American Express To Now Take Out $70

| About: American Express (AXP)

Summary

American Express lights up the markets with its earnings. Best trading day in quite a few years.

We are holding this stock because it offers considerable downside protection plus it's trading below its historic average valuations.

We are now watching carefully for an intermediate top in the market.

As I write, American Express (NYSE:AXP) is up 10%+ after announcing an impressive set of third quarter earnings which caught many by surprise. The stock was actually downgraded a few weeks ago, which resulted in the stock dropping from around the $64 level to sub $60 levels over the past few weeks. However, with the convincing earnings beat of $1.20 per share (compared to $0.97 expected), the stock will probably report a 10%+ rally today (20th), which is unprecedented for this stock over the past few years. We (our premium portfolio) actually went long this stock about a month ago at the $64.50 mark.

Many times in our portfolio, when underlyings are announcing their quarterly earnings, we take advantage of the high implied volatility to sell out of the money calls (or covered calls) to bring in additional income. We couldn't really do this time around due to the stock trading too far below ($61.27) our entry price ($64.50) before earnings were announced.

However, the real reason was that Amex's earnings multiple yesterday was just too low (10.8) to risk losing the shares on a covered call trade. In fact, even with the 10%+ move today up to the $67+ level, Amex's earnings multiple has only moved up to the 11.9 area which is still well over 3 points below the company's 5-year average. I was always bullish due to its valuation, but now that 2016 earnings guidance has been increased, I still believe there is more room in this rally. Here are other reasons to back up my bullish argument.

Firstly and most importantly, the reason whyAs I write, American Express is up 10%+ after announcing an impressive set of third quarter earnings which caught many by surprise. The stock was actuallydowngraded a few weeks ago, which resulted in the stock dropping from around the $64 level to sub $60 levels over the past few weeks. However, with the convincing earnings beat of $1.20 per share (compared to $0.97 expected), the stock will probably report a 10%+ rally today (20th), which is unprecedented for this stock over the past few years. We (our premium portfolio) actually went long this stock about a month ago at the $64.50 mark.

Many times in our portfolio, when underlyings are announcing their quarterly earnings, we take advantage of the high implied volatility to sell out of the money calls (or covered calls) to bring in additional income. We couldn't really do this this time around due to the stock trading too far below ($61.27) our entry price ($64.50) before earnings were announced.

However, the real reason was that Amex's earnings multiple yesterday was just too low (10.8) to risk losing the shares on a covered call trade. In fact, even with the 10%+ move today up to the $67+ level, Amex's earnings multiple has only moved up to the 11.9 area which is still well over 3 points below the company's 5-year average. I was always bullish due to its valuation, but now that 2016 earnings guidance has been increased, I still believe there is more room in this rally. Here are other reasons to back up my bullish argument.

Firstly and most importantly, the reason why we initiated a position in American Express was because of its strong competitive advantages. Competitive advantages protect against downside risk so we insist on only holding stocks that we feel have a competitive advantage in its sector. This is important as timing the purchase is one of the most difficult skills an investor will come across.

I have seen quality cheap stocks get much cheaper and stay cheap for a considerable period of time. When this happens in our portfolio (as it undoubtedly does), we trust the process (and our positions), collect the increasing dividends along the way and wait for our positions to come good.

So why did we trust this stock when it dropped to $59 a few weeks ago? Well this stock (especially after losing the Costco (NASDAQ:COST) contract) has come in for a lot of criticism regarding its fees and the like. There is no doubt that the industry is changing in the sense that merchants now want to steer customers towards payment providers that will ultimately suit them.

However, an appeals court recently sided with American Express and against merchants on the fact that merchants have to pay higher fees to accept AMEX cards. The court ruling basically stated that customers' needs also have to be taken into account here. The higher fees justify the higher rewards and if the merchant does not want to pay this fee, then it can simply not accept AMEX cards. This was good news going forward if you are an American Express bull.

Combine the preservation of its big spending brand along with the $1 billion cost cutting target by the end of next year and the reasons start to stack up quickly why the company remains a strong buy.

In fact, American Express reported a 3% cut in its costs in the third quarter and also stated that its extra earnings will be used for investment purposes for the remainder of the year. Therefore, I will be watching consumer spending metrics closely over the next few quarters as this would be the last linchpin that could adversely affect earnings in the near term

In terms of where we will be exiting this stock, we can see from the chart below that today's earnings announcement resulted in the stock blasting through resistance at the $66 level. If the breakout can hold, the stock's next heavy resistance is not until the $75 level.

Click to enlarge

Furthermore, stocks are well overdue an intermediate decline. We are now 17 weeks into this intermediate rally but we still are not seeing any signs of a move down into an intermediate cycle low.

Click to enlarge

So what I want to see is the above chart getting overbought (on the RSI indicator) and marry this with an ultra pessimistic reading on the robo ratio as this ratio is still not indicating that an intermediate decline is on hand at present.

Click to enlarge

Source : Sentimentrader.com

To sum up, American Express in one way has been fortunate that the general stock market (SPX) hasn't undergone a profit-taking event as of yet. This may give the stock time to take out $70 in this cycle. We will take profits at that point and then re-enter when equities print their next intermediate cycle low which looks like it now may take place after the elections. we initiated a position in American Express was because of its strong competitive advantages. Competitive advantages protect against downside risk so we insist on only holding stocks that we feel have a competitive advantage in its sector. This is important as timing the purchase is one of the most difficult skills an investor will come across.

I have seen quality cheap stocks get much cheaper and stay cheap for a considerable period of time. When this happens in our portfolio (as it undoubtedly does), we trust the process (and our positions), collect the increasing dividends along the way and wait for our positions to come good.

So why did we trust this stock when it dropped to $59 a few weeks ago? Well this stock (especially after losing the Costco contract) has come in for a lot of criticism regarding its fees and the like. There is no doubt that the industry is changing in the sense that merchants now want to steer customers towards payment providers that will ultimately suit them.

However, an appeals court recently sided with American Express and against merchants on the fact that merchants have to pay higher fees to accept AMEX cards. The court ruling basically stated that customers' needs also have to be taken into account here. The higher fees justify the higher rewards and if the merchant does not want to pay this fee, then it can simply not accept AMEX cards. This was good news going forward if you are an American Express bull.

Combine the preservation of its big spending brand along with the $1 billion cost-cutting target by the end of next year and the reasons start to stack up quickly why the company remains a strong buy.

In fact, American Express reported a 3% cut in its costs in the third quarter and also stated that its extra earnings will be used for investment purposes for the remainder of the year. Therefore, I will be watching consumer-spending metrics closely over the next few quarters as this would be the last linchpin that could adversely affect earnings in the near term

In terms of where we will be exiting this stock, we can see from the chart below that today's earnings announcement resulted in the stock blasting through resistance at the $66 level. If the breakout can hold, the stock's next heavy resistance is not until the $75 level.

Click to enlarge

Furthermore, stocks are well overdue an intermediate decline. We are now 17 weeks into this intermediate rally but we still are not seeing any signs of a move down into an intermediate cycle low.

Click to enlarge

So what I want to see is the above chart getting overbought (on the RSI indicator) and marry this with an ultra pessimistic reading on the robo ratio as this ratio is still not indicating that an intermediate decline is on hand at present.

Click to enlarge

Source: Sentimentrader.com

To sum up, American Express in one way has been fortunate that the general stock market (SPX) hasn't undergone a profit-taking event as of yet. This may give the stock time to take out $70 in this cycle. We will take profits at that point and then re-enter when equities print their next intermediate cycle low which looks like it now may take place after the elections.

Disclosure: I am/we are long AXP.

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.