Egypt is free! …and the market rejoices.
There’s nothing like a successful revolution to juice the bullish sentiment on Wall Street. While Egyptians celebrated Mubarak’s resignation by dancing in the streets, traders marked the occasion by sending US equity indices to yet another recovery high.
Last week ended in decidedly bullish form as risk was once again embraced, and recovery expectations continued to propel stocks higher. Despite our long-term reservations, the Mercenary trading book enters the week net long, with the intention of taking advantage of the sustained “risk-on” mentality.
Our gross exposure, however, is still very light as cross currents and macro risks continue to make for a difficult and somewhat unpredictable trading environment.
As Jack noted on Friday, oil and gold prices are following the way of Mubarak. The regime change has traders breathing a sigh of relief (at least temporarily) as the perception is that a peaceful transfer of power will keep oil flowing from the Middle East to developed nations.
Gold is obviously seen as an attractive hedge for politically and economically challenging environments. But with the Egypt crisis now accepted as resolved event, and the US and European economies showing signs of recovery, gold’s attraction is fading. Considering the incredible rise for precious metals over the last several quarters, a shift in sentiment here could touch off a significant move for the yellow metal.
So as we boot up the systems for this week, we’re balancing big-picture risks with near-term optimism. It’s time to roll with the bull camp while keeping close tabs on our risk.
A Breakout With Room to Run
The trading game usually requires patience as well as a willingness to act aggressively when the opportunity is right…
Late last year, we identified Neutral Tandem Inc. (TNDM) as a strong telecom opportunity with a stable domestic business and strong potential in emerging markets. It took a bit of time for the stock to begin its move, but this past Thursday, TNDM broke sharply higher – contributing to our profitable week.
On Tuesday, the Mercenary Live Feed recommended a long position for TNDM, using a stop/limit order to be filled if the stock broke above its recent consolidation. TNDM didn’t actually trigger the buy order until Thursday, but when it broke out, the move was quite impressive.
Mercenary Trader portfolios entered the trade at $16.26 – a bit above our buy stop level as the stock was very active – and watched the position rally more than 10% in just two trading days.
Within 24 hours of entry, the stock had already reached the level where our risk point is automatically adjusted to breakeven. So at this point, Live Feed subscribers are sitting on an attractive gain with the initial risk now minimized.
TNDM should have plenty of room to run, both from a fundamental and a technical perspective. Fundamentally, the company has no debt, plenty of growth opportunity, and a forward PE of about 15. A recent acquisition should put TNDM in a great place to capture new business in developing countries, and a stable customer base in the US gives the company plenty of cashflow to work with.
Looking at a longer-term weekly chart, I’m impressed by how much overhead room TNDM has before running into resistance. Several disappointments in 2010 have shaken out all but the strongest of investors, and yet the business remains healthy with stable earnings.
Depending on the environment an how the pattern sets up, we may have the opportunity to add pyramid positions along the way – while simultaneously tightening risk points to protect our gains. Stay tuned as this name has a lot of potential for the weeks and months ahead.
Airlines Set for Takeoff
Few industries will benefit more from falling oil prices than airlines. Lower fuel costs should help boost profit margins, and more importantly, give the companies a better environment for hedging their long-term fuel arrangements.
At the same time, signs of economic recovery (whether perceived or actual) continue to drive air travel. Business travel has been picking up over the last few quarters and there are expectations that leisure travel should follow suit this year.
In an environment where perception is reality, airline stocks have begun trading more constructively over the last two weeks – with the Egypt crisis resolution as a likely catalyst for new trends higher.
Delta Air Lines Inc. (DAL) has seen revenue climb between 14% and 18% the last three quarters, and positive earnings have given investors new optimism. This year the company is expected to earn more than $2.00 per share and yet the stock is trading near $12.00 – a significant discount even to its airline peers.
DAL has established a key support area between $11.00 and $11.50 and with Friday’s action the stock is now above the short-term 20 EMA. A break higher would take out the more important 50 and 200 day averages, and also break the bearish trendline established in December.
This looks like a key inflection point for the stock, and a great opportunity to capture profits on a shifting trend.
United Continental Holdings (UAL) has been a relative strength leader for the airline group – with less significant declines and a bullish overall trend.
Friday’s decline in oil prices sent the stock higher, testing the 1/27 high print. A move above this level could offer a key inflection point, while still allowing for tight risk management if the breakout is called into question.
UAL is expected to earn $5.00 per share this year and tack on another 10% in 2012. Obviously, we don’t put a lot of faith in such long-term predictions (there are too many variables to be able to accurately predict these earnings levels). But knowing Wall Street’s projections, it’s easy to understand why traders could pile into UAL sending the stock price significantly higher in the coming weeks and months.
Gold Loses its Luster
In a world of uncertainty and fear, gold offers stability and preservation of value. But when danger clouds blow over, precious metals can turn into a heavy portfolio weight – dragging down performance.
The last few months have offered numerous opportunities to trade precious metals (and metal producers) from both the long and the short side. In order to successfully trade today’s fluid environment, traders need to be willing to play either side of the market – capturing opportunity as perceptions shift.
On Friday, we closed out our remaining bullish precious metal positions as Mubarak’s exit sucked the majority of fear out of the trading world. A stable US dollar and relative calm in Europe also serve as bearish influences on gold prices.
This week, we’re likely to flip our hat around and trade gold from the short side – capturing profits as goldbugs begin to feel their own set of fear for the first time in nearly two years now.
Looking at a longer-term chart, we can see a long-term bullish trend for the yellow metal. Bullish traders are likely to defend this trendline because so much is at stake. Initially, a short gold trade could lock in profits even if GLD only traded down a few dollars.
But considering this long-term trend and the shifting dynamics, a break of the $125 to $128 level could turn into a watershed event. If this trend truly breaks, we could see a massive move lower as the commodity retraces its heady gain, and huge long positions are reversed.
The big picture will likely take more time to develop – and that’s good news for us as a reversal could offer us several chances to add horizontal and vertical exposure to the theme.
We’re not in the business of “predicting” a collapse for precious metals. Rather, we take an objective view of the situation with a major decline being one of many plausible scenarios. As nimble traders, we will take the signals as they come, and manage our exposure and risk accordingly.
This week should give us some great information on how global markets will fare following the Egyptian revolution – along with plenty of other political and economic developments across the globe.
Stay nimble and trade ‘em well!
MM
