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With the third-quarter earnings season ahead of us, let’s take a moment to reflect on the second quarter that is wrapping up. During the last reporting period, 480 stocks in the S&P 500 Index had reported as of Tuesday’s close. Out of these, 389 exceeded analysts’ consensus view, with overall net earnings growth of 54.15% year over year. This leaves the S&P index with a trailing price-to-earnings (P/E) ratio of 16.1 and assumes a forward P/E of 13.3, based on analysts’ expectations of $81 in net index earnings by this quarter next year.
While P/E ratios seem to be in a relatively neutral-to-low state looking forward, there are still issues to contend with, namely housing and unemployment.
According to a Fitch report from earlier this month:
- May Residential Mortgage Backed Securities (RMBS) delinquencies declined for the second straight month, following a steady four-year increase; this is a positive.
- For subprime: 44.8%, down from 45.2%
- For Alt-A (borrowers with less than full documentation and lower credit scores) 33.9% percent, down from 34.1%
- They did note, however, that “approximately nine percent of performing Alt-A loans and 37 percent of performing subprime loans are modified and have a substantial risk of re-default.” This is still a negative sign.
This week, we got the following data:
- Existing home sales dropped 2.2% to 5.66 million vs. expectations of 6.17 million
- Sales peaked at the end of 2009, then dropped for three months. They have been trying to claw back but remain below estimates.
- New home sales dropped by almost 33%, the worst month-over-month drop since the data was first tracked. That number also represents contracts signed, which is a percentage that won’t close.
With this not-so-great housing data, the market has fared relatively well. Many believed that the Federal Reserve meeting Tuesday and Wednesday (particularly the rate announcement Wednesday) would have been a huge catalyst, but I disagreed on air because it is not typical of the FED to makes dramatic shifts in policy and statements.
The Fed knows they need to keep rates low and that’s what they did. There really is not much the FED can do at this point to support the ailing housing market and stimulate employment growth except for keeping money as cheap, easy, and plentiful as possible, of course while keeping inflation at bay. This doesn’t seem to be an issue … for now at least.
I do believe that this morning’s unemployment claims will be higher than expected (460,000 is a rough consensus estimate). This could be a bearish catalyst, and next week’s non-farm payroll numbers may have a much better chance of creating market volatility, especially if that number is weak.
From there, I have already discussed the ramifications of earnings season in my article, Here Come the Earnings.
As for the housing sector and its woes, traders can look to less-risky bullish or bearish trades among the homebuilders. Based on my analysis of the technicals, these stocks are a bit oversold here and may bounce. They started moving higher yesterday on the housing data.
Don’t forget that Lennar and KB Home report this week; both stocks touched their lower Bollinger bands during the day yesterday and bounced off those levels.
I am also looking at apartment REITS as a possible beneficiary of the glut of housing inventory as consumers remain reluctant to purchase homes as prices continue to drop.
One of the stocks in the sector that is favored by analysts is CPT – Camden Property Trust – which is trading at about $43.50 per share with a dividend yield of 3.76%. It does have lower volume and relatively wide spreads in the options, so use caution.
Here are some technical and fundamental points on CPT
- Chart support at $43.00
- Primarily in the sun belt region, which is becoming popular again for investment
- High occupancy levels (currently 94%)
- Steady returns and the continuing oversupply in home ownership will continue to lead to more rentals.
- The eco boom generation (18-30) will be larger in the coming years and may be renting before purchasing homes, according to analysts.
- The stock is currently trading at a discount to the net asset value of the company and may climb to a substantial premium in the next couple of months based on historical price behavior.
- Above 200-day single moving average (SMA)
In other matters of interest, BP plc (BP) volatility has been crushed; it has come down from 110% down to 67%. While this is still relatively high, investors who are bullish can reduce risk greatly compared to long stock by selling an out-of-the-money put spread with fewer than 30 days until expiration to limit time exposure. Remember that a put spread’s maximum gain is the credit collated, while the maximum loss is capped at the difference between strikes (the short put and the long put) minus this credit.
If you are taking the contrary position and agree with Brian Kelly (my colleague from Fast Money), instead of buying puts, which costs you theta and lower your breakeven, you can take a limited risk/limited reward view by selling upside call spreads with fewer than 30 days till expiration to limit time exposure. Spreads also help mitigate vega risk. The risk/reward profile of a bear call spread is the same as a bull put spread, as both are credit spreads. The maximum reward is the credit collected, while the maximum risk is the difference between strike prices minus the credit.
Whatever strategy you choose or method you employ in the markets, TEST it first! See you next Wednesday on Fast Money.
Photo Credit: David Paul Ohmer
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