Last year, Cisco Systems retested its March, 2009 lows. I never would have expected Cisco (CSCO) to be one of the few stocks to accomplish such a dire milestone. A month later, I noted an opportunity to set up a pairs trade with short CSCO and long Juniper Networks (JNPR) once the ratio of their stock prices reached around 0.95. I also argued that given the historically low valuations in both stocks, a rally seemed likely. Two weeks later, I decided it was time to trigger the pairs trade with the ratio at 0.90. The trade worked out extremely well given the sharp stock market rally from the October, 2011 lows. I made several adjustments to the trade after that, taking profits on Juniper into rallies and buying back into JNPR on sell-offs.
I became so comfortable with the JNPR side of the trade that I never blinked while accumulating a fresh JNPR position over the past two and a half months without establishing a short CSCO position. Departing from the original strategy was costly given JNPR has now returned to 2011′s multi-year lows AND I was not positioned to take advantage of another disastrous earnings report from CSCO two weeks ago. The additional irony is that the CSCO/JNPR ratio has bounced around the key 0.95 level over the same time I have built up the long position in JNPR.
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The ratio of stock prices between CSCO and JNPR sits at multi-year highs
Source: StockCharts.com
So, it is time to leave the past behind and re-initiate the proper pairs trade. I prefer using options given the promising upside potential and the tight cap on potential losses. While the profits last year were made on the long side, I think it is much more likely that the profits this time will be made on the short side. JNPR seems ready to break 2011′s lows. On May 17, JNPR reached its lowest point since the 2011 lows. The subsequent bounce was quite tepid, and the stock is already sinking again. Buying interest appears too weak to avoid a fresh breakdown.
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Juniper Networks struggles to remain above 2011 lows
CSCO's chart is even more telling from a longer-term basis. CSCO's peak in 2007 created an ominous head and shoulders technical pattern. The stock lost almost 50% after falling out of this pattern. In April, 2012, CSCO's post-recession rally stopped cold right at the shoulder level. Since then, the stock has experienced an on-going sequence of rapid plunges that set-up the next calamity in the stock. May's plunge is likely to lead to even lower prices in the coming weeks and months. The weekly chart shows the unfolding bearish action.
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CSCO is slowly but surely unraveling
A monthly view of CSCO makes the steady decline even more clear. I do not think CSCO will survive another retest of 2009 lows without first printing even lower prices.
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CSCO's downtrend points toward another test of 2009 lows
Here is JNPR's monthly chart for comparison. Note well that JNPR has managed to make fresh multi-year highs before and after the recession. The 2009 lows successfully retested 2006 lows. In other words, JNPR still has some longer-term positive momentum.
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Juniper is retesting 2011 lows but has higher highs working in its favor over the long-term
Source for stock charts: FreeStockCharts.com
Be careful out there!
Disclosure: I am long JNPR.
Additional disclosure: Long JNPR call options
