Monday, October 10, 2011

4 Keys for Investors to Profit During this Earnings Season

Stocks have been in a deep slump since July 22. Is it a coincidence that earnings season for most companies in the S&P 500 was winding down during this time? As corporate commentary grew quieter, there were fewer fresh positive data points coming to help offset the building global gloom.

As a quick recap, corporate profits remain exceptionally strong, yet the broader macro environment, led by crises in Washington D.C. and Europe, has been brutal. Will this coming earnings season, which kicks off on Monday, Oct. 10, bring the spotlight back into a more positive focus? There are solid reasons for optimism and pessimism. Simply put, continued solid quarterly results, paired with correspondingly bright forward outlooks, can no longer be taken for granted in this shaky global economy. Here are four themes you need to closely monitor before making any further buy or sell decisions.

1. Big vs. small; U.S. vs. global

Even as blue-chips stocks have slumped, small caps have had an even rougher time these past few months. In the past three months, the S&P 500 has slid about 15%, while the Russell 2000 Index, a proxy for small caps, has slid more than 20%. Many small-cap stocks are off 30% or even 40% since the July market rout began.

But this trend may soon reverse itself, so the safe haven provided by large-cap stocks my not prove quite as safe. The S&P 500 is reflective of global economic activity, because blue chips, on an aggregate basis, now derive more than third of sales and profits from foreign markets. This could prove especially troublesome for companies with have a high degree of exposure to Europe, such as Procter & Gamble (NYSE: PG), Coca-Cola (NYSE: KO) and Microsoft (Nasdaq: MSFT). The major European economies appear to be slipping into recession, while the U.S. dollar has rallied against the euro. Taken together, these factors are likely to dampen foreign-sourced profits for many blue chips.

In contrast, smaller companies tend to have much less foreign exposure. Sure, the U.S. economy has been tepid, but recent data points -- such as the Institute of Supply Management (ISM's) manufacturing and service surveys -- have been a little better than many had expected. In addition, the United States still looks better positioned than Europe in terms of a possible slip into recession.

As earnings season kicks off, pay close attention to what companies are saying about their foreign operations. If Europe is really delivering a blow, then you'll need to quickly assess your holdings to identify potential European exposure -- you may not want to wait until your holdings come out with a dismal quarterly report.

2. Watch the balance sheets

One of the biggest concerns in an economic slowdown is rising inventories and rising accounts receivable. Companies need to plan ahead and build inventory in anticipation of future demand, and if inventories sharply spike quarter-to-quarter as a result of an unexpected slowdown in sales, then chances are profit-sapping markdowns are coming to move the goods. This typically applies to retailers, but may also be a concern for industrial firms like Caterpillar (NYSE: CAT) and Honeywell (NYSE: HON).

In a similar vein, rising accounts receivable as a percentage of quarterly sales can be a huge red flag. This would be an early warning sign that some delinquent customers simply can't pay their bills, and those sales will need to eventually be written off. Companies rarely discuss their balance sheets in quarterly press releases, so you'll have to listen to the conference calls to hear the real truth about what is happening with these key balance sheet metrics.

3. All eyes on the banks
For much of the summer, bank stocks have been taking a beating. Investors have grown concerned that banks such as Citigroup (NYSE: C), Morgan Stanley (NYSE: MS) and JP Morgan (NYSE: JPM) have a significant exposure to the Greek economy, and if the country defaults on its external debt, then U.S. banks will need to take significant write-downs. In response, industry executives such as Citigroup's Vikram Pandit have issued vague statements that exposure to Europe in general -- and Greece in particular -- is a lot less than many fear.

The banks will need to do better. If their stocks are to trade back up to book value, then investors will need to be provided with a lot more detail about how any European write-downs may influence book value. On the coming conference calls, listen closely for a discussion of Europe. If exposure is as limited as these banks have been saying, then a powerful sector rally could ensue.

More broadly, the market simply can't sustain any sort of broader rally unless bank stocks are participating. A flailing bank sector is a serious symbolic headwind for investors who fret about the broader health of the U.S. and global economies. So you'll need to see an "all-clear" from the banks before aggressively buying other sectors you may have been eyeing.

4. "It's (still) the economy, stupid"
No matter how good corporate earnings -- and outlooks -- may prove to be, the economy still needs to do its part. Friday's jobs report (Oct. 7), where 103,000 jobs were created (137,000 when shrinkage in government employment is backed out) was surely a positive data point. Last week also saw decent readings from the ISM's monthly surveys of the manufacturing and service sectors. As along as these types of reports don't deteriorate and spook the markets, earnings results -- and outlooks -- can set the tone for the market in October and into the winter.

Action to Take --> A key reason for the market's deep slump these past weeks is a lack of any positive catalysts. Many stocks are now quite cheap and this week's positive trading sessions highlight the fact that bottom-fishers are starting to wade back in. For the rest of the crowd, a still-robust profit outlook from corporate America may be the catalyst to get stocks moving.

Fund Blamed For Gold Sell Off, Salida Capital, Tumbles 37% In September, 49% YTD

Last week, a fund rumored to be on deathwatch, was Toronto-based, gold and energy-focused hedge fund Salida Capital (whose gold exposure, in addition to Paulson's, were both factors in the rapid drop in the price of gold last week, following concerns that it was being liquidated in the open market - for more on Salida's gold exposure, read the attached letter). The fund promptly came out and refuted said rumors, however upon review of its monthly P&L, we are somewhat skeptical about its survival chances, even if, in principle, we agree with the fund's investment philosophy. The reason for our skepticism is that Salida was down a whopping 37.2% in September, and 49.4% YTD, a collapse which only compares to that of Paulson's Advantage Plus, and demonstrates vividly just how much of a misnomer the name "hedge" can be when applied to members of the asset management industry. What is worse, however, is that the reason attributed for this epic collapse is amateur hour 101, and any LPs should be far more concerned by the explanation provided for this underperformance than the actual underperformance itself.

Salida says: "September was an extremely difficult month for the Salida Strategic Growth Fund, which fell 37.17% in the month and 49.44% year-to-date. On the back of August's market selloff, we felt that our core gold, energy, and other resource names were trading at very attractive levels, particularly in light of prevailing commodity prices. We further felt that the Fed was moving ever closer to a QE3 announcement, and even more importantly, U.S. money supply had been growing extremely strongly through the summer months even without a QE program. U.S. money supply growth in recent years has proven to be very reliable leading indicator of risk asset markets. So far, however, it appears that this newly printed money has this time flooded into U.S. treasuries offering record low yields." In other words, it's all M2's fault. The problem with this simplistic observation is that as we pointed out two months ago, the move in M2 has nothing to do with the Fed, and everything to do with asset reallocation, when investors scrambled out of equities and into the "safety" of their bank accounts. Furthermore, the unwind of Regulation Q was also a main driver for this surge in the broad monetary aggregate. Alas, Salida made the most fundamental rookie mistake in finance and assumed correlation to be causation (as did Art Cashin, Dennis Gartman and Andy Lees) of Fed stimulus. The irony is, as we said, that we agree with Salida's underlying premise: "With an election year looming, a sputtering economy, and a Fed Chairman who has in the past touted the ability of unconventional monetary policy to cure such economic woes, we believe the [QE3 Large Scale Asset Purchases] announcement will come." Alas, the question is when. And as Salida just found out the very hard way, in finance you may be 100% right eventually, but if your timing is off, well, as Salida itself says, "True money–printing QE3 will come — timing is the question." In that, at least, they are 100% correct.

As for the reason why gold sold off so precipitously two weeks ago, a lot of it has to do with feedback loop concerns that Salida (as well as Paulson and other long-heavy funds) may be liquidating. From the fund's letter:

On the back of this surge in money supply, we made two mid–August investment calls:

1. We continued boosting our exposure to gold, believing it to be a relative safe haven, and that it would continue to attract inflows as QE3 speculation grew in the face of a renewed U.S. recession. While bullion performed well in 2011 through August, it was hit hard in September, falling a dramatic US$200/oz in only a 3–day span. Margin hikes by the CME and the Shanghai Gold Exchange, disappointment from the Fed, and rumours of redemption/margin call–driven fund liquidations and European central bank selling took their toll. These factors tend to be temporary in nature. In fact, with much of the developed world now in or close to recession, European sovereign debt concerns intensifying, and Chinese growth appearing to slow, the fundamental backdrop for gold has rarely been more compelling. A bet on bullion is a bet that central banks are about to ramp up money printing — a logical bet in our view. In fact, we feel safer in gold than anywhere else in today’s market.

2. We felt that a money growth–fuelled market rally would provide a good bounce to beaten–up energy stocks given the relative resilience of the oil price. Not only did the bounce not occur, but the sector has continued to sell off. Sell off is an understatement — it’s been decimated, with the WCAT ETF (a basket of mid–cap energy stocks) falling almost 40% over August and September alone. Our impression is that the sell–off is at least partially driven by forced fund liquidations (i.e. selling to meet margin calls or redemptions). While these factors tend to be temporary in nature and unsupported by fundamentals, we admittedly have less confidence in the short term outlook for the price of oil than we do in gold. It’s not $80 WTI (or $100 Brent) that has investors spooked — it’s the potential for oil to head lower in the near term. And with recessionary conditions spreading, we can’t totally dismiss such a scenario. Accordingly, we’ve now raised our level of hedging in both the energy sector and the broad market.

These two calls have been costly, as the market has moved against us. We still believe that the reasoning was logical, but arguably ill–timed. In hindsight, we underestimated the short term impact of forced selling.

Considering that the letter was written October 3, it is probably safe to assume that Salida was not the source of gold liquidation. At least not yet. (more)

This Bullish Engulfing Candle Says Buy This Coal MLP: NRP

Relieved traders surely noticed the sharp rally in the S&P 500 this week. The rally occurred just when it seemed the overall market was headed much lower because of a break of support at the key 1100 to 1120 zone in the S&P.

What is less known is this formation was termed by Richard Wycoff, a famous technical analyst and teacher, as a "spring" formation. A spring occurs when a stock breaks a key horizontal support level and then quickly rallies back into the support zone. The spring is often the springboard to a rally that lasts several weeks and takes prices much higher.

In conjunction with the bullish action in the overall market, many individual stocks showed impressive turnarounds. One I'm particularly attracted to is master-limited partnership (MLP) coal producer and marketer, National Resource Partners (NYSE: NRP).

In the chart below, you'll notice NRP weekly bullish engulfing candle (the large white body wraps around or engulfs the previous red body). This candle is often a technical signal of an important reversal in trend. While I want to trade cautiously in this very volatile market, this may be an opportunity to buy NRP, a company with extremely solid fundamentals, trading at bargain basement prices.

As the fifth-largest owner and leaser of coal reserves in the United States, NRP controls more than 2 billion tons of coal reserves in 11 U.S. states.

The company leases its reserves in exchange for royalty payments. Because the company leases rather than operates its properties, it has limited operating expenses. As a result, it sports a robust current annual yield of about 8.4%. This yield should support the share price even if you don't stick around long enough to collect many dividend payments.

Metallurgical coal (met coal) accounts for about 33% of NRP's production and nearly 40% of its coal royalty revenues. In fact, 25% of all met coal in the United States comes from NRP properties. Metallurgical coal is used in steel-making. The company also has thermal coal reserves, used to generate electricity.

Chairman and CEO of Peabody Energy, Gregory Boyce, believes we are "in the early stages of a long-term super cycle for coal." In the past decade, coal was one the world's fastest-growing fuel sources. With Asian nations building coal-fired power plants, this trend should continue. What it means in the near-term, is that there should be support for coal prices.

Furthermore, recent merger and acquisition (M&A) activity among coal companies -- such as the joint bid between ArcelorMittal (NYSE: MT) and Peabody Energy (NYSE: BTU) for Australian coal producer Macarthur Coal, as well as the buyout offer for Walter Energy (NYSE: WLT) -- creates a bullish undertone for coal shares.

From a technical perspective, NRP shares currently appear to be near an attractive entry point.

The stock is down roughly more than 20% from its July 2011 high of $34.43, but appears to be on the cusp of breaking its intermediate-term downtrend line, formed off the July high.

For much of 2010, shares were on a strong uptrend, rising from a low of $16.48 in May 2010 to a high of $35.56 by March 2011.

Encountering strong resistance in a zone around $34-$36, shares gradually dropped to support near $23. During the Oct 3rd trading week, the stock jumped off $23 support and looks poised to retest a shelf of resistance near $28.

If the stock can break $28 resistance, then it could bullishly break out of a descending triangle pattern. Shares could then retest the $36 level. From my buy-on-stop level of $28.03, this would represent more than a 30% gain.

From a fundamental perspective, NRP is very solid.

For the first half of the 2011 year, the company reported record revenue, as a result of high coal prices -- especially met coal -- and higher coal production at its Central Appalachian properties. For the six months ending June 2011, revenue increased 23% to $176.2 million, from the year-ago period.

Due to the growing demand for metallurgical coal by developing nations such as China and India, the company expects record level of met coal exports for the full 2011 year. NRP also anticipates met coal prices will stay about $300 per metric ton, well above 2010 prices. As a result, analysts estimate full-year 2011 revenue is likely to expand 15.5% to $348.1 million, from $301.4 million last year.

By 2012, analysts project revenue will likely increase a further 10% to $383.4 million.

With MLPs, the key financial measure is not earnings, but rather distributable cash flow. Distributable cash flow is a figure based on earnings that also adds back expenses such as depreciation and depletion.

For the first half of 2011, distributable cash flow increased 115% to $83.9 million, from $38.9 million. The rise was due to strong revenues and improvements in working capital.

With growing coal royalty revenue, distributable cash flow should continue to rise throughout the full 2011 and 2012 years.

In 2010 and, so far, for 2011, the company's quarterly distributions have remained unchanged at $0.54, for an annual yield of about 8.4%.

Because NRP has a solid fundamental outlook and looks to be at a technically attractive entry point, I plan to go long on the MLP, if it can breaks $28 resistance.

Risks: If there is a sharp slowdown in China or other Asian countries, coal demand will drop and the MLP will likely suffer. That said, Chinese gross domestic product growth is expected to remain close to 9%, which should underlie robust coal demand.

Given overall market volatility, I will, however, enter the position with caution, placing a buy-on-stop order at $28.03, just above the resistance level. This means I will only enter the trade if the stock reaches $28.03 or above.

My stop-loss will be $23.63, just below a shelf of support. My target is $36.56, the stock's recent high. The risk/reward ratio is roughly 1.94:1.

Technically Precious With Merv Burack

Ho-Hum! 50 points here, 50 points there but really not going anywhere. Gold can’t seem to get any upside steam. Is more downside ahead?



Trend: Gold remains above its slightly positive long term moving average line but is in a very precarious state. A close at or below $1585 would place gold below the line and most likely the line would turn downward at that point. Such close would also place gold below the FAN line number 1, which has been considered as a long term support line.

Strength: The recent price action has not shown much strength when viewed by the long term momentum indicator. The indicator is still in its positive zone but only by a few % points. It remains below its negative sloping trigger line suggesting a continuing weakness in the move.

Volume: With the week’s gold action being basically of a lateral direction the volume indicator has been moving in a likewise manner during the week. It does remain below its negative sloping long term trigger line.

At the Friday close the long term rating remains BULLISH but a very weak bull at this time. We need some upside price action to improve the strength of the rating.


The action during the week was basically a lateral drift type of action. We need some improved volume upside activity to get back into a bullish mode.

Trend: Gold remains below its negative sloping intermediate term moving average line and below FAN line number 2 which had been considered as an intermediate term line. The action remains trapped between FAN lines 2 and 1 as expected. A close above the $1682 level just might give us that push into even greater heights but that would still be below the moving average line.

Strength: The intermediate term momentum indicator has been moving in a lateral drift for the past two weeks, just below its neutral line. The negative sloping trigger line had moved below the indicator during the week but now the indicator is below the trigger.

Volume: As mentioned above, the volume indicator has been moving laterally this past week but remains below its negative sloping intermediate term trigger line.

At the Friday close the intermediate term rating remains BEARISH, confirmed by the short term moving average line tracking below the intermediate term line.


As the chart shows, the short term action has gone into a lateral drift giving us a box pattern. A break-out from this box should clue us in to the direction of the next move. Should the break be to the up side that would not necessarily indicate a new bull market ahead as there is a lot of resistance in the $1800 to $1900 area from earlier action. It would take a serious move to get through that area. My guess, and it’s only a guess, is that the eventual break will be to the down side with the next support in the high $1400 level. BUT let’s let the daily action tell us what’s what.

Trend: A couple of upside days during the week but gold could not break above its downward sloping short term moving average line.

Strength: The short term momentum indicator has been inching upwards during the week and remains above its positive sloping trigger line but unfortunately the indicator itself is still in its negative zone.

Volume: The daily volume activity remains low, which is the expected volume during a short rest in a down trend. The short term average volume line has been sloping downward for the past couple of weeks again indicating a continual lowering of the volume activity as time goes by.

At the Friday Close the short term rating remains BEARISH but not strongly so. It would not take much more upside to improve this rating. This bear is still confirmed by the very short term moving average line remaining below the short term line. However, the very short term line is moving upwards and very close to breaking above the short term line.

As for the immediate direction of least resistance, The Stochastic Oscillator is in its positive zone and the very short term moving average line is trending upwards but the Friday action is giving me cause for concern. I’ll go with the lateral direction for the next day or two until things firm up a little better.


Although silver had a better week than did gold it is still the weaker recent performer of the two. We do see a similar box pattern forming in silver but the overall strength suggests the down side still more in command than is the up side.


Silver went bearish in the long term P&F chart a few weeks back with an initial projection of $28. This it reached quite fast. The next downside projection, per the P&F chart, is to the $14 level. That seems so far away but there it is. Don’t risk any money on that projection but do keep it in mind as it is a valid P&F projection until a reversal is verified.

Trend: Silver had dropped below its long term moving average line a few weeks back and remains there. The moving average line is now in a definite downward slope.

Strength: The long term momentum indicator remains in its negative zone and below its negative sloping trigger line.

Volume: Similar to the gold volume indicator, the silver volume indicator has been tracking a lateral path these past couple of weeks. It remains below its negative trigger line.

At the Friday close the long term rating remains BEARISH.


Trend: Silver remains well below its negative sloping intermediate term moving average line.

Strength: The intermediate term momentum indicator remains in its negative zone but has moved above its trigger line. The trigger, however, remains in a negative slope.

Volume: Although moving in a lateral direction the volume indicator remains below its negative sloping trigger line.

At the Friday close the intermediate term rating remains BEARISH. This is confirmed by the short term moving average line remaining below the intermediate term line.


Trend: Silver moved above its short term moving average line on Thursday but closed below the line on Friday. The moving average line remains sloping downwards throughout. Of greater importance, silver is in a box and needs to get out of the box before any trend can be confirmed.

Strength: The short term momentum indicator is showing greater strength than the price action would suggest. However, it is still in its negative zone but above its positive sloping trigger line.

Volume: The daily volume action remains very low and not giving us any particular message.

On the short term at the Friday close the rating remains BEARISH, confirmed by the very short term moving average line.

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‘Time short’ for eurozone, says Cameron

David Cameron has urged European leaders to take a “big bazooka” approach to resolving the eurozone crisis, warning they have just a matter of weeks to avert economic disaster.

The UK prime minister wants France and Germany to bury their differences and to adopt before the end of the year what he claims would be a decisive five-point plan to end the uncertainty, which was having a “chilling effect” on the world economy.

Meanwhile, on Sunday, Angela Merkel, the German chancellor, and France’s President Nicolas Sarkozy spelt out their determination to defend the stability of the euro as they met for a bilateral summit in Berlin, though they refused to spell out details of their plans.

Mr Sarkozy insisted that the two leading governments in the eurozone were pursuing a common course, and were ready to announce a comprehensive package before the summit of the G20 leading global economies in Cannes, France, at the beginning of November.

Mr Cameron’s interview with the Financial Times increases pressure on eurozone leaders to act, including pressing Mr Sarkozy to agree a plan of action for the recapitalisation of Europe’s banks.

Separately, Mr Cameron wants Germany and others to accept the “collective responsibility” of euro membership and to increase the firepower of the eurozone’s €440bn bailout fund to stop financial contagion spreading from Greece.

Although he refused to speculate on a Greek default – some British government ministers believe it is now inevitable – he said all uncertainty had to be removed about the country’s economic future.

He also called for the International Monetary Fund to be more active in “holding feet to the fire”, confronting eurozone leaders in the starkest terms possible with the consequences of further prevarication.

The final part of Mr Cameron’s plan is to address Europe’s underlying weaknesses, including deepening the single market and improving the governance of the eurozone, if necessary through treaty change.

“That’s the menu,” he said. “It’s not à la carte – you have to do the whole thing.” His comments reflect growing frustration in London and Washington at the incremental approach so far adopted in response to the crisis. “Time is short, the situation is precarious,” he said.

Mr Cameron believes it is vital that Europe’s leaders get ahead of the markets by announcing a comprehensive plan, comparing it to the “bazooka” approach once advocated by Hank Paulson, former US Treasury secretary.

He said Europe’s leaders must break the habit of doing “a bit too little, a bit too late” and conveyed the message in person over the weekend to Mrs Merkel.

Mr Cameron’s endorsement of new EU bank stress tests – applying market-based write-downs to sovereign debt holdings – is a tacit acknowledgement that Greece may not be able to meet the onerous terms of its austerity plan.

The tests could put new pressure on the British government to inject more capital into state-owned Royal Bank of Scotland, although Mr Cameron said he thought this would not be necessary.

Separately Mr Cameron called for EU “safeguards” put in place to protect the interests of non-euro members like Britain as the single currency area becomes increasingly integrated.

He detected a French-inspired plot to discriminate against the City of London simply because it operates outside the eurozone. “I’m not having them trying to move our financial services industry to Frankfurt – forget it,” he said.

US Weekly Economic Calendar

DateTime (ET)StatisticForActualBriefing ForecastMarket ExpectsPriorRevised From
Oct 112:00 PMFOMC MinutesSep. 21-----
Oct 127:00 AMMBA Mortgage Index10/08-NANA-4.3%-
Oct 138:30 AMInitial Claims10/08-400K406K401K-
Oct 138:30 AMContinuing Claims10/01-3700K3700K3700K-
Oct 138:30 AMTrade BalanceAug--$45.5B-$46.1B-$44.8B-
Oct 1311:00 AMCrude Inventories10/08-NANA-4.679M-
Oct 132:00 PMTreasury BudgetSep--$64.0B-$67.0B-$34.6B-
Oct 148:30 AMRetail SalesSep-1.2%0.6%0.0%-
Oct 148:30 AMRetail Sales ex-autoSep-0.4%0.3%0.1%-
Oct 148:30 AMExport Prices ex-ag.Sep-NANA0.3%-
Oct 148:30 AMImport Prices ex-oilSep-NANA0.2%-
Oct 149:55 AMMich SentimentOct-
Oct 1410:00 AMBusiness InventoriesAug-0.4%0.4%0.4%-