Trader's Hedge: Approach Market With Caution

I hope all of you have a Valentine and already know what love is on a personal level. At 48, I am still searching but “can’t stop now, I’ve traveled so far, to change this lonely life.” And that is all the mush allowed in this article about stocks.

There is a good lesson to be shared here about investment. No good comes from expressing love when it comes to successful investing because, if you do, there will only be “heartache and pain.” Investors have to analyze and reanalyze the reason to be in or out of a position almost daily, and yet, never fall in love with the company. “This mountain I must climb” of not falling in love with any stock should be one of your top investing rules. The best advice I can give any investor is “gotta read between the lines” and leave love for your personal life.

I am more cautious on the overall market than I was last fall (October 9, 2012) when we began adding long positions to participate in the expected fall rally. January 2013 delivered several new highs on major indexes, and February has mostly been flat ahead of the March 1 deadline for sequestration. The bulls are clearly in charge of the market right now, but that is always subject to change without notice. The looming debate on sequestration could impact US GDP growth enough to make me cautious on that item alone. Of course, there are many other concerns to consider as well. Europe has presented some new printing opportunities for America and continues to be a concern on the global front. Suffice to say that the preponderance of evidence, which I refer to often, are tilted in the favor of caution right now, and therefore, I am recommending caution in the short term.

As always, we should now turn our attention to the DHTH portfolio and evaluate what to do with the portfolio. Cooper Tire and Rubber Co. (CTB) was added on October 9, 2012 and will quietly exit on February 15, 2013 with a +23.1% return. CTB did pretty much exactly what we hoped for when acquiring the stock at $19.13. Recall that we recommended acquiring ½ the desired shares and at the same time sell the Feb 13 $20 call and put (+$3.55). CTB is trading today at $26.05 so the ½ shares will be called away at $20 and the put will expire. We also picked up a $.10 dividend on November 29, 2012. I still like CTB and if the market corrects will continue to review for re-entry.

I would like to add a yield stock and a short hedge given my cautionary view on the overall market. I have recommended Seagate Technology (STX) twice in 2012. We took positions on January 27, 2012 (+14%) and June 6, 2012 (+26%) using stock and options. This time around, I prefer to simply buy to own STX for the yield and potential gains in price appreciation.

Seagate Technology designs, manufactures, markets, and sells hard disk drives for enterprise storage, client compute, and client non-compute market applications worldwide. The company’s products are used in enterprise servers, mainframes, and workstations; desktop and notebook computers; and digital video recorders, gaming consoles, personal data backup systems, portable external storage systems, and digital media systems. It also provides data storage services, including online backup, data protection, and recovery solutions for small and medium-sized businesses. Seagate is a leader in the hard drive industry.

Reason for Selection: STX can still be picked up for a great price with great earnings growth. STX is projected to grow EPS from $5.18 to $5.49 in 2013: 6% EPS growth all for 5 times earnings. And that growth is built on not only recent upward analyst projections but also on a 4.4% yearly dividend yield. As we have discussed before, the levered free cash flow for STX is $2.55B.

I believe it is prudent to add a short (hedge) position at this time. Avis Budget Group, Inc. (CAR) is one of the stocks that appears overbought to me at $24.30. CAR has nearly doubled since May 2012 with levered free cash flow of -$1.15B. The Sabrient Earnings Quality Rank on a 1-99 basis is 2! In layman terms this means that investors are paying 15x on earnings that have serious concerns about the sustainability and quality of the earnings being reported. Quite predictably, insiders have been lining up at the sale door in 2013 (CAR insider activity). CAR provided us the golden opportunity to open a short position today by announcing a narrowing of their loss, driving the stock up +5.38% today. This has set the stage for the perfect storm: CAR is overbought technically (using Wilder’s RSI 14), insiders are rushing to sell in mass, earnings quality and cash flow are very poor but someone is pushing the stock higher.

Again, I hope everyone knows what love is personally and has a wonderful Valentine’s Day. Remember not to fall in love with any investment or stock position. When it comes to stocks “Got to read between the lines, in case I need it when I’m older.” Trust me when I say that we will need the money when we’re older.

Recommendations:

Buy to open STX at the market

Sell to open CAR at the market

Allow CTB to expire and enjoy the gain