Fall Forecast:

Barron’s interviewed 10 strategists and the consensus view is for a 4% rise to 1700 by year end for the SP500. Looking for 2013 earnings of $107.85 and $116.50 next year. They like technology and industrial stocks, which should have good profit growth in 2014. Bond-like equities will continue to underperform. However, Tobias Levkovich of Citi says utility stock valuations are “compelling.”

Three of the ten expect a decline to about 1600.

David Kostin of GS likes AMXN, NFLX, R, RHI and LUV. Thomas Lee of JPM likes DIS, TWX, PCLN and MA.

OTHER NOTES

An article touts Carmike Cinemas. A “follow-up” on RUTH, currently at $11.82, can get to $15 in the next couple of years.

Allstate (ALL) at $47 can gain 50% over the next few years, according to Ken Crawford at Argent Capital. The stocks is at 1.1x book value and 9.3x estimated 2014 EPS. Those multiples are below the market. The yield is 2.1% and there is a $1b+ share repurchase program.

Newcastle Investment (NCT) is a REIT is going to focus on senior living, which is primarily mom-and-pop owners. NCT is targeting a 20% ROE.

Follow-up

Bill Nygren still likes DLPH, 11x ’14 earnings, as well as DTV. DTV is 10x next year’s expected earnings and the share count continues to decline. A merger with DISH would generate big savings.

Review

JPM might get hit for $6.8b in legal losses above reserves for manipulating energy markets.

Re-Energizing Peabody – Seerat Sodhi of QCI thinks BTU can roughly double in price.

Interview with David Kotak – Kotak said he is about at a 60/40 split between stocks and bonds now and mentioned that the NJ Turnpike tax-free munis were recently yielding 4.73% and the taxable NJ Turnpike bonds were at 5.15% (can be used in an IRA).

Vito Racanelli wrote about Teleflex (TFX). The price is down 12% for its April high and trades at 15x next year’s estimate, which is the average PE for the last 10 years and about 1/3 below its highs.

Here are some comments in Barron’s this week:

Kopin Tan wrote about the high valuations of grocery stores that sell natural, organic products. FWM, a 12-store chain in the NY area, is not profitable and sell for 112 times projected 2015 earnings. They had a 21% increase in annual revenue but SSS were up 1.4% and the average basket size was up 0.5%. SFM went up 123% on their first day of trading. By comparison, WFM trades at 27x 2015 projected profits.

Andrew Bary writes that “Barron’s estimates that Post’s net asset value is about $700 per share.” He is referring to the Washington Post (WPO), after the sale of the namesake newspaper. WPO is priced at $585.

Outerwall (OUTR) sells for 10x 2014 estimated earnings at a price of $60.85. OUTR has a FCF yield of 17%. Stock deserves a 12 multiple (David Englander wrote the article).

An MLP article mentioned ACMP, EMES, EPD, MMP and SXL has picks.

A bear market will begin with days, according to Robert Morrow. Morrow, an engineer by training, has used “vibration analysis” to predict market moves. He has high marks from Timers Digest and has made some prescient calls in the past, including the 2007 crash.

See the Barron’s note.

We closed out the short trading position that we spoke about last week in CAT. CAT had declined about 4% since then on disappointing earnings.

Today we closed out the pairs trade we wrote about on July 3 (+CHY/-CHI). We entered the trade at a spread of 6.3% and exited today at a spread of 5.09%, the difference represents the profit. To profit on a trade like this, you need the spread to narrow, which is what happened here.

see https://envisionco.net/?p=165

We are closing out our long positions in CAT at about $86. We had mentioned CAT as a good long term investment at about $87 on May 5 and we still believe that. But with the China slowdown the stock maybe susceptible to a near to intermediate term decline. Famed short-seller Jim Chanos mentioned as much at the Delivering Alpha conference yesterday. We had a buy/write position, a long position (in a longer term account) and a short position (in a short term trading account). We are closing out the first two positions and holding the short for the time being.

We looked at KO today. KO reported disappointed earnings yesterday as global growth slowed. KO is a good company for the long run but we would like to see the price drop. Based on historical parameters, we see the stock dropping to around $35 and would begin purchasing at $36.50. Given current information, we are setting a target price of $57.11 in 2017.

SPY opens up this morning close to resistance.

We have described in previous posts how to trade pairs. Today, we went short CHI and long CHY. Both are convertible bond closed-end funds run by Calamos. CHY is trading at a discount of about 7.3% and CHI is trading at a discount of about 1.4%. The difference is about 5.9% and the average difference (looking at monthly closes) over the last 2 years and a few months is about 3.3%. We entered our particular trade at a difference of 6.3%. We will aim to close the trade when the gap narrows.

See previous posts on pairs trading:

https://envisionco.net/?m=201212

and

https://envisionco.net/?m=201302

Warning: These are not guaranteed profitable trades. Please consult an investment advisory and understand the risks of these trades.

Mortgage REITs (MREITs) have taken a huge hit over the last couple of months and especially the last couple of weeks. AGNC is down 29% and NLY is down 20%.

Here are some of the basics on how they work. MREITs buy mortgage bonds and use leverage to compound their returns (and their losses). They essentially are borrowing short and lending long. Thus, MREITs like a steep yield curve. That helps amplify their income. But MREITs also trade at prices close to book value. And when interest rates increase, book value of bonds decreases. And when you add in the leverage, they can decrease very quickly and any benefit from a steeper yield curve will be more than offset by a decline in book value over the short run.

Let’s make up an example. Assume you are an investor and buy an MBS bond with a face value of $100,000, trading at par, that yields 2.8% and has a 15-year maturity. The market value of the bond is $100,000.

Now, what if the market yield on that bond increases to 3.4%? Now the market value of the bond is $95,766.95. Your $100,000 investment has declined by $4,233 or 4.23%. However, if you are an MREIT and are leveraged 5 to 1, that would mean that your $100,000 initial investment was composed of debt of $83,333 and equity of $16,667. Suddenly, the book value of your investment has declined from $16,667 to $12,434 ($16,667 less $4,233). The dollar loss to equity is the same but the percentage loss is 25.34% (with leverage of 5 to 1) versus 4.23% (with no leverage).

Investing in variable rate securities, or putting on hedges via options or swaps can help reduce the risk. But a MREIT that concentrates on fixed rate securities with minimal or ineffective hedges will take a big loss in this kind of example.

There is one glimmer of hope, the wild increase in rates has steepened the yield curve. That has the advantage of helping MREITs to increase earnings and to lower the risk of prepayments. Lower interest rates encourage homeowners to refinance, which causes the mortgage investor to lose their higher yielding investment, to likely be replaced wth a lower yielding mortgage. The higher rates now in the marketplace will likely lower the risk of prepayments. That, coupled with the higher spread and some stability in rates, might help the MREITs to help cash in again. Or maybe not if rates continue to increase and/or if the yield curve flattens.