SepTaper or OcTaper? It really doesn’t matter from where I am sitting. Did yields get a tad ahead of themselves touching 3% on the 10 year a couple weeks ago? Maybe, but they are going back there to be sure, and the fact that 2 days after the Fed’s head-fake the 10 yr yield is only 2.76% tells me that market participants remain positioned for a re-test and the Fed to finally move their feet in the next month or two.
Make no mistake about it, this is a fairly dicey trading environment where some of the largest players in the investment universe had already reallocated tens, if not hundreds of billions of dollars over the last few months in anticipation of higher growth, higher yield environment. While I am by no means a macro trader, it is my sense that even if Fed does not Taper as soon as most investors expect, yields will likely stay put as it has to come at some point and that this past spring they way overshot to the downside.
From where I am sitting I am inclined to play single stocks stories and attempt to identify disconnects btwn, fundamentals, valuations, technicals and how the options market is pricing the situation.
JNJ is just the sort of name that has bugged me all year. Here is a company that by all accounts is executing well in a difficult macro environment, and the stock has been rewarded outpacing the SPX’s ytd gains by more than 8% (up 28.5% in 2013 vs SPX up 20.25%). In the early part of the year when rates were VERY low, investors were desperate in their search for yield and piled into 3% dividend payers like JNJ. But now with rates higher and not apparently budging to much, stocks like JNJ have come a bit out of favor. As the SPX made a new all time high on Wednesday, JNJ remains almost 5% off of its all time highs made in Aug.
The one year chart below of JNJ is forming the potentially troubling technical pattern called a head and shoulders top, with the stock just today rejected at the 50 day moving average, with a possible re-test of the $85 neckline in the offing. (For a more detailed look at the technical set up check out Enis Chart of the Day post from Aug 22nd here).
The stock’s PE, trading at almost 16x next years earnings that are expected to grow at only 7% (for the next 3 years) on sales that are only expected to grow at low single digits seems a tad expensive and approaching the highs of the last 5 years (below). While valuation has not been a great reason to short stocks in this bull market, investors may start to get a tad more choosy in the next leg of the rally (if there is one) and rotate into more cyclical laggards trading at discount to the market rather that at or above a market multiple.
The last input I wan to look at with JNJ is implied volatility (blue line below), which while elevated from early 2013 levels, it remains at 6 month lows, slightly below realized vol (white line).
I wan to look at October expiration as it will catch the company’s Q3 earnings and will also likely catch a good bit of the upcoming budget debate, or at least the part leading up to a potential Govt shutdown that could add to market volatility and keep these short dated options bid.
I want to take a near term bearish view on JNJ that a potential combination of any of the following over the next month: earnings disappointment, technical breakdown, rotation out of quasi bond proxies, or a broad market sell off could cause increased volatility (downward) in JNJ shares.
TRADE: JNJ ($90) Bought Oct 90 Puts for 1.35
Break-Even on Oct Expiration:
Profits: Below 88.65
Losses: btwn 88.65 and 90 lose up to 1.35, above 90 lose full 1.35
Trade Rationale: Broad market moves are going to be tough to catch in this very unpredictable market, a market that seems to be trading on almost everything other fundamentals. Despite JNJ performing well in difficult environment the shares reflect that and given the relative cheapness of options, risking less than 1.5% over the next month, with earnings a couple day before expiration, should keep these options well bid and the trade in the game.