3 Stocks To Buy, 2 Stocks To Sell, What's Next For The Market

by: David Ristau

Stocks To Trade:

Today, we are looking at an earnings trade in Google (NASDAQ:GOOG), longs in Lululemon (NASDAQ:LULU) and Merck (NYSE:MRK), shorts in Toll Brothers (NYSE:TOL) and SPDR S&P (NYSEARCA:SPY).

For an earnings trade, we are looking at Google. The company is looking very solid right now, and it started to break out over its 50-day MA today. What we like about GOOG is that the company looks very enticing heading into its Q4 earnings report. According to analyst estimates, the company is expected to see around 10% growth in earnings and 50% growth in revenue. Both of these levels are very solid, and we believe that the stock should see strong support into that report, which should be coming out in late January. One of the most enticing aspects of GOOG is its exposure to the mobile market with its Android software. Google CEO Larry Page made comments that Google is in the early stages of monetizing the mobile market and will be a great growth market for the company moving forward. We believe the company's strong exposure to mobile ads will help GOOG grow in 2013 further and is a large part of that 50% growth in revenue that analysts are expecting. One of the knocks on the company has been its acquisition of Motorola Mobility (NYSE:MMI), but MMI showed some promising results in its latest quarterly report with 11% growth in sales and better earnings than expected at 0.12 vs. 0.06 expectations. If MMI turns things around further, it should drastically help GOOG. The stock has been very strong as of late and has great support at $645 with the 200-day MA, which has not failed in many months. We can make 16% selling the 645/640 bull put spread for Jan19.

Trade: GOOG, Jan19, 645/640 Bull Put Spread

Max Gain: 16%

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For longs, we like the looks of Lululemon and Merck. LULU looks primed to breakout right now as it pushes towards strong resistance at $75 on the back of some solid earnings for the company reported last week. The company beat expectations last week when LULU reported revenue of $317M and EPS at 0.39. Expectations were for revenue to come in at $305M and earnings to be at 0.37. The company grew revenue by 37% and earnings by 44%. Both rates are very solid, and we believe the stock looks primed for another move higher. So far, the move on earnings has been somewhat muted, but we like LULU as a holiday shopping season play if it can break above $75. What is holding the company back is Q4 earnings projections in the report. The company projected EPS of 0.71 - 0.73, which was below the 0.75 expectations. We believe the market, though, has shown so far that it was pleased with the earnings, and the stock has started to push higher. With another 25% growth in earnings expected in 2013, the company is still a great high growth, momentum play. If it gets over $75, it could take off as LULU has a 22% short float. That type of move would create a strong short squeeze sending shares even higher. MRK is also looking strong as of late. The company has rebounded nicely off the $43 line, which it fell to after earnings on October 26. The company has now had three tests of $42-$43 and never failed. The earnings showed some weakness as sales declined 4% to $11.5B, missing expectations for $11.57B. The issue for the company was that its Singulair patent expired, and the company saw competition rise for the drug. Since then, though, the stock has been rallying back as the company's Alzheimers' drug advanced into the next stage and will be used by 200 patients. Expectations are high for this drug, and with results not expected until 2013, the news has given a nice floor to the stock. Since results will not be known for some time, however, risk remains low that the drug can disappoint until late 2013. With the strength we are seeing in the stock, strength at the $42-$43 area on three tests, and strong rebound, we like MRK for a bull put spread.

Equity Trade: LULU, Long

Breakout Point: Break of 75.00

Options Trade: MRK, Jan19, 43/41 Bull Put Spread

Max Gain: 11%

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For shorts, we like the looks of Toll Brothers and SPDR SPY ETF. TOL is looking like a good short as the residential construction industry is starting to show some weakness, and recent earnings were not strong enough to maintain strong valuations. Currently, TOL is sitting with future PE at 21, which is pretty strong and will require strong results from earnings to maintain and even exceed. The latest reults on December 4 were not good enough in our opinion though. The company reported $400+M in earnings with strong growth it seems. Yet, included in that was a tax benefit of $351M and inventory write downs of $1.5M. Revenue grew by a solid 48%, and the backlog grew by 70%. The issue, for us, was that a lot of this information was factored into the share price already. The stock has grown nearly 50% this year, and its starting to show weakness. The stock broke down out of an upward channel it was in, and it testing the $30 line, which has not failed since August. The $29 line has not failed since July. Below that is the 200-day MA at $28. We see several solid support lines, but if investors start to take profits into the end of the year, we could see some weakness in TOL moving forward. We like shorting on failure of $30 as it would confirm our suspicion. Until then, keep TOL on watch. Another position we like is a bear call spread in the SPY. The reason, for this, is we believe that the market is starting to show a lot of strength on hopes that the fiscal cliff situation will be avoided. The problem is that this is hope, and its never good to trade/invest on hopes. We believe a SPY bear call spread is a great way to hedge a bullish market in case the deal does not happen. We are not speculating that a deal will or will not happen. Rather, we believe it is important to have hedges in place. Right now, th SPY has not been able to break through 146-147 all year, and we like looking at that area for a hedge. We can still make 20% on Dec31 146/147 bear call spread, which is a great hedge to a long portfolio. Its smart to not be too long in this market with such significant risk on the horizon, and we believe moving some money into a hedge is extremely important.

Stock Trade: TOL, Short

Breakout point: Break of 30.00

Options Trade: SPY, Dec31, 146/147 Bear Call Spread

Max Gain: 20%

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Tomorrow's Outlook:

The market looked positive on hopes of a deal throughout the day on Tuesday, but heading into Wednesday, will those hopes last or turn into reality? Unlikely. Senator Harry Reid commented in late trading hours that a deal is unlikely before Christmas due to th fact that Republicans will not budge on tax cuts for the wealthy. With unrest between parties still existing, those hopes may soon turn into fears for the market. Tomorrow, we will also be reacting to the FOMC rate decision and news. The Fed is widely expected to extend its Operation Twist buying of Treasury bonds past December 31, which may have a short-term positive effect on the market. At the same time, easing has seemed to turn into more of a negative for the market as a whole versus a positive like it was then QE1 and QE2 happened. The market will definitely be able to react to that extension or lack thereof tomorrow as well. We should have a fairly important inflection day tomorrow with more developments over the fiscal cliff occurring as well as Fed decision.

Chart courtesy of finviz.com.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: The Oxen Group is a team of analysts. This article was written by David Ristau, one of our writers. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.