By: Bill Spencer — April 25, 2020
Small-Cap Saturday - For Earnings Season We're Bullish on this Drug Maker
Big Bill here.
As we enter Week 4,778 of the lockdown (or what feels like it)...
How are you and your family getting on?
I'm holding up tolerably well and digging into some books I bought last year but never had time to read.
(I've just started in on George Will's The Conservative Sensibility.)
But a buddy of mine named Sal sent me this yesterday.
(Click any image to enlarge)
If that screen capture accurately captures how you're feeling right now... take heart.
Because "This too shall pass". Like George Foreman says, "I guarantee it!"
Plus, there is some good news to be had...
In fact, if after reading last week's column you bought the Oct 30 Put option on iShares Mortgage Real Estate Capped ETF (REM), the Put is trading for $11.40 right now.
That's 5.5% higher than the $10.70 it was trading for last week.
(Remember, we're bearish on Housing, and the value of a Put option goes up as the price of the underlying stock or ETF goes down. REM itself is down -0.93%.)
So you're up 5.55% in just one week -- a 288% annualized return.
And if you want a reassuring sign that the March 23rd market low was in fact THE low...
You should read (or re-read) what my friend and colleague Costas Bocelli had to say this past Thursday ("Has the Market Bottomed? Find Out Here...").
I promise his analysis will steady your nerves.
For our part, since earnings season is upon us, today we're going to revisit a strategy you read about back in February.
It's a very quick play that involves buying a stock (or selling it short) if after reporting earnings, it makes a move counter to its current trend and technical /relative strength attributes.
This high-probability move can be a great way to potentially grab a double-digit profit in a matter of days.
Before we get to the strategy, let's look at the market.
All the major averages lost ground this week, with our Russell 2000 small-cap proxy bringing up the rear.
The good news is that, even though it fell, for the second week in a row the market behaved "normally". That is, we saw no stomach-churning advances or declines.
And we did see a slight softening in the "breadth" of the market.
Remember, at True Market Insider, we focus on the "internal" market. We don't ignore the "external" market -- the Dow Jones, the S&P 500, the Nasdaq Composite etc.
But we know that the various market sectors behave like mini stock markets unto themselves.
When we look at market breadth, we're looking to see how sector bullishness and sector bearishness are currently distributed across the market.
This image was generated by the data engines that power Sector Prophets Pro, our Premium data and research service.
Sectors under the control of the bulls (i.e. Demand or buyers) are shown in blue. Sectors in the hands of the bears (Supply, or sellers) are shown in red.
After the close on April 17th the bulls controlled 17 sectors -- 38%.
After yesterday's close they controlled 14 sectors -- 31%.
This change is a far cry from the stampede from blue to red we were seeing in mid- to late-March.
Our key internal indicator - the New York Stock Exchange Bullish Percent Index (NYSE BPI) is still in an X-column and still on a "Buy" signal. That means the market is showing strength in the short- and as well as the longer-term.
What's more, the chart didn't fill any additional boxes over the past week.
So that's another sign that the market has at least stabilized.
As I mentioned before, today's strategy is one we put into action back on February 15th.
At that time we had in our sights set on three weak stocks set to report earnings early the following week.
When I say these stocks were "weak" I mean it.
We were able to spot that weakness by running each ticker through the Position Key feature of Sector Prophets Pro.
Here is the image SPP generated when we put one of the stocks, FLR, into the Position Key.
The stock was in a weak sector (the first and second red arrows)...
It was weak against its sector peers (the third arrow)...
And it was weak against the market as a whole (the fourth arrow, at the right of the image).
Our plan for these stocks was simple and came in three parts.
One, watch to see if any or all of them delivered an earnings "beat" (reported revenue and/or earnings numbers that exceeded analysts' estimates)...
Two, watch over the next couple of days for that stock to pop higher on the strength of that beat.
Three, short it (or buy a put option on it).
The thinking behind the strategy is that because the stock is weak, and resides in a weak sector, it'll likely fall back to Earth very quickly after a short-term move higher.
And then you'll get paid, also very quickly.
As it happened, not one of the three stocks from February followed the script by beating on earnings and then jumping higher in the short term.
But that's Ok!
Because with this strategy you're not "buying on the rumor". You're not taking a position and committing your capital ahead of earnings and then relying on an earnings beat to move your stock higher.
You wait for the up move, and then you short the weak-sister stock.
Naturally you can use this strategy on a strong stock as well, which is what we're going to do today.
If you find a stock in a strong sector that's outperforming its peers and the market as a whole...
And that stock disappoints on earnings (reports an earnings "miss") you wait for it to dip on the news, and then you buy it or purchase a Call option on it.
Because it's a strong stock in a strong sector, it'll likely rally quickly, and you'll get to bank your returns.
Pfizer Inc. (PFE) is set to report earnings next Tuesday, April 28th.
The stock checks all four of our "strong" boxes.
It's in a strong sector. The Drugs sector's BPI chart is on "bull confirmed" status -- the strongest designation for a BPI chart.
The sector is outperforming the market; its RS Chart is in an X-column (the second blue arrow from the left).
Pfizer is strong against its sector peers (the third arrow).
And it is outperforming the market as a whole (the fourth arrow, on the right).
If Pfizer disappoints on earnings next Tuesday (or if investors don't like the "guidance" they hear from management) and then drops in price on that news...
Buy it and wait for the rebound that is very likely to follow.
Better still, if PFE dips, consider buying the September 33 Strike Call option.
Right now the mid-price between the bid and ask for that option is $5.30. The price will almost certainly change by next week, so I'm just mentioning here so it can serve as a baseline.
One option contract controls 100 shares of stock. So by purchasing the Call option you gain bullish exposure in PFE for $530.
Pfizer trades for $37.38, so a 100 share straight stock position would cost $3,738.00 -- seven times as much.
If PFE were to pop 10% in 14 days, say, that option would be worth $8.36 -- a gain of 58%.
Again, these numbers will move around, but you get the idea.
Stay safe and sane and I'll see you next week,
Editor-in-Chief, True Market Insiders