negative perceptions. Without another conference call for either company for at least a month, there will be no fundamental data to counter the negative perceptions.

The best move may be to purchase puts to hedge my investment, but I am reluctant to do so until I am sure that this will decrease my risk rather than increase it.

For the time being, I am going to sit tight, let my SPY short play out, and keep my ear to the ground for rumblings from international markets. As long as $100 forms a floor for Brent oil prices, my stocks should remain strong investments. If oil falls below $100, I will have to reevaluate my strategy.

 

Disclosure: I own CJES and HAL. I am short SPY.

Waiting for the short

I believe the market is beginning a pullback. Stock price action has not agreed with reality for the past few months – the fundamentals of the economy are simply not strong enough to warrant the 15% rise off of the June bottom. The looming fiscal cliff, the inability/unwillingness of banks to lend their capital, and the general global recession have taken their toll on U.S. businesses, yet stock prices are rising. 

This cannot go on. However, I am aware of the old adage, “The trend is your friend.” However Friday established a “hammer” formation on the candlestick charts, a signal of reversal, and today’s downward move signals that I may be right. I am probably going to enter the trade if tomorrow’s market action confirms we are in a downtrend. I will probably use a tight stop to limit losses if I am wrong, but I believe the market will fall at least to the 1300 area.

Portfolio Review

BNCC is now up 150% after the announcement that the private offering – which was way below the intrinsic value of the bank – has been withdrawn. I will attribute the first 50% to skill (based on high earnings for BNCC), and the last 100% to luck.

I advise selling at least half at this point – there will be a lot of profit taking going on now, but the stock still has huge growth potential.

I need more powder to load up in case of a crash, so I may need to sell more. Also, GMCR looks extremely attractive here, so I think I will buy more for a fall rally.

My remaining position in IMAX is killing me; it was a mistake to retain half of my position after the Avengers premier. I should have sold it all. I am going to sell out of my position and purchase long-dated calls for January 2013 and January 2014 – yes, I may give up a substantial amount in case of a crash, but the reward:risk is probably around 3:1 for Jan 2013 $20 calls. (I think the stock could go as high as $26 after The Hobbit – which was the level of resistance in early March, and the calls cost $2 a piece.) For 2014, I’m not quite as sure,  but the theater base will be large enough that margins will have come up by then, and there are two knockout blockbusters in late 2013 – the sequels to The Hobbit and Hunger Games.

RLD looks good for the rest of the year. Exactly as the CEO had indicated, the capital expenditures have come down as the theater base has reached saturation, so free cash flow is positive for the first time in several years. This will translate into either decreased debt load or higher cash balances.
At a price/book ratio of ~3, we can’t expect rising cash balances, and thus increasing equity, to have a major effect on stock prices.

However, if management chooses to retire debt, we could get a small boost to the net income to help year-over-year comparisons.

The pre-tax income of RLD last quarter was $7624 k and the cost of interest was $313 k, so we could get a boost to pre-tax income of 4.1%, translating to a post-tax increase of 6.5%. (The post-tax increase is way higher, due to the insane tax rate of 60% that RLD voluntarily pays, instead of taking its deferred tax assets).

Management used the free cash flow last quarter mostly for cash reserves, but devoted about 10% of the free cash flow to paying down debt and buying back shares. If management continues to do more of the last two options with future cash flow, we could get a real impetus higher for the stock. I am all for free cash flow valuation, but the P/E ratio is really what attracts new investors to a stock.

My small position in GLW was most definitely entered prematurely, however, once we see signs of TV sales increasing, it will already be too late to enter the position. I will hold, but if I do not see signs of TV sales increasing this fall, I will sell before the spring.

CJES and HAL continue to dominate a large portion of my portfolio. With oil prices near $100 and rising, I cannot see a GOOD reason for the low prices on oil service names.

The reason for the initially depressed prices for the whole sector is low natural gas prices. However, the negative feedback of these prices has caused less natural gas production, and thus, prices for natural gas are rising. This rise in natural gas prices has still not filtered down to the oil service names in a major way. However, this trend will continue into the fall. The major impetus for this sector could come in the form of an unusually cold winter. Even in the absence of that, I do see an increase of at least 20% for the whole sector by next spring, however the boon of cold weather would take the sector up an additional 20-30%.

Halliburton has another factor of course – the continuing coverage of BP’s Macondo disaster. However, as the court proceedings go on, it seems more and more likely that HAL will not bear any of the liability for the disaster, and the blame will fall squarely on the shoulders of BP, or, possibly, Transocean. Perhaps this is my own biased way of reviewing the events, but until there is more clarity, I am content to hold HAL.

I still consider CJES to be my lowest risk position. The main risk is that of EPA regulations imposing more costs on hydraulic fracturing, however the combined upsides from the inevitable oil-shale trend and its incredibly low P/E ratio make it too good to pass up. The only other concern I could think of is that the company is too good to be true – I will have to do more investigation on the operations of the business in East Texas to assuage that concern.

I sold off GOOG a while ago for more cash. Though the stock has appreciated since, and still remains at a low P/E/Growth, I feel the market overall is getting overheated, and big-cap names like this will be most discounted if there is a sell-off in the S&P 500.

I still have the VIFL I bought at 4.50 and doubled up on at 5.20, so it’s up considerably. I held it too long, I should have sold at $7, but I deceived myself by looking for a wedge pattern to the upside. Now, I must move on and accept the fact that it is tying up far too much of my capital. It is still slightly undervalued with a PEG of .84 and a cash-backed out PEG of .70, and it has an attractive free cash flow yield, however it is not as undervalued as I would like it to be for a hold. I fear I must unload some shares, at a slightly decreased price in the low $6s. An opportunity for a higher price was lost, but if I translate this sale into a better idea, like GMCR or CJES, I think I will end up glad I did.

GMCR is still terribly undervalued here, with PEG of .50. Again, if a cold winter blows through, we could get a big coffee boost, but this is not something to be counted on. Without any winter effect, GMCR is an idea that has been proven in one geography – the Northeast – and is now spreading across the continent, locking in rapid earnings growth as it spreads. Starbucks has been clear in its plan to partner with, rather than compete against, GMCR, and this is perhaps the most important coffee brand.

I am not concerned about the patent expiration, because the only competitors to release on the Keurig platform are low cost store brands. Since GMCR has a high upfront cost and typically high K-cup costs, the customers already on the system are those with disposable income who are willing to spend for high-quality, branded coffee. I would only be concerned if a more premium brand, like Peet’s or Starbucks, decided to offer their own K-cups.

The SEC investigation is ongoing, and is the biggest risk with this investment. However, the potential reward is at least 100% from the $23-24 level. The risk is hard to quantify, but probably less than 60%, so I feel comfortable deploying up to 20% of capital, though I currently hold closer to 7% of my capital in GMCR.

That is everything I hold right now. The take-aways are: Load up on cash for a potential market crash, and sell off on the least undervalued options to move into the few incredible values out there.

Disclosure: I own shares of BNCC, GMCR, IMAX, HAL, CJES, GLW, and VIFL. I may purchase more shares of GMCR in the next 72 hours.

Speculation Diary

No speculation yet, though I may get long the Singapore dollar if I see a good technical entry point. Cannot bet on the dollar/euro with this much uncertainty out there. AFK looks like a decent long on my general speculation that Africa will really emerge in an environment of high oil and commodity prices and a lack of other high growth emerging markets. Gold may be a good long here, but I am not well enough versed in the fundamentals of gold trading to speculate.

The S&P may be a good short in the next few days. I would have to wait for a break and an unsuccessful test of the 1400 level. The fundamentals in the United States are much worse than the market is suggesting here.