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The good news is options are still one of the best ways to gain outsized performance
in this coming trader’s market with low risk in a stagnant market that we
see ahead in 2009. We are really excited about the opportunities we expect
to see for making money by trading options in the New Year.
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Trade #1: The Obama
$1 Trillion Infrastructure SpendThis is certainly the most-telegraphed and anticipated trade idea for 2009. As a
result, it may carry some risk as expectations get ahead of the reality of enacting
massive new spending programs as tax receipts plummet. Generally, many infrastructure
companies have bounced significantly off their lows. We would look to take advantage
of pullbacks.In any event, the passage of new infrastructure programs should benefit a wide array
of companies including Caterpillar (),
Cummings (),
Fluor Corp. (),
Foster Wheeler ()
, Granite Construction (),
Walter Industries (),
International Business Machines Corp. (),
Cisco (),
etc. Our favorite infrastructure trade play is Shaw Group Inc. ().
SGR is an engineering, technology and construction company that serves the oil industry,
utilities and government agencies. Based on current expectations, the company is
trading at a 7 P/E on next year’s earnings estimate.Let Nick Atkeson and Andrew Houghton
show you how to double your money twice each month.
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Trade #2: Stay Away From Highly Leveraged Business Models
January is historically one of the three biggest credit issuance months during the
year. We are entering January 2009 with the credit markets in a state of disarray.
We will be watching credit issuance in January with a close eye as it may tell us
about the stock market action for much of the coming year.Companies that rely heavily on debt financing will have profits crowded out by interest
expense. Junk debt yields are now above 20%. With the cost of capital
greatly elevated, many business models may cease to be viable. Additionally,
highly levered companies are exposed to bankruptcy risk with relatively small negative
changes to their revenues.We already are aware of the troubles facing auto manufacturers, home builders and
the banking industry. Other industries that appear particularly exposed include
commercial real estate, gaming and traditional media/communications companies.
Before buying any equity or option on that equity, make sure you check the debt/equity
ratio and the schedule of when the debt rolls over.An example of a company in the crosshairs of the market downturn caught with too
much debt is Cracker Barrel Old Country Store Inc. ().
This consumer discretionary company has net long-term debt of about $36 per share
and is trading for about $19 per share. Not good.
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Trade #3: Buy Small Capitalization Stocks
Small cap stocks tend to be equity financed rather than debt financed. Although
this is not an attractive time to raise growth capital through equity (2008 had
the fewest number of initial public offerings since 1979), many of these companies
do not have meaningful levels of long-term debt.Maybe more importantly as we move toward the inflection point of bad to less bad,
investors typically buy small cap stocks to capture the highest sensitivity to an
economic recovery.Mebane Faber of Cambria Investments writes about the outperformance of small cap
stocks in the wake of “really bad years” in the market.He writes: “A simple system of holding the smallest 20% of stocks every January
since 1927 results in returns of around 10% a year (and that is without sitting
in cash the remaining 11 months of the year which would add an additional 3.5% per
annum to returns). That dwarfs the 1.5% return for the largest 10% of stocks in
January.""What about investing in small cap stocks in January following a terrible year
for stocks? In this case I examined all of the years back to 1927, took the 10 worst
years in stocks, and examined how small caps (bottom 20% by market cap) performed
the following January. The average performance for the S&P 500 the year prior
was -21.22%.The results? An astonishing average performance of 18.17% per January
with the worst year being a positive 2.2% (2003). Adding in cash returns the following
12 months and you have returns over 20%. The average performance of the large
caps (top 10%) in January of those years would have been a paltry 3.1%.”
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Trade #4: The Strong Will Get Stronger
Look to buy companies that will take share during the downturn. Examples may
include Toyota and Honda as the U.S. automakers sort through their troubles but
certainly emerge with less market share. Another example is the migration
of consumer electronics from stores like Best Buy ()
to Wal-Mart ()
and Costco ().
Google ()
appears to be taking share from a variety of competitors.Again, looking at the balance sheet will help determine who might take share.
Positive cash flow, no debt and a solid position in their respective industry is
a good starting point to find future winners.
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Trade #5: Buy the Basics
There are some industries that will be substantially less impacted by the “demand
destruction” occurring in this downturn than others. Many of these winners
are companies in sectors such as agriculture and chemicals.Two of our favorites are Dow Chemical ()
and Intrepid Potash ().
Although DOW does have some debt exposure, it is a blue chip company trading
at less than 10 times earnings with an 8% yield that appears rock solid.Intrepid Potash ()
is a potash mining company with operations in New Mexico and Utah. Potash
is a critical ingredient for fertilizer. In a world of crazy change, one constant
is that people will keep eating and farms will keep growing crops. The company also
has a price advantage as its transportation costs are below industry average.
In 2009, the company plans to increase production capacity by about 15%. The stock
is currently trading at about four times earnings per share. The potash mining
business has huge barriers to entry. To open a mine costs about $2.5 billion and
takes 5 to 7 years. In a world where credit is tightening, this company should be
free of new competition for the foreseeable future.Both the larger potash companies, The Mosaic Co. ()
and Potash Corp. of Saskatchewan (),
are also of interest.
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Trade #6: Real Estate Will Get Worse
We believe real estate values will continue to decline well into 2009. Although
November housing starts and permits are hitting all-time lows, there are still more
than 11 months of unsold home inventory on the market with demand running at ever
more depressed levels. Additionally, the foreclosure rates are not slowing
down.Although the residential market is likely to decline further, we would rather focus
on the commercial real estate market. Like lending patterns in residential
real estate, commercial lending became irresponsible in the same way but a few years
delayed. The impact of poor lending decisions and loan resets have yet to
be felt fully in the commercial market. Additionally, with companies reducing
the size of their operations and retailers closing stores, much of the highly levered
commercial property will go vacant raising serious negative cash flow issues for
its owners.iShares Trust DJ US Real Estate Index ETF is one way to gain broad exposure the
to the commercial real estate sector. ProShares offers double long and short
ETFs that key off of IYR for those who enjoy extreme volatility in their portfolios.
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Trade #7: Buy Inflation Adjusted Treasuries
Treasury Inflation-Protected Securities ()
are essentially Treasury bills that pay a fixed coupon, but adjusts the principal
annually according to the rise in the consumer price index (or CPI, which is a measure
of inflation). TIPS can be purchased directly or through the iShares TIPS Bond ETF
().If inflation is defined as "too much money chasing too few goods," we
may see some, as the government is required to print dollars as never before to
pay for the incredible debt burden that it has recently acquired. Remember, for
those in debt, inflation is good because debt is put on in today’s (or yesterday’s)
dollars and paid off in future dollars, which are worth less.Analysts estimate that the TIPS market is currently priced for deflation for at
least the next seven years. If inflation expectations of just 2% are re-priced back
into TIPS (where they were just two months ago), you could experience double-digit
capital appreciation in these securities over the next two years.
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Trade #8: Mid-Year Inflection Point
There is a strong possibility that in the middle of 2009, the equity market may
begin to anticipate a better 2010 and start to run. If this is the case, we
may want to switch from defense to offense and get long the more levered companies.
During the first half of 2009, expect to see many false starts where investors anticipate
the turn too early and suffer losses as a result. We saw this to some extent
in 2008 with the Russell 2000 Index ETF ()
outperforming the broader market by as much as 10 percentage points up through September.
Since September, it has pulled much closer to in-line with the rest of the market.
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Trade #9: A Potential Doubler Over the Next Six Months
Here is a great trading opportunity you can act on now.
Central European Media Enterprises ()
operates commercial television channels in Central and Eastern Europe in places
like Croatia, the Czech Republic, Romania, Slovenia and the Ukraine.The investment theme has been: As these countries thaw out from Russian control,
their television markets will look, feel and act more like the television market
in the United States. One of the problems the company faces, however, is $25 per
share of long-term debt. The stock is currently trading at about $21.70.With the Fed rate reduction today, option investors have purchased CETV July 40
Calls ()
more than 4,000 times. Not only is the volume unusually large (11-times usual volume),
these options would require that the stock appreciate about 100% during the next
six months to be in-the-money.The current ask price for these options is $1.80, so this trade appears to be more
than just a lottery ticket. Check it out.Good luck trading in 2009.
Let Nick Atkeson and Andrew Houghton
show you how to double your money twice each month.
