I will admit that I, much like everyone else in this market, have been pretty pessimistic over the last few months or so. When the S&P closed outside of its recent trading range on Jan 20th I thought we were getting ready to break down. The averages since moved higher to the middle of their recent trading range only to later crash down dangerously close to the November intraday lows. However, the market has improved slightly since edging closer to those lows. I was thinking back to November 20th when we hit the previous lows and how my mindset at the time was that we would simply keep falling, or if nothing else, retest that level within a matter of days or weeks.
Well, it's Feb 19th. One day shy of three months later we have retested the lows. In retrospect, I should have been buying everything in sight on Nov 20th. After the Dow touched its intraday low below 7500, it moved higher to close at the top of its range on Jan 2 at 9035. For you home gamers, that’s a move of 1535 points on the Dow or 20%. Ask yourself if we are better off than we were when we hit the previous lows on Nov 20th? I can think of at least one confident, motivated, and charismatic President who has changed a few minds.
Like many Americans I’m infatuated with President Obama. He’s young (for a president), he’s funny, and he gives one hell of Braveheart speech. This may be the only man in the country right now with the ability to take our current situation and turn it into something far more positive in the not too distant future. This man is incredibly smart and is actually attacking these problems in a logical and thoughtful way. Many critics and pundits are going to scrutinize his policies and actions over the next year but he’s attacking this problem exactly as he should. The stimulus bill is going to have some positive impact. Even if not every project is shovel ready, you can’t spend shy of a trillion dollars with nary a twitch in the economy. Also, regardless of whether all the money is spent immediately or over two years, we are looking at the long-term picture here. When you’re sick you don’t shotgun NyQuil. This will undoubtedly help the economy.
The housing plan Obama unveiled last week may not address every single fault with the housing market. The Jumbo mortgages will not be covered under the Obama plan. Critics the other day were saying how this could put the California market at risk because in many areas the median home value is in excess of $417,000. However, Larry Kudlow reported this morning that in California home sales have doubled whiles prices have plunged. I like the strategy he is using here because he is knowingly attacking the root of the problem and trying to stop the ongoing wave of home foreclosures. If he can arrest the rise in foreclosures it will help home values for the entire market. Obama even mentioned in his speech that having a neighboring house in foreclosure can affect the value of your own home by thousands of dollars. The concept is that if we can stabilize the housing market, the masses of MBS will stop deteriorating bank balance sheets.
Obama has at least begun attacking two of the three so-called legs of this stool as the administration puts it. The third leg of this plan will address the banks and will hopefully silence the nationalization debate, for better or for worse. The key here is that Obama has to do something, and I think we can say with utter certainty that he plans on at least some modest effort to address the banking crisis. The banking stocks are going to continue these double-digit daily swings until we know what the rules are going to be going forward and what if anything will come of bank nationalization or good bank bad bank. Once we have an understanding of what the administration plans on doing to address the banking crisis, I think we can begin to move higher. Even if the administration’s plans are not in full effect yet, having a clear plan will help us put in a bottom and move higher.
I really respect Obama for his ability to get an array of advice from many viewpoints to get a good grasp on the situation. He has been consulting with everyone from heads of industry to the House Republicans. His choice of Geithner may have been controversial but he may be one of the few people that understands the many complexities and background involved with this crisis. Regardless of personal opinion, he is likely one of the only people qualified to deal with this. The sharp decline we saw following his lackluster plan shows just how much the fate of this market depends on clean plans of action. The market built higher in anticipation of some transparency following Geithner’s speech and fell flat on its face when it got nothing. I think once we get that clarity into the plans we will mover higher.
The question is, if we move higher, will this be another temporary rise to the 9000 level only to fall back for what feels like the tenth time? If so, we can still probably get a decent 20% run up in equity value over the time it takes for Spring to roll in. What if we break out, though? Maybe Obama is as aggressive throughout his administration as he sure seems right now? I’m positioning myself long-term now while we are at what I know was a previous bottom. If we break lower, I think it goes without saying the outlook becomes severely grimmer. I might reconsider this plan but for now I’m fairly confident.
Looking longer term, if we see a bounce off these previous lows, I think there are certain things that have a better shot to really take off. The last time around these levels we didn’t have much to look forward to. This time around we have green energy tethered to oil both trading just off or at their lows. We also have the expectation that Obama is going to repeal the Bush administration’s embryonic stem-cell research ban. This spells good things for biotech, solar, and oil in my opinion.
I’m looking to longer term calls right now and if I see the beginning signs of improvement I’m going to be looking to longer term LEAPS. I’m particularly excited about the levels were seeing in oil. I think the prices we saw at the peak were likely a little overinflated with the huge run up we saw with several asset classes, equities included. But, like the stock market I think we might be oversold at this level.
The most accessible way to play Lt. Sweet Crude for the individual investor is US Oil Fund ETF (USO). I’m looking at five month time horizon as we normally see a seasonal peak in July followed by the selloff into Winter. If we do see a reversal at this level, I would still expect this seasonal trend to hold. I’m looking at calls in the Jul 2010 timeframe. With USO trading at a significant discount to the underlying Lt. Sweet Crude price as a result of the recent oil contango, the options on USO are particularly cheap right now. I picked up options last Wednesday at $1.80. These were trading above $11 a contract at the beginning of January when oil was well off its high. If we even see a modest reversal in oil to January levels there is lots of upside potential. If we see some kind of an oil reversal into July, hold on for a hell of a trade. I’m very bullish on this trade at these levels.
Regarding alternative energy, I’m looking to First Solar (FSLR). The name is a favorite on the Fast Money desk and with good cause. First Solar hit an all-time high of $313 in May of last year. It has since fallen to $87 on Nov 20th. It has only climbed since then and now trading in the $130 area. That's a 50% move while the markets have more or less traded sideways. With Obama’s plans to beef up home grown green energy and “greening” existing federal buildings, I think they stand to fare pretty well in this administration regardless. I think there is a potential for a significant rise in FSLR here. This was a $300 stock in the Bush administration. With Obama’s green policies, I don’t see why they can’t make a significant recovery here. I’m looking to a similar June timeframe at first. I picked up Jun 19 09 calls with strikes at $145 and a smaller amount at a more speculative $195. Should FSLR move north of $200 by June these should be looking pretty good. That's a 50% move from these levels roughly. We did it once, can we do it again?
I’m slightly more conservative with the stem cell trade. I think we undoubtably get a bounce off the repeal of the research ban. However, all of this federal funding focused on infrastructure, housing, and massive bailout has some worried that government funding might be focused elsewhere for the short term. Geron (GERN) was one of the first names out of the gate when the news broke weeks back that it received FDA approval for human trials of a stem cell therapy for acute spinal injury. I’m looking to Mar 19 09 $10 calls as a speculative play. If we break through that I’ll reevaluate the longer play. A couple years out, if we begin to see positive results from these trials, the stock could really take off over the next few years.
The luxury of options is that we are minimizing the amount of money were putting to work in this less that stable market. Luckily for us though, we’re trading around the lowest levels we’ve seen. Contract prices are looking cheap and if we get a rally on a clear plan of action there’s a lot of potential upside. I’m placing a bet on the HOPE trade.
Disclosure: Long calls on USO, FSLR; Long GERN.