3 Pre-Taper Trends That Should Remain Strong Post Taper

by: Lamarcus R. Coleman

Over the past few months, the markets have been keenly sensitive to the continued prospects of quantitative easing and whether or not a taper would take place in the near term. For a while, our attention was temporarily diverted to the budget battle and 16-day shutdown. However, now that we have a temporary, and I stress temporary, solution to the debt ceiling fiasco, markets are trading with no taper until next year in mind. This poses the question of how one should play the market leading up to Yellen's first taper and whether or not some of the previously identified trends remain advantageous. In prior articles we identified real estate, consumer discretionary, and the increase in online education as opportune trends. Some key recommendations included D.R. Horton (NYSE:DHI), Grand Canyon Education (NASDAQ:LOPE), Home Depot (NYSE:HD), Whirlpool (NYSE:WHR), AutoZone (NYSE:AZO), Pier 1 (NYSE:PIR), and Dollar Tree (NASDAQ:DLTR) on the long side. On the short side were Wal-Mart (NYSE:WMT), and Target (NYSE:TGT).

Before analyzing whether or not these trends remain prevalent, let's first take a look at how these positions have performed since they were first mentioned. Relative to the trend in the real estate arena, D.R. Horton was recommended in an article published on 11/18/12 (click here for article), Home Depot was recommended in article published on 11/14/12 (click here for article), and Whirlpool and Pier 1 were featured in an article published on 5/1/13 (click here for article).

To take advantage of what I perceived as the roots of a developing trend in online education, in an article published on 11/11/12, I offered Grand Canyon Education and Apollo Group (NASDAQ:APOL) as being two potential plays on this trend, but stated that I preferred for reasons listed in the article (click here for article). I also felt that the dollar stores would continue to pressure the margins on bigger retail outlets. As a result in an article published on 11/27/12, I offered Dollar Tree as a long play on this trend and Wal-Mart and Target as short plays (click here for article). AutoZone was also recommended in the article published on 11/27/12. To offer a general status of performance over this period, the closing prices of the positions on the day in which the corresponding article was published will be used as entry prices and yesterday's closing prices will be used to calculate gains/losses. (See Table Below)

DLTR 41.13 11/27/2012 59.37 44%
WHR 112.9 5/1/2013 144.6 28%
PIR 22.7 5/1/2013 21.01 -7%
DHI 18.9 11/18/2012 19.47 3%
AZO 382.38 11/27/2012 432.59 13%
LOPE 22.32 11/11/2012 43.66 96%
HD 61.47 11/14/2012 75.08 22%
WMT 69.5 11/27/2012 75.9 -9%
TGT 62.57 11/27/2012 64.27 -3%

One key caveat; this presentation doesn't account for the effects of hedging and the highs/lows achieved over the time period. For instance, D.R. Horton, which was recommended on 11/18/12, experienced a beating as we neared the taper that never happened. One could have purchased puts when I mentioned this stock in a follow-up article, at which time the stock was up 38% (click here for article). Doing so, one could have at least locked in 30% of the run-up and cashed in when the options expired, but +3% is better than a negative anything. Also worth mentioning, while I preferred Grand Canyon Education to Apollo Group, Apollo Group yielded a return of 43% as of yesterday's close, which is good (exceeding the broad market), but still lagging Grand Canyon Education which has a 96% gain over the same period.

The market has fluctuated some from the original mention of these plays but has maintained an upward trajectory. The key question now is whether or not these trends remain viable. The market is irrational. It has been driven largely by the Fed. Other markets global, especially FX and Bond markets have been affected by this phenomenon as well. The market must revert back to reality at some point. To achieve the greatest profit potential with the least amount of risk, one must prepare for the divergence of the "Fed Effect". Those who choose the right positions now will be ready when the market begins to behave rationally again, and realize that tapering should be positive for stocks and not negative.

With this in mind let's take a look at the trends presented. The real estate arena was amongst the hardest hit during the core of the crisis, thus it will experience one of the longest recoveries. However, a key consideration of this trend will be the reduction in stimulus and the apparent rise in rates in the future. Mind you, rates will not be raised anytime soon (i.e. late 2014- 2015), but once we get off the juice, portions of the real estate arena will begin to take a beating. Namely, the mortgage REITs which are highly sensitive to the interest rate market. I feel that a selloff in the broad market will occur as a result of the taper which will be a great time to accumulate key positions. These stocks, while providing a gateway to the stabilization of the real estate sector, should not be susceptible to the gradual removal of QE as much as the broader market. They also should be pretty well insulated against the gradual rise in interest rates, pending that the market doesn't over react and send yields to extreme highs.

Home Depot is trading at 5% off of its 52-week high. It has experienced an upward trajectory similar to that of the broad market this year. It appears to be just above the key support level of $72. Its next level of resistance is $78. At current levels, I would be looking to lock in some profits by either taking some off the table, or buying puts. If it doesn't break and hold the $78 level, I would look to accumulate shares near support of $72. From a valuation perspective, the stock still trades at a P/E and PEG less than that of the industry. Home Depot will report Q3 earnings on November 19th. At its last earnings announcement the company raised its guidance. During this time it reported same store sales of +10.7%, U.S. comp sales increase of 11.4%, and a total sales increase of 9.5%. Net earnings were 1.8B versus 1.5B in Q2 fiscal 2012. The company has repurchased 4.3B in shares and intends to repurchase an additional 2.2B by year end.

D.R. Horton will report earnings for Q4 of its 2013 fiscal year on November 12th. The company reported Q3 earnings on July 25; at this time its sales order backlog increased 36% in homes and 56% in value compared to the year prior. Net sales orders also increased 12% in homes and 30% in value to $1.8B from year prior. The stock, after hitting a high of around $28 in May of this year has since sold off but appears to have found a bottom at $17.60. The next key levels of resistance for the stock are $20 and $21.52 which is the high from the first bounce off support. The stock is trading at 28% off of its 52-week high and at the 100-day moving average which is acting as resistance. I would look for a near-term pullback to around $19 as a potential entry. If the $20 level is broken and held, I would use it as a support entry.

Pier 1 has had a major run-up from this time in 2012 at which time it was trading at $11.57 to a high of over $25 in May of this year. Since then, the stock has sold off, and has bottomed out at $19 after retracing all its gains for 2013 earlier this month. The stock is nearing resistance at $21.56. If this level is held, it could go to $24 by year end. If the stock fails to hold this level, I would look to get in at somewhere around $20, however, if $19 is broken, of which I don't expect, I suggest waiting it out because the trend lower will continue. At current levels, its P/E and PEG are both under the industry average at 18.27 times and 1.13 times respectively. The company is also less leveraged than that of the industry and has wider margins. On the 18th, the company announced a $200M buyback. On September 19th, the company reported an increase in same store sales of 3.5% and increase in total sales of 7.6%. The company reported EPS of $.17 in Q2 versus $.24 a year ago. The firm also reduced forward-looking guidance.

Whirlpool is trading near a key resistance level and is 3% off its 52-week high. Next key levels of support are in the $139 and $128 areas. From a valuation standpoint, at current prices the stock seems overvalued with a P/E and PEG above its industry, but still below the broad market. On this basis I would wait for a pullback to somewhere around $136. If $134 was broken, I would sit out and wait to see if it tested the $128 level before going long. The company just reported earnings for Q3 this week. At which time it stated that it achieved record Q3 earnings, margins continued to expand as well as sales growth, and it raised its full year guidance. The company also cited strong industry growth from housing within its North American operations.

With the economy strengthening, I would be looking to take some profits in AutoZone and Dollar Tree and play with the house's money. These two stocks are great plays during the heat of a crisis. They are good stocks afterwards as well, yet, if unemployment, which is currently at 7.2%, continues to fall, and the consumer doesn't feel a squeeze in the credit markets, these stocks could lag the broad market at the height of the recovery. Until then, however, I would look to find an entry near support.

AutoZone has come off its high for the year having extended 138.2 after a 38.2 retracement at the end of April from its open at the beginning of the year. The stock is trading about 6% off its 52-week high. From a valuation perspective it has a P/E and PEG less than the industry at 15.85 times and 1.05 times respectively. Support and resistance going into year-end are $411, and $436. A break above $436 could see the stock retest its highs from August. On September 25th, the company reported Q4 increase of 12% in net sales from that of a year ago. Net income rose 14.7%. The company repurchased 3.5M of shares for the fiscal year and currently has an additional $468M remaining under the plan authorization.

Dollar Tree is scheduled to report Q3 earnings on November 21st. The stock is trading at about 6% off of its 52-week high. It currently has a P/E above the market at 20.98 times but a PEG below the industry at 1.23 times. Dollar Tree hasn't experienced a significant pullback this year. I would look to get in at the $55 or $50 support level. On September 17th, the company announced a $2B buyback plan. The company also entered into an agreement with J.P Morgan to repurchase $1B under a variable maturity accelerated repurchase program. The company reported Q2 earnings on August 22nd. At which time comparable store sales increased 3.7%.

I think the trend in online education will remain sustainable as we approach the taper. A couple of reasons drive this assumption. First, it's readily apparent that we are more technologically advanced than ever, seeking more competitive offerings especially on a mobile front, and constantly building out a way to commingle these occurrences in the context of a social environment. In fact, due to many of the online education providers providing social platforms within their educational platforms, I would expect integration with leading social platforms to come in the future. Secondly, education is a driver of business investment, the economy, etc. How you ask? Education is not necessarily seeking a formal education from a four institution, but it is the continued quest for knowledge. Aspiring entrepreneurs educate themselves, spending countless hours conducting research outside of a formal classroom setting. These individuals go on to create profitable companies based on the education obtained. There are more mediums of knowledge acquisition being developed in a mobile context that will further stimulate the online education trend. Also, the middle class, who bears the brunt of our economic weight, will continue to seek an education. These individuals will continue to include traditional and non-traditional students. The non-traditional students will continue to play a key role in the online education arena because they require greater flexibility than the traditional student, of which is a key offering of online education. Based on this, Grand Canyon Education should be a great buy on a tapering pullback. I would definitely have this position hedged to lock in profits from the run-up which began at the end of last year.

Grand Canyon Education is trading 1% off its 52-week high. Given its appreciation, I would definitely recommend waiting for a pullback if you haven't gotten in already. The question is when that pullback will come. My guess is that the market as a whole won't experience a significant pullback until we begin tapering. Ideally, I would look to scale into a position around the $36 and $32 support levels. The stock has a P/E of 25 times above that of the market. The company will report Q3 earnings on Tuesday, October 29th. During its Q2 earnings announcement the company stated that net revenue had increased 18.6%, enrollment had expanded by 15.2% and operating income expanded by 24%. The company also posted an EPS of $.42 vs. the consensus of $.40 in Q2.

As for Wal-Mart and Target, these positions were offered as representative of the relative strength in the dollar store sector. I feel that these stocks will suffer more than the dollar stores on a pullback once tapering begins. Based on this assumption, I would hold, but hedge my short positions.

Wal-Mart is trading 5% below its 52-week high and has a P/E below the market at 14.81 times. The stock has made lower lows beyond the 50% retracement posted at the end of June. The stock is at a key resistance level and should trade down if it fails to hold $77. Earnings met expectations for Q2 of $1.24/share on August 15th. EPS and revenue growth both have recently lagged that of the industry. The firm is also more leveraged than that of the industry average, but does generate sales at 12 times debt service. The company will report Q3 earnings on November 14th.

Target is trading at 15 times forward earnings and is also trading below the P/E of the market. It's also trading below its 100-day moving average. Earlier this month the stock appears to have found support near the 76.4 retracement level from its high. The stock is also trading at 13% off of its 52-week high. Target currently has more leverage than the industry average and declining EPS growth. The firm also has posted revenue growth lagging that of the industry. The firm recently reported Q2 earnings which were up 6.1% but on light same store sales numbers of an increase of 1.2%. The firm also stated that it expects EPS to be near the low of its prior guidance. Target will report Q3 earning on November 21st.

Tapering signals the end of the crutch of stimulus. This means that in order for tapering to end, our economy would have to possess enough strength to continue the moderate pace it has been on, toward a stronger recovery in 2015. With inflation subdued, of which I have many questions and see red flags of which are beyond the scope of this text, the Fed has not been pressured to end QE. As result, economic data is the primary contingency of tapering. My suggestion is to continue to play these current trends to the upside. Tapering, in my opinion, will be the trigger back to reality. Don't jump the gun. Stay with the trend, but have a plan for once the trigger is activated.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.