3 Battered Stocks That Are Ready To Turn

Includes: CHK, CRM, JPM
by: Convex Strategies

Market conditions are pretty rough right now, but they are going to get much worse. The driver of this market is clear: News flow out of Europe. This correction won't end until either 1) EU News flow drastically improves (i.e. Greece's pro-status quo parties gain a little ground and can form a government; Spain fully recapitalizes its banks; Spanish and Italian bond yields ease, etc), or 2) The Federal Reserve or ECB executes further easing or liquidity injections (notably another Fed dollar rate cut? And there's always the chance at LTRO 3.

Until then, expect the big picture trend to be downwards. There will be a few bullish retracements, but don't expect them to last long.

However, it is always intelligent to stay ahead of the current trend, and start picking stocks you think are going to do well when the market inevitably turns.

Here are three stocks that should soar when the market shifts:

JP Morgan (NYSE:JPM): JPM's trading disaster is a sign of the times, and an investment in a TBTF bank involves the near certain risk that management is going to engage in speculative behavior that could turbocharge profits when they're right (and the Fed accommodates by loading their coffers with cheap cash). With that perspective in mind, JPM is not an outlier, and shouldn't be looked at as the worst bank around just because it had a bad quarter in the markets.

Obviously, the long-term investment solution is to avoid big banks like JPM, Goldman Sachs (NYSE:GS), and the like. They are essentially black boxes with management that gets paid inappropriate sums. For a short-term play, however, JPM has an excellent risk-reward profile.

Poor market conditions have resulted in JPM's CDS "hedged" (yeah right) positions moving against its trading desk. Traders have been closely watching this position deteriorate, and are pricing JPM's stock accordingly. However, the loss is unlikely to be much greater than $5 billion. The trade was based on the 'skew' in the index, or the difference between fair value and current price. As the index comes into fair value, JPM will be in better shape.

All of the bad news for JPM (in the short-term, of course) is out in the open now. The stock has undergone the perfect storm of traders shorting it down due to both the trading issue and general European worries. When the market turns, investors will find it cheap on a valuation basis and some investors may find its yield of 3.50% attractive. With so much negative sentiment surrounding the stock, it will outperform when the market turns.

Salesforce.com (NYSE:CRM): It's clear that when market conditions are favorable, "market leaders" like Salesforce generally outperform. Throughout this correction, Salesforce has largely underperformed on big down days, and vice versa.

The long-term investment thesis for this company, quite frankly, is nonsense. The GAAP vs. Non-GAAP earnings dilemma (more here) reduces management's credibility, and makes the company feel like a scam. There are very few multi-billion dollar, publicly traded companies (at least that I know of) where hundreds of millions in executive stock option compensation can result in either significant annual losses or large profits.

However, understanding what is going to happen with the stock, as opposed to what should happen, is far more important and relevant if you're trying to make money trading.

The reality is that despite a few days of heavy selling in the past month, Salesforce has held up remarkably well overall during this broader market selloff. In the midst of last year's Summer/Fall Europe-induced market downturn, CRM scoped out 52 week lows below $100 per share as demand for growth stocks dried up. This time around, institutional demand actually helped CRM test the $165 all-time high twice, and the stock appears to have found support at $140. After an earnings report that "beat" Wall Street's nonsensical metrics, the stock has found new buyers to make a break at $165 once again.

The underlying demand for the stock has been astonishing, and when overall market sentiment shifts positive, Salesforce is going to outperform in a big way.

Chesapeake Energy (NYSE:CHK): The short thesis is relatively well understood for CHK. The market is now fully discounting management's poor history, Chesapeake's potential funding gap, and thus its potential insolvency.

The critical issue for shorts in CHK, however, is that there will be no such funding gap. As explained here, in an economic environment where interest rates have been pushed to zero, Chesapeake will have no problem staying afloat in the short-term, as banks slowly steal more future equity from shareholders. CHK bought at least a year's time with its recent $3 billion loan from Goldman Sachs and Jeffries, which has destroyed the short thesis of an impending bankruptcy.

Now, with the stock catching a bid at about $14 from major buyers like Blackrock and Carl Icahn, coming asset sales, and fresh (yet long-term unsustainable) financing, shorts are going to begin rushing for the exits.

A shift in overall market sentiment is going to be the icing on the cake, and the likely catalyst for a perpetual short squeeze to get shares back above $20.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in CHK over the next 72 hours.