Back on the Buy Side

I know the unusual volatility the last few weeks may have been a test of investors’ willpower, but as I mentioned in yesterday’s update on the website, our stocks are now leading the S&P 500 in the recovery just as our hedge shielded us from the real brunt of the decline. I’m very pleased how our strategy has passed the latest test with flying colors.

With the market as a whole back in rally mode, a solid majority of our stocks are beating the benchmark by a substantial margin. The S&P 500 has rebounded a healthy 3.4% since last Friday’s close, the best week in two years. Counting today’s dramatic surge in Aratana Therapeutics (PETX) – which we sold this morning at an unexpectedly rich 16% profit – our long-oriented trades were up 3.8%.

Drill down, and our outperformance this week becomes even more robust. Let’s start with the red ink. Only one of our stocks, Castlight Health (CSLT), gave up ground this week. It did bounce 3.4% in the rally since Tuesday’s close, and I want to keep an eye on that momentum. CSLT remains a potential quagmire for the short-sellers, who still owe the market 28% of the float, so it won’t take much to spark a short squeeze to drive it higher.

All of our other long trades were in the black, and we are getting close to taking profits in a couple of them. ChannelAdvisor (ECOM) is now up 16% for us in two weeks, and Semtech (SMTC) is up almost 10%. Six of our stocks beat the S&P 500 and four more than doubled its performance, rallying 7%–11% in the last five days. If overall momentum stays positive, I could see us ending the year with three or even four of the wins that we short for to go along with the five double-digit winners we’ve already booked this month.

This is the rhythm I like for us, because as we lock in our profits and retire those that failed to live up to their promise, we can keep taking advantage of new opportunities. That’s what we did with General Cable (BGC) today. It closed $0.02 above our $14.95 buy limit, so if you weren’t able to get in today, you may well get a chance early next week.

I am looking forward to what the market brings us as 2014 winds down and the new year begins. Two weeks ago, too many stocks looked overbought, overvalued or both, leaving my screens crowded with energy stocks priced for disaster and few traders willing to get in the way of the falling knife. Now that a bit of the froth has cleared, I’m seeing more of the potential set-ups we look for. Things may slow down a bit the next couple of weeks, though we could lock in some gains. As always, I’ll let you know when it’s time to buy or sell, and if there is less movement than usual over the holidays, I suspect we’ll be busy to start 2015.

Answering Your Questions from the Chat

“What About Stop Losses?”

I was overjoyed that so many of you were able to join me for our live chat meeting on Monday. If you missed it or would like to see it again, you can watch it here. I especially love your questions. The more I hear from you, the better I can try to make Absolute Capital Return the best it can be and help us all have the best possible experience.

I would like to take the opportunity over the next few issues to get to some of the questions I received most often and didn’t get a chance to answer in the chat. Several of you asked about stop losses, so let me take a few moments to share my thoughts.

In the current environment, I am generally not using stop-loss orders in any of my services because while I am passionate about the end-to-end investment potential of every stock I recommend, the part in the middle will rarely be a smooth ride to the target. That’s especially true in a volatile market. We have seen stocks like Constant Contact (CTCT) and our additional UVXY position dip deep into the red before ending in the green, and now it looks like Finisar (FNSR) may follow in their footsteps after a sometimes harrowing ride.

Stop losses can make sense in certain situations, and if they allow you to sleep at night, I encourage you to use them. At the moment, I prefer to watch our stocks every day and decide in “real time” to sell rather than have an existing order in place. There are a few limitations to orders. Sometimes you don’t get the price you want if a stock gaps down at the open, and sometimes specialists can see sell orders lined up and move the price around a bit to clear the orders out and then the stock moves higher. And in this volatile market, bounces can be quick, so there’s always a risk you sell at the bottom.

So I watch every day, consider the overall environment, trading patterns of specific stocks, headlines, technical indicators and more to determine if it’s time to cut losses or if a bounce remains likely. When a trade becomes truly untenable, you’ll know it because that’s when I’ll send you a Trade Alert and recommend you sell.

“What Should I do with SC?”

I also received questions from some of you who were unable to sell Santander Consumer (SC) when unsubstantiated buyout rumors briefly pushed the share price above $21.50, and within about 20 minutes of the Trade Alert recommending you sell, the company issued a statement that caused the stock to come back down quickly. I understand the frustration for those of you who didn’t get a chance to sell, so let me give you an update on it now.

The short answer is that SC remains on my radar and you can definitely hang on until the stock makes good on the fleeting promise we saw last week. I suspect it won’t take long.

Sometimes the market opens up windows of opportunity that close very quickly. This was one of them. When I initially recommended SC as a buy, I was not expecting such a short exit window – this trade was structured as a way to get exposure to a more gradual recovery story ahead of Wall Street. I thought a month ago that SC could take until February to break above $20.30. For a few minutes last week, that scenario played out well in advance of what anyone expected.

Where do we go from here? The underlying logic has not changed, so you can feel comfortable holding SC if you still own it. In fact, it is now within about $0.40 of where we sold it, so it only needs a few more percentage points to get back to double digits. Today represented a serious challenge to the $19.81 resistance level, and I was encouraged to see the stock break above with conviction and volume in the last hour of trading. If SC can hold above that line, a run back to $20.30 seems extremely likely. At that point, you would be able to sell. I will continue to follow the stock and keep you in the loop.

Outlook: Holidays, New Year and Beyond

Before I share my thoughts on whether this week’s rally can continue for the remainder of 2014 and into next year, I would like to remind you that we are on a holiday-shortened schedule next week. Look for an early weekly update on Wednesday, when Wall Street shuts down at 1 p.m., and remember that trading is likely to be light when the market reopens on Friday. Stocks can definitely still move in lighter volume, so I’ll be watching and let you know if we need to take any action.

I would also like to thank those of you who attended Monday’s online chat and remind you all to mark January 13 on your calendar for the next one. Based on your response, it looks like you are getting a lot out of these events. I do, too, so I am eager to continue holding them.

As to the market, it seems likely the next few weeks will give us the Santa rally the almanac traders love to contemplate. Money is already rotating out of the richest areas of Wall Street into small-cap stocks, obscure industries and unfairly neglected stories like ours. As I mentioned earlier, we may see the year go out with a flurry of profitable activity, so please keep checking your email for Trade Alerts.

The underlying mood has certainly mellowed. The S&P 500 looked overbought and dangerously rich three weeks ago, but the intervening sell-off took the broad market to the edge of being oversold and then gave us a healthy bounce. Traders evidently realized that stocks had been beaten down to bargain prices, and the Fed provided the spark. Unless the fundamental storyline changes between now and earnings season, it looks like our near-term downside has been determined – and the upside remains open.

And the storyline has not changed since oil prices plummeted around Thanksgiving, when a lot of the big money was on the sidelines anyway. Growth in China has backed up a bit and fiscal conditions in the European Union remain a bit brittle. Both were drags on the market mood a month ago and neither situation has gotten appreciably worse.

Likewise, the U.S. economy continues to signal that it is healthier than it has been in years, with both GDP and the job market improving at robust enough rates to buoy corporate results and household budgets alike. That story hasn’t gone away. Now, after a relatively brief crisis of confidence, I think investors recognize this. While some macro moving parts have shifted, they again tend to support the bullish status quo narrative.

If anything, 20% cheaper gasoline than last year and the promise of even stronger fuel relief ahead may make this holiday season brighter than anyone expected. Retail inflation was already flat in October and negative in November. Weaker commodity markets give the Fed even more room to keep liquidity on the generous side.

The precipitous drop in petroleum prices has increased the pressure on countries like Russia, Iran and Venezuela, which relied on expensive exports to soothe political tensions and keep their own oil-dependent domestic systems running. These countries were largely isolated within the global economy a month ago, and Russia in particular has become increasingly estranged from the West over the past year. Recent developments only accelerate that process.

So in this context, when Fed Chair Janet Yellen reminded us all this week that the central bank will remain “patient” when it comes to tightening monetary policy next year, all that happened is that traders got a chance to take a deep breath and remember the reasons they bought their stocks to begin with.

Oil prices are still low but global demand has not gone over a cliff. Economic activity remains strong without looking anywhere near overheated. The Fed is more interested in protecting the market than punishing it. Stock prices have come a long way over the last year, but at a forward P/E under 16, the S&P 500 is at worst fully valued – it will take a bit more multiple expansion to become a bubble. Some stocks look richer than others and need to be sold. Others are still cheap and can support a little more upside before they catch up to their peers.

These are the closest things to eternal investment truths we have, and now that traders have heard the quiet, persistent voice of the Fed cutting through the noise, the fear and the gloom, it is clear that there was room for a little year-end rally after all. Best of all, our trades are outperforming and I am seeing more potential opportunities for us to continue our success in 2015.

Have a great weekend. I’ll be in touch with Trade Alerts as needed and again next Wednesday with the Weekly Update.

Sincerely,

Hilary Kramer
Editor, Absolute Capital Return Portfolio

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