Straight Talk from the Fed

It was a somewhat surreal end to a week in which Wall Street was literally rattled by an earthquake, and then just a few days later found itself preparing for evacuations as Hurricane Irene marches up the East Coast.

Even with this unusual and potentially dangerous distraction, the market paused to listen to the much-anticipated speech from Federal Reserve Chairman Ben Bernanke, and the market seemed to be OK with what it heard. Stocks dropped sharply when the initial bulletins hit that he wasn’t announcing the start of more quantitative easing (QE), but the promise that it will be considered at the next Fed meeting in September (which he expanded from one day to two) was enough to pacify investors, and the market quickly bounced back.

I think investors like that the Fed is seriously considering more easing, and Bernanke again promised the central bank will do everything in its power to restore growth and increase employment. I think the market also liked that he admitted there is only so much the Fed can do, and that Congress and the administration must step up with additional economic policies to create growth and reduce the deficit. He warned that another ugly display of gridlock and partisan politics like we witnessed a month ago when the debt ceiling needed to be raised could hurt the economy, and I agree with him.

Bottom line: Bernanke didn’t really offer a whole lot new, besides being specific about QE discussions at the September meeting, but I think that was what the market was expecting after all of the speculation leading up to the speech.

There was also additional news this week that investors took in a mostly positive light. Some economic data indicated that, while growth is slow and a recession is not out of the question, it does not appear imminent. Even today’s news that U.S. GDP grew just 1% in the last quarter (revised down from 1.3% and a little worse than the expected 1.1%) had some positive nuggets – primarily that consumer demand was decent. The shortfall came on business inventories, which can be volatile and are easier to correct over time. The one exception was weekly jobless claims, which came in higher than expected. 

I also think Warren Buffett’s decision to make a $5 billion investment in Bank of America (BAC) is significant. I know some criticized the deal as being unfair to existing shareholders and as doing little to help the bank’s capital position, but if any investor’s actions carry weight, they are the Oracle of Omaha’s. At the very least, the move shows that Buffett does not believe the financial system is falling apart, and his influence could ease some of the short-selling we’ve seen in U.S. bank stocks.

Through it all, the S&P 500 gained nearly 5% for the week amid the still-heightened volatility. So far, support has held in the low 1100s, most recently around 1120, which we will continue to watch closely.

Next week could be a more characteristically quiet end to the summer season, but that’s by no means a given. Europe’s debt crisis remains a concern, and we will all be watching Hurricane Irene. First and foremost, we hope that everybody stays safe and that property damage is less than currently feared. We’ll keep an eye out for any potential impact on the market next week.

 

Updates on Our Trades

We were fairly active in our trading this week, using the market’s strength to book profits in our “invest in quality trades” in 3M calls and UTX, and taking the painful but necessary step of closing out losses in our call options that were badly damaged in the recent selling in MS, VLO, CMI and GOOG. Yesterday, we closed out the double-short gold ETF DZZ for a quick gain, and it did move lower when gold rose following Bernanke’s speech. Rumors in Europe are also moving gold prices, and I thought it best for us to take our profits.

In terms of new positions, we bought the GOOG Sept. $500 calls (@GOOG 110917C00500000) after closing out the $550s. As we’ve talked about, the acquisition of Motorola Mobility surprised everyone, but the reaction sure looks excessive. The $500 calls are in the money and are a higher-probability trade in the current market.

Earlier today, we opened a position in the GeoEye (GEOY) December $30 calls (@GEOY 111217C00030000). I really like the stock here in the low $30s, well below the intraday high of $42.31 just four weeks ago. The valuation is favorable and there is plenty of takeover speculation to drive the stock higher. We went with a December expiration in case we need a little time for this to play out, since it’s hard to pinpoint if or when an entire company will be sold.

In terms of our open trades, we are keeping some of our older call options on a short leash. The ABB Sept. $20 calls (@ABB 110917C00020000) were up slightly this week and are still in the money. Any positive news out of Europe would drive them higher, but if we don’t get movement soon, we’ll be closing them out. The COP Sept. $65 calls (@COP 110917C00065000) were also up marginally, and energy prices remaining firm should help COP. As with ABB, these options still have three weeks to expiration and the stock is just above their strike price. Again, we’ll look for a good opportunity to get out at higher prices

The ARIA November $9 calls (@ARIA 111119C00009000) were up more sharply and are now back in the money. We have two-and-a-half months to expiration on these, and positive news about the company’s promising pipeline of drugs would give the stock and the calls a nice boost.

As for our common stock positions, Pharmasset (VRUS) moved nicely this week and is challenging resistance at $130. The stock may have made another higher low this week, which would be a good sign.

Goldman Sachs (GS) was volatile but flat on the week. The stock shrugged off the news that CEO Lloyd Blankfein had hired a criminal defense lawyer in relation to his testimony in Congress this year. At this valuation, with the stock selling at less than tangible book value, the shares are becoming more resistant to such headline risks.

Sinclair Broadcasting (SBGI) finished up slightly. Gains weren’t spectacular, but they came after rising the previous week when the market was down, and the chart continues to suggest SBGI is building a nice base for an eventual rally.

Finally, American Apparel (APP) traded mostly sideways. However, there were reports that billionaire investor Ron Burkle was interested in helping the company refinance a portion of its $160 million debt load. He loves sexy businesses (so to speak) and distressed stories, so this investment would make sense for him. Burkle owns 3.1% of APP common stock, and a non-dilutive refinancing would be very bullish for the company.

I hope you have a great weekend. If you are on the East Coast, please be careful and stay safe. I’ll be in touch next week with more Trade Alerts.

Sincerely,

Hilary Kramer
Editor, High Octane Stocks