Short Term Speculation on the Yen

I have established a small short term position long USD and short JPY (Japanese Yen). This is ahead of the Bank of Japan meeting April 3-4, on the expectation that they will announce a more ambitious plan to devalue the yen than the market expects.

I believe this will occur because, in the current risk-on environment, the US Dollar has been sinking. I do not believe this will last. Equities are continuing to make all time highs, however, if stocks continue much higher, they will be entering overvalued territory. I believe the markets are getting ahead of themselves.

However, the theory of reflexivity would predict that this strength in stock prices would subsequently strengthen the economic fundamentals. An advancing stock market draws foreign and domestic capital and allows companies to issue their own stock at advantageous prices to fund acquisitions and organic growth. In such an environment, the risk-on environment may continue.

The reason I am not paying attention to the reflexive implications of a rising stock market is that the positive bias that would normally accompany such a move is not there. More and more, so-called experts are questioning whether the current economic strength can continue in the absence of the Fed’s monetary stimulus, which will be coming to an end this year. If the conclusion of the Fed’s program pulled out the legs from the market, we might end up with a “sell-in-May-and-go-away” type scenario.

The government’s sequestration lends further support to the “sell-in-May” hypothesis. Economic think tanks are reducing their estimates of the impact of sequestration. I think these estimates are short-sighted. The full effects of sequestration will only be felt later in the year, and I believe they will take the market by surprise. As a consequence, I believe the stock market will suffer a pullback sometime in the coming months. I am watching the markets closely for signs of technical weakness, so that I can make an opportunistic short.

A decreasing market would lead to a “risk-off” environment, in which the US Dollar would go higher. This, coupled with the Bank of Japan’s plans to devalue the yen, should propel the USD-JPY exchange rate much higher. To help matters, there was a doji reversal in the one-day charts last week. I have set a stop limit at the bottom of this reversal, near the 93.70 mark.

Closing the 3D Systems Corporation (DDD) Short

I closed out my 3D Systems Corporation (DDD) short position early last week. The trend has become unreliable.

As I pointed out on March 5, the downward trend was imperiled by Stratasys’s (SSYS) strong earnings. Further, rumors of an acquisition have been floating around.

Owners of manufacturing companies and conventional printer companies would like to get in on this trend, and may consider $3 billion a small price to pay for DDD’s patent portfolio, plus its future earnings. And, with a larger company’s capital at its back, DDD would no longer need to resort to equity-financed acquisitions, which put it at the risk of such reflexive boom-busts as we have just seen.

My March 2012 puts were saved in the nick of time on March 15, closing in the money before expiration. In retrospect, these were the wrong tool to use; I must remember to use puts further out into the future to avoid such a high time-value depreciation.

My May 2012 puts fared much better, and made a many-fold profit. In addition, my short equity position generated a substantial profit.

The negative trend may continue a little longer, but we are currently in a test period. There have been numerous articles recently highlighting the DDD’s fall in stock price as a bargain. This kind of positive perception is not what I would expect in a typical reflexive bust. I would expect the perception to turn increasingly more negative as the stock falls, until a true capitulation point.

I cannot predict what will happen with DDD until I see the next earnings report. If that shows a disappointing low earnings growth figure, then we will have proof that the negative perceptions have affected the fundamentals via the stock price, and it may be safe to re-engage in a short until the stock capitulates.

Given that the next earnings is not due for another couple of months, I cannot justify taking any action on DDD. If the stock reaches levels of ~$20/share, I would consider purchasing it as a long position, but until then, I am simply watching.

For more updates on my portfolio, check my blog

Portfolio Review

I am no longer as confident about my hypothesis that 3D systems (DDD) is in a bust phase. The better-than-expected revenue and earnings at competitor Stratasys (SSYS) has buoyed optimism in the space. I am worried that this will turn around the tide of negative perception that has driven DDD lower in recent weeks.

However, I am encouraged by the fact that 3D systems has not made any recent acquisitions. This would seem to fit with the thesis – that as the stock price declines, the ability of 3D systems to trade overpriced stock for companies with real earnings will decrease. Now 3D systems will have to be measured by its organic growth alone, which is not enough to sustain its lofty multiple – a P/E ratio above 70.

Stratasys seems to be at a different place in its own reflexive process. The results reported were better than expected partly due to a large acquisition. However, the boom has not been as strong as 3D systems’. Reflexivity plays a smaller role in Stratasys’s earnings – the company does not rely as heavily on stock sales to finance its acquisitions, thus the effect of perception on fundamentals is less direct. In addition, the organic growth rate (i.e. growth rate independent of acquisitions) seems to be larger than that of 3D systems.

For now, I am in wait-and-see mode. But I am edgy. I upped my short position on Friday, after reading 3D systems earnings report and seeing the fall on Monday at a much larger volume of transactions followed by a rise that was sustained by fewer transactions. Thus, I established that the rise was temporary, an effect of smaller-sized market participants, and the big money is still selling the stock.

In addition, I have been killed on my puts for March 14. This was a trading mistake. I never should have bought options that close to expiration, and I have paid for that lesson. The time value depreciation is much larger than the potential gain from a stock fall, unless the stock breaks $30/share before they expire. My May puts are hovering at profitability as well. In the future, I will probably steer clear of options as a tool – my type of reflexive reasoning has been better at predicting eventual results than the timing of those results. I purchased the options to take advantage of the short-sale restrictions that had been in place, and these options should have been replaced by short stock positions at a good opportunity.

As for my other positions, they are not fairing as well as I would have hoped. Though C&J Energy (CJES) finally broke its resistance at $23-$23.50, it is still testing this price, now as a support line. It remains to be seen whether the price will hold. WTI Crude has been in a steady decline for the past few weeks, so I believe that CJES holding above $23 is dependent on WTI holding above $90.

I have more confidence in Core Labs (CLB), because of its dependence on overseas operations. However, Core Labs does not offer an attractive value at this price. I would be willing to trade it for something more undervalued that is exposed to the same trends.

Bassett Furniture (BSET) has been a reliable play in my portfolio, as the housing boom seems to be continuing uninterrupted. It still has not reached a multiple of book value that I would be uncomfortable with, and the housing boom is far from over, so I am sticking with BSET for now.

The banking stocks ( and BBBI.ob) are relatively flat since purchase. They likely will not move much without a major announcement.

But BNCCorp’s annual statement provides an insight to a potential weakness in the company. Though it has been making a killing issuing mortgages in North Dakota, profiting off of the Bakken Shale explosion in the region, BNCCorp’s interest income has been steadily falling in an environment of low interest rates. If the mortgage banking revenue begins to fall off, the company will not be able to sustain its current level of earnings. At a 40% discount to book value, the stock is still worth owning at this point, but this is something to watch.

PGS (PGSVY) has declined significantly in recent weeks. It released fantastic earnings for 2012, however the guidance was below analyst expectations, and the stock dropped. It is sitting at an attractive price; with Price to Free-Cash-Flow ratio is sitting below 10, excluding expenditures on its MultiClient operations (P/FCF is a useful ratio to evaluate PGS because it has to depreciate those large Multiclient expenditures over time). I have confidence that PGS will be able to find buyers for its current MultiClient projects, since they are in high interest areas like offshore Africa. With Brent Crude prices above $110, offshore Africa will become more and more attractive to the big exploration and production companies. I would be willing to accrue more shares if I can get a price in the low $16 range.

As for Food Technology Services, Inc. (VIFL), I am waiting for the next earnings release and conference call to review the investment.