Investing: March 2010 Archives

After the passage of health care legislation by the House last night, we speculated that traders would dump health care stocks in a panic and we would have the opportunity to buy them on the dip.  We cited money managers such as BlackRock's Bob Doll who said that health care stocks were cheap.  We expected that the sentiment of people like republican congressman Paul Broun from Georgia, who said that health care reform would "destroy America," would be the prevailing one among traders.

We were wrong -- completely and utterly wrong.

As the headline in the Wall Street Journal said, health care ETFs gained on the passage of the reform bill.  Apparently, investors like Doll weren't the only ones who felt that while there would be pressure on margins, the addition of 32 million additional customers will yield higher profits.  ETFs focusing on pharmaceutical stocks were up, with gains among major ETFs in this sector ranging from 1.4 to 1.8 percent on the day.  And biotech ETFs also gained, although the gains were smaller.  Those were up by around 0.8 percent.  Hospitals, who will gain because they will see fewer patients who do not have insurance, increased by 1.6 percent.

The only segment of the health insurance industry that didn't participate in the gains was the insurance industry.  These stocks were down by about 0.1 percent.  Here, investors are concerned that while they will get more customers, these customers will not be the kinds of clients they want.  Also, their ability to shed unprofitable customers will be lost and that is a concern as well.

Still, though, traders agreed that health care stocks will for the most part benefit from the reforms that passed yesterday.  And their initial reaction casts a lot of doubt on the contention of those who claim it will destroy America.

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The conventional wisdom is that health care reform passing Congress would be bad news for stocks in the health care sector.  Drug companies, health insurance companies, and other medical services providers would get hurt by health care reform, according to the conventional wisdom.  But as we have demonstrated before, the conventional wisdom may be conventional, but it's not always wise.

The rationale behind the "sell health care stocks if health care reform passes" is simple.  The people who think this way believe that health care reform will destroy profits for companies in the health care field.  Gone will be the 39 percent increases in rates by companies like Anthem Blue Cross, a subsidiary of Wellpoint.  The prohibition on the government using its bulk buying power to negotiate better deals on drugs from pharmaceutical companies like Pfizer will also be gone.

So, naturally, the conventional wisdom is that stock prices will fall and companies like Wellpoint and Pfizer will be doomed.

What this analysis fails to consider is that while these companies will give up some pricing power, they also will get access to 32 million more customers.  According to its website, UnitedHealthGroup has 70 million customers.  So, the number of people who will need -- by law -- insurance will increase tremendously.  Getting access to these people is well worth, in our view, the downside.  So Wellpoint will no longer be able to increase premiums by 40 percent, a huge mistake from a public relations perspective and a way to lose customers.  They'll benefit by having access to a huge new client base.

So will drug manufacturers.  Right now, without insurance, many people simply can't afford the drugs they could use to improve their health.  Margins will be cut somewhat, as bulk prices are negotiated.  But getting access to 32 million more people who can use your product will make up for that.

That is the thinking behind the very successful investor who leads BlackRock, Bob Doll.  The passage of health care legislation would remove uncertainty and expand coverage, Doll said.  He added "there could be some outperformance coming" and called many health care companies "very cheap relative to the overall market."  Health care companies, Doll said, will benefit from the aging population in the United States as well as increases in the number of people with insurance.

"The country will spend more money on health care, and that's a good thing for the revenues of these companies.  We are aging as a population and trying to increase our standard of living, and a recipe for that is more money for health care," Doll said. 

Instead of panicking like many will do if the health care reform legislation that's up for a vote does pass, smart investors should take a cue from people like Doll.  Increasing revenues due to an aging population as well as higher coverage levels are a winner for the health care sector.  They will have to give up some pricing power in order to get access to more customers, but that often happens anyway as large buyers of services always get a discount.

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A sure sign that the markets are recovering is our portfolio.  So far this year, all of the major indices are up, and that means that naturally, our portfolio has grown in size as well.  Many people would look at that as proof that the markets are trending up, and it's definitely that.

But the big sign that things are recovering is our options positions.  As you know, we sell covered calls in order to increase our returns.  We sell out of the money options, expecting that they'll expire worthless.  And the odds are in our favor.  After all, around two thirds of all options expire worthless.

What then, does it tell us when many of the covered calls we sold are in the money?  And it's not just in one sector.  It's in several.  And keep in mind that we sold these options less than a month ago!

For Intel, which we purchased after it reported blowout earnings, increased its revenue, and boosted its margins yet dropped, we sold the March $21 call.  The stock was trading at around $20.75 at the time, so we figured that we might get our stock called away, but the odds were good that we might lose a quarter or so in the worst case.  Well, as things developed, that view was wrong.  Intel stock closed at $22.24 yesterday, so it's very likely we'll have our position called away.  Still, we'll gain about five percent on our investment in a couple of months.  That's a return we'll take.

We'll try to retain our position in Intel, however, by possibly selling a April call at a higher strike price and using the proceeds to close our options position.  That may not work, but it's something we'll try to do.

AT&T is something that we purchased in order to collect dividends and increase our returns by selling calls.  Again, we sold out of the money calls, and less than one month later, we'll be looking at that position going away.  We'll take it, though, because we'll get more than the dividend and capital gains we expected for a year in a month.  AT&T, as you'll recall, is part of our do it yourself income fund.

Finally, Ford, which we said we'd take out for a test drive back in November, has been a big winner for us.  We bought the stock before we wrote about it, and our effective price was around $7.75.  When we wrote about Ford, it was trading at around $8.25 a share.  Yesterday, it closed at $14.10.  That means our call options for the stock, which we sold at $13 and $14, are likely to be called away.  Keep in mind we sold these about a month ago.  At the time, the stock was trading at $11.21 a share.  That means the stock has appreciated by 25.8 percent in less than a month!

Unfortunately, we are going to leave some money on the table after our positions are called away.  We may buy back our options in some cases, but since we tend to be fully invested, that may not be possible.  If that's the case, we'll find new positions to stake out.  When you get a stock that pops by five, ten, 20, or even 25 percent in a month, you likely will leave some money on the table if you sell options.  But that's not something that's likely to happen so selling covered calls will be a strategy we intend to continue using.

As you know, one of the tools we use to increase gains beyond a passive buy and hold strategy is the technique called buying dividends.  Here, we buy a stock that's about to go ex-dividend and hold it long enough to get that dividend.  We then goose our returns a little more by selling covered calls against that stock.

This week, a company called Vector Group is going to go ex-dividend.  The stock, which is trading at around $15.50, will pay out a dividend of $0.40.  The ex-date is March 17, 2010, which is Wednesday.  That will give us a yield of 2.6 percent.

We will add to our returns by selling a April $20 call, which is trading at $0.20.  That will give us an additional 1.3 percent on our trade.  Our total return will be 3.9 percent, and we'll hold the position for about five weeks.

That works out to an annualized return of 40.3 percent, which we will gladly take.

By taking a well known technique -- buying dividends -- and adding a twist to it, we enable ourselves to increase our returns beyond what can be typically expected.  With most analysts predicting muted investing returns for the next decade or so, this is critical.

The week that closes on Friday has been light on economic data, and the final three reports will all be out by 10:00 AM.  The reaction to this data will determine whether or not equities can continue the rally which has brought the S&P 500 to its highest level since October 2008.  On Thursday, the S&P 500 climbed by 0.4 percent to 1,150.  The Dow was up by 0.4 percent as well, rallying to 10,612.  And the Nasdaq climbed by the same 0.4 percent to 2,368.

In order for that rally to continue, it's likely that data on retail sales, consumer sentiment, and business inventories will have to meet or exceed expectations.  Data that disappoints is likely to end the three day winning streak for stocks.

First up is retail sales, with the report on February's retail sales coming out at 8:30 AM.  As you know, consumer spending is two thirds of the economy, and retail sales account for a large portion of consumer spending.  In January, consumer spending was up by 0.5 percent, and spending excluding the volatile auto sector was up by 0.6 percent.  Analysts expect things to be much more subdued this month, with the consensus estimate according to Econoday expecting a drop of 0.2 percent in retail sales.  Excluding autos, the consensus estimate is expected to be flat.  Estimates range from -0.8 percent to 0.3 percent for the retail sales figure and -0.6 percent to 0.5 percent for the figure excluding autos.

Expect retailers to rally on data that beats expectations, and expect them to fall if the numbers come in below expectations.  One potential way to trade this report is to use the S&P 500 Retail SPDR, which has the symbol XRT.  If you're an investor with a longer term outlook and retailers drop, you can buy on a dip.  Only do this, however, if you feel that retailers will recover during the time period where you're willing to hold the investment.

Up next, at 9:55 AM, will come the University of Michigan's Consumer Sentiment Index.  This fell in February, dropping by 0.8 points to 73.6.  The consensus estimate is for the index to climb to 74.0, with estimates ranging from 72.0 to 75.0.  This index will give traders more information on what the consumer is thinking.  Coming only an hour and a half after retail sales data, the consumer sentiment index could either confirm the retail sales number or it could make the picture more cloudy.

Finally, just five minutes after the consumer sentiment index is released, we'll get data on business inventories.  As you know, much of the boost in GDP last quarter was due to the increase in inventories.  Inventories tend to rise during good economic times and fall during difficult ones, as companies see less demand for their products and keep less stock on hand.  Increasing inventories is a sign that businesses are more optimistic about future conditions and feel that their customers will buy more of their products.

The consensus estimate is for inventories to increase by 0.2 percent, with estimates ranging from no change in inventories to an increase of 0.6 percent.  The last report showed that inventories slipped by 0.2 percent in December, which surprised traders and served as a warning that businesses were not as optimistic about economic conditions as some thought.

On a week where the amount of economic data released was relatively low, the week closes out strong with three important releases.  The retail sales and consumer sentiment index will give investors clues on what's happening now in the economy.  And the inventory data will provide clues on what might happen next.

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One of the pillars of conventional wisdom when it comes to sports is that spending more equals more wins.  If that were the case, then the New York Yankees, also known as the Yankee$, would have a lot more than two World Series rings in the past decade.  So obviously, there is more to it than spending a lot of money.  One of the reasons that this doesn't work as well now is that it is usually the older players who command the most money.  They are the ones with the track records and histories to justify the big salaries.  But they often are the ones who have past their primes, and who won't deliver as much as they have due to their skills declining as they age.

But that's baseball.  The NFL has a hard salary cap, and it has a floor.  So, the question is, in a more level playing field, does spending money equal success on the field?

Surprisingly, the answer is no.  The top five spending teams in the NFL and their payrolls are:

• New York Giants, $138.4 million
• Houston Texans, $128.3 million
• Miami Dolphins, $126.9 million
• New Orleans Saints, $121.6 million
• Chicago Bears, $120.7 million

Of these teams, only the Super Bowl winning Saints made the playoffs.

The bottom five teams as far as payrolls go are:

• Kansas City Chiefs, $81.8 million
• Tampa Bay Buccaneers, $84.6 million
• Seattle Seahawks, $89.1 million
• Dallas Cowboys, $90.3 million
• Cincinnati Bengals, $93.8 million

On this list were the division winning Cowboys and Bengals.

So it's clear that in a more level playing field, spending does not equal winning.

That brings us to another question.  Which team gets the most bang for its buck?  In order to determine this, what we did is break down the cost per win among NFL teams.  The leaders here are:

• Indianapolis Colts, $7.4 million per win
• San Diego Chargers, $7.5 million per win
• Dallas Cowboys, $8.2 million per win
• Minnesota Vikings, $8.3 million per win
• New Orleans Saints, $9.4 million per win

Now we're seeing a pattern here.  The teams that spent their money wisely, and who spent the least per win all made the playoffs.

On the other hand, the teams that squandered their money and paid the most per win?  Not a playoff team among them.  They are:

• St. Louis Rams, $99.7 million per win
• Detroit Lions, $50.0 million per win
• Tampa Bay Buccaneers, $28.2 million per win
• Washington Redskins, $25.0 million per win
• Oakland Raiders, $22.3 million per win

The key to winning in the NFL appears to be spending wisely.  This is likely due to the salary cap and floor.  General managers in the NFL have to balance their needs with the cost of filling those needs.  And everyone has a budget.  It's not like MLB, where teams like the Red Sox and Yankees can just outspend teams like the Twins and Devil Rays.

Want a league where everyone has a shot at winning?  Implement a hard cap like the NFL has, and make general managers spend their money wisely.  That will put a premium on intelligent decisions on players, and it will help alleviate competitive imbalances that exist in MLB.

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Many people have criticized hedge funds and private equity funds for profiting from the big run up in various equities during the time when the bubble was inflating while buying credit default swaps to profit when the bubble burst.  While that may be the case, sometimes, investors have a chance to trade a hedge fund stock to profit.

That is the case with Blackstone Group.  The company will pay a dividend of $0.30 soon, with the ex-dividend date falling on March 11, 2010.  As you know, that means investors need to hold the shares by the day before the ex-dividend date in order to receive the dividend.

The stock is trading at a shade under $15 right now, and it is yielding 8.1 percent.  That means that if you buy the stock and hold it until the ex-dividend date, you will receive income of a little more than two percent.  You'll receive that income for holding the stock for just four days, and you can profit more from any capital gains that occur.  Or, if the share price goes down -- and the shares fluctuated by $0.48 on Friday so that's possible -- you just hold on until you break even.  Even if that takes a month, you earn a little more than 24 percent on an annualized basis on your trade.

To boost your earnings, you can sell call options.  The $15 March call for Blackstone is trading for $0.19, which means you book that additional income and goose your returns even more.  That will increase your earnings to 3.3 percent, and you'll receive that for holding on to your shares for two weeks until the options expire.  That's an annualized return of 85 percent, something you should be happy to take.

Many people hate hedge funds, saying that they make money unfairly and don't play by the same rules small investors do.  While that may be true, sometimes, you can play the same game as they do, and profit from it.

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Investors looking at economic data for signs that the economy is improving received some today.  The ADP national employment survey for February showed that 20,000 jobs were lost in the private sector, which was the smallest decline in private sector payrolls since they started shrinking in February 2008.  ADP reported that private sector service jobs increased by 17,000, which was the second monthly increase in a row.  However, as in the previous month, this increase in service sector jobs was not enough to overcome the loss of jobs in the goods producing sector.  This segment of the economy suffered a loss of 37,000.  Even there, though, there was good news, as manufacturing added 3,000 jobs.  This was the first increase in manufacturing jobs since January 2008.

Both large and small businesses cut their payrolls.  Large businesses, with more than 500 workers, slashed 10,000 jobs.  Small businesses, defined as those with less than 50 workers, cut 18,000 employees from their payrolls.  However, medium businesses, which are those with between 50 and 499 workers, added 8,000 employees.  This was the first increase in payrolls among medium sized employers since January 2008.

While companies continue to be hesitant to add employees due to the slow pace of recovery in the economy, the ADP report is a sign that the jobs market is improving.  The chairman of Macroeconomic Advisers, which produces the report with ADP, said "this report really is pretty encouraging."  He added that he expects payrolls to start to show growth in the next month or two.  And an economist with Stone & McCarthy Research said the data shows "the labor market is very much on the mend."

The Institute for Supply Management's non-manufacturing index (NMI) was also positive, coming in at 53.  That was 2.5 percentage points higher than January's 50.5.  Figures above 50 indicate growth.  The index was higher than the consensus estimate of 51.  Estimates for the NMI ranged from 48.5 to 52.9.  Slightly more than half of the sectors in the survey showed improvement, with nine indicating growth, and eight indicating contraction.

The chief economist at Woodley Park Research said that the index indicates "a broadening of the economic recovery."  He added the data "are encouraging, to say the least."

Finally, the Fed's Beige Book, which sums up economic conditions in each of the Fed's 12 districts, showed growth in the economy as well.  According to the Fed, "economic conditions continued to expand...but in most cases, the increases were modest."  There were nine districts that reported gains.  In the Atlanta and St. Louis districts, economic conditions were described as "mixed."  And in the Richmond district, which was pounded with two huge snowstorms, reported that economic conditions "slackened or remained soft across most sectors."

A former Fed researcher who is now an economist at JPMorgan Chase said that the report increases the chance that the Fed will reiterate its intent to keep interest rates low for "an extended period."  While the report indicated that the economy is showing growth, the growth "was described in pretty restrained terms."

The response of traders to this data was restrained.  The major indices didn't move much today.  The Dow dropped by 0.1 percent, falling to 10,397.  The S&P 500 was essentially flat as was the Nasdaq.  The S&P 500 ended the day at 1,119 and the Nasdaq closed at 2,281.

The reaction of traders may hve been the right one, as the data shows more of the same conditions we've seen so far in this economic recovery.  While the economy is growing, it's not a smooth recovery, and it's certainly not a strong one.  And jobs, like in past economic cycles, are going to be slow to recover.  However, with consumer credit constrained, without jobs recovering, consumption can't.  And that means the economy is likely to grow slowly.

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Those of you who have been regular readers may recall that one of our trades that didn't work out was our trade for Novatel Wireless.  While Novatel had a new product, the MiFi, which was a big hit, lower than expected sales of the product caused the stock tp plunge.  We said we'd hold on to our position, however, because we believed the product would eventually pay off and we'd be rewarded.

We still think there's a lot of gain to be made in Novatel, but we're going to close our position in that stock in order to make some money in the meantime.

Frontier Communications is a telecommunications company that's headquartered in Stamford, Connecticut.  It's got the normal telecom offerings, such as a combination of television, internet, and phone service.

And it's also got a fat dividend.  The yield on the stock is 12.8 percent.

Frontier isn't a company that we'd invest in, but it's a company we're more than happy to trade.  The company goes ex-dividend on March 5, so that means we need to hold shares of the stock by no later than March 4.  We expect the stock to trade up on that day, as people seek to get the dividend.

So we closed out our position in Novatel and we'll use the proceeds to buy Frontier.  The stock closed at $7.66 on March 2.  The dividend will be $0.25, so just collecting the dividend would give us a 3.3 yield in a few days.  But we'll goose our returns by selling a $5 call that expires on March 19, 2010.  That option is trading for $2.60.  So that means we'll get a total return on our trade of $2.85 on a stock that goes for $7.66.  That's a gain of 37.2 percent in 15 days, for an annualized return of 905 percent.

These trading opportunites are very rare, and they need to be taken advantage of when we find them.  So we'll close our position in Novatel, and move into this position.  We will use the proceeds to make up for some of our losses in Novatel.

The problem too many people make when investing is that they fail to act on opportunities like this one.  They are not easy to find but they are definitely worth looking for.

In a report that the International Council of Shopping Centers and Goldman Sachs said not to read too much into, same store sales dropped by 0.8 percent in the week of February 27.  In a year to year comparison, this figure increased by 0.7 percent.  Highlighting the way that data can fluctuate in the month of February for retailers, the ICSC is still calling for two percent growth for the full month of February.  Another thing to keep in mind is that much of the Northeast was slammed by a big snowstorm last week, which obviously kept shoppers out of stores.

Still, even if the ICSC figures -- which measure weekly sales at major chain retailers -- do show that projected two percent increase, it still shows that the consumer isn't really opening up his wallet.  Spending in the early part of 2009, which came right on the heels of the near collapse of the financial system, was hardly robust.  And a gain of two percent off those low figures is not something to get excited about.

While one week's data shouldn't be used to extrapolate too far, when combined with the drop in consumer confidence, housing sales, and increase in jobless claims we saw last week, it's clear that of anemic retail sales is still in place.

That should get investors to think about whether they should take profits on retailers who have had big run ups.  Most investors who put their money into the stocks of retailers in the past year or two have big gains.  It may be time to take those gains or at the very least, use options to protect against losses.

We will get more economic data today, with auto sales being reported.  It will be interesting to see whether Toyota's competitors can take advantage of its problems to gain market share.