A sell signal for the S&P 500 is coming from U.S. Treasuries, but this is still a “buy weakness” market until something changes.

Monsanto – positive trends expected to continue

McCormick – downside risk

Greenbrier – upside risk

As we’ve discussed frequently so far in 2013, our basic view of the market right now is based on the Federal Reserve’s support of the markets through U.S. Treasury and mortgage-backed security purchases, which combine to be the greatest amount of liquidity the Fed has ever given and is expected to continue through 2013 and perhaps even longer. Somewhat tied to this view is the “Great Rotation” view among so many that money is going to come out of bonds and Treasuries and go into U.S. stocks. This would naturally lead to a rise in interest rates and that’s exactly what we’ve seen for much of 2013 – U.S. Treasury yields have gone higher even though the Fed has been buying U.S. Treasuries. These means more money has come out of Treasuries than the Fed was able to put in, and much of that money has gone into U.S. stocks.

However, during the past three weeks we’ve seen U.S. Treasuries rally and yields decline. This shouldn’t be too much of a concern given the Fed’s action, but it does go against the “Great Rotation” theory and in the past has coincided with stock market selling. For nearly 10 years now, whenever yields have rolled over from an overbought level based on the stochastics to the point they are now, the S&P 500 has sold off with it or was about to, but also, by this time, it was at or near the end of the selling.

The S&P 500 closed last week at a high, so we haven’t seen such selling yet… and given the liquidity added to the market in April – four out of five trading days each week during the month – we’re not confident we are going to see any real selling. Still, this is the first real sell signal we’ve gotten in 2013 other than just some simple seasonality and it is worth watching closely. We are still buyers of weakness though so we will view any such selling as a buying opportunity.  Or, more accurately, we are focused on trading long around earnings and looking to hold some of our successful trades for an extended period and that’s the strategy we want to continue to have while the Fed is adding so much liquidity to the markets. But during periods of selling, we well take profits more quickly on our long trades and will give a little more weight to trading short.

For much of the past couple of weeks, the S&P 500 has pushed against the 1,563 area and then sold off the next day. Each selling day saw a higher low, but the S&P 500 couldn’t make it through until Thursday. To be confident the market isn’t selling off like, we need the S&P 500 to remain above this 1,563 area. There is still more support below, so we will still have a bullish bias as long as these support areas hold, but we’ll lighten up and be less aggressive below 1,563.

Monsanto

The biggest downside risks to Monsanto (MON) going into its earnings release are probably weather and comparability. The fiscal second quarter is the strongest seasonal period for the company as seeds are shipped ahead of planting. During the fiscal second quarter last year we experienced an unusually warm winter and mild spring, which puled forward sales from future periods into the second quarter. That means comparisons to the same quarter last year will be tougher since this year has been much cooler – to the point that the Economist recently published an article Jason Hansen, the scientist most commonly credited for first brining awareness to global warming, admitted that their global warming models have been wrong and unless temperatures rise over the next couple of years, the whole global warming theory will have been proven wrong.

But while the pull forward last year makes for tough comparisons this quarter, it makes it easier during the second-half of the year. In fact, even though the company soundly beat estimates last year, it also said that earnings during the second-half of its fiscal year would be essentially flat. That put the near-term growth behind it and the stock sold off over the next six weeks before bottoming. That could very well be the positive this quarter as the company should see stronger growth in the second-half of the year compared to last year. That suggests stronger earnings releases are still ahead and puts our bias on the long side with the upward trend in earnings estimates.

Still, when it comes to trading shares of Monsanto after earnings, there are also important factors such as guidance, but those items tend to affect the stock more on the gap. From there, the stock has traded based whether it beat or missed the MyRollingStocks® number. For example, when Monsanto has provided negative guidance in the past but reported earnings that were above the MyRollingStocks® number, the stock gapped lower by 3.59% on average, but then gained an average of 5.23% throughout the day and a month later it was up an average of 9.01%. The one time the company provided positive guidance but reported earnings below the MyRollingStocks® number, it just marginally ticked higher at the open, but was down 0.82% by the end of the first day and an additional 2.0% on the second trading day.

The consensus earnings estimate is $2.55 per share and the MyRollingStocks® number is $2.63 per share. The company is scheduled to report earnings before the market opens on Wednesday, April 3, 2013 with a conference call at 9:30 AM ET.

Technically, the stock gapped higher last quarter after it beat the MyRollingStocks® number and was an after-the-news play where we pointed out that the price pattern gave us upside room in the stock to just under $103, which it hit about two weeks later. We generally shoot for a greater return for our short-term trades, but this still calculates to a 95% annualized return before commission. Still, from the gap higher in January, the stock has formed a similar pattern just on a longer time scale, where as long as the stock remains above $105 it has upside room to $112.

McCormick & Co

Last quarter McCormick & Co (MKC) missed estimates and lowered guidance. The stock sold off on the news with heavy volume, which has turned out to confirm $61 as a strong support area that we see little evidence is going to be broken. The stock is a long way from $61 at the moment though and when you consider the company has historically traded at 16.8 times forward estimates but is currently trading at 20.7 times 2014 estimates, there is plenty of room for the stock to trade lower from Thursday’s close of $73.55.

The stock has also spent the entire month of March technically overbought based on the 14-day Relative Strength Index (RSI). The general rule is that when a stock exits the overbought condition it pulls back to the area it was when it first entered the overbought condition. For example, back on June 18, the stock entered the overbought condition at $57.83 and traded its way up to $59.24, but by June 25, it had traded back below $57.83. The stock opened on June 29 at $59.40 and the RSI pushed above 70, and by July 24, the stock was back below $59.40. The same move came after the overbought conditions in September and November.

There is support at $67 based on the prices just before the company’s negative earnings in January, and that happens to be the open where the stock pushed its way into its current overbought condition. A pullback to this level would be reasonable, but we see $68.40 as a better target to either look to take profits on a short sale or to consider going long after the news.

McCormick is scheduled to report earnings before the market opens on Tuesday, April 2, 2013 with a conference call at 8:00 AM ET. Statistically, the best trade for McCormick has come when the company beat the consensus earnings estimate but missed the MyRollingStocks® number and then opened lower on the news. This quarter, the consensus earnings estimate is $0.56 per share and the MyRollingStocks® number is $0.58 per share.

Greenbrier Companies

The railroad companies we generally follow are either right around their all-time highs or looking to break out to all-time highs. They’ve been able to do so without multiple expansion too as nearly all are trading right in-line with their average forward PE multiple over the past 15 years, which means the move has come with rising earnings estimates. The growing earnings provide the railroad companies with the ability to pay for new freight car equipment. We haven’t seen much of that growth trickle down to Greenbrier Companies (GBX), but that appears to be at the cusp of changing.

The data on the previous page for Greenbrier shows earnings estimates for 2014, which bottomed basically in February. The company had revamped one of its production lines to add capacity and that was resulting in flat earnings growth expectations for 2013 while the rail industry expanded and its railcar peers outperformed. Now the new production is beginning to come online and, in the meantime, the company has been gaining new orders and increasing its backlog. That’s why you see the increase in 2014 earnings estimates begin to move higher in March and that appears to be the beginning of a trend that should continue for several more months and quarters as the more recent orders bring the backlog to more than a full year’s production rate. About half of the recent orders have been for the higher-margin tank cars, which is part of the reason why Michael Baudendistel at Stifel Nicolaus recommended owning shares of Greenbrier ahead of its earnings release.

Greenbrier’s peer that has led the group has been Wabtec (WAB), and it is currently trading fairly close to its historical forward PE multiple of 15.8. Greenbrier has not commanded the same multiple as Wabtec in the past since it has historically traded at just 13.9 times forward estimates. But the stock still needs to get to $34 to trade at this historical multiple using current estimates – estimates that are expected to trend higher for the next several months and quarters – and that means the stock will need to increase by approximately 50%.

For the quarter, the consensus earnings estimate is $0.37 per share and the MyRollingStocks® number is $0.42 per share. Greenbrier is scheduled to report earnings before the market opens on Thursday, April 4, 2014 with a conference call at 11:00 AM ET.

Russell Reversals

Below is a list of upcoming earnings releases of Russell 2,000 companies that missed earnings estimates last quarter and traded down on the news. Buy the stock at the open after it reports earnings if it beats the consensus estimate and reports positive earnings (does not report a quarterly loss). Sell at the close of the next trading day.

A strategy of buying a Russell Reversal at the open following the earnings announcement and holding until the close on the second trading day would have averaged approximately a 58% annual return over the past 11 years.   A loss was made just under 40% of the time with an average decline of 4.15%, but there were more gains than losses and the gains were greater than the losses.

This is still a Fed-driven market and weakness should be bought, but there is evidence that we may see such weakness soon.

QUALCOMM – a longer-term trading strategy for a Fed-driven market

TASER – tailwinds are building

Newmont Mining – a laggard

 Wal-Mart – there is downside risk

 HEICO – some upside risk

Kadant – some upside risk

Price Trend

There was a day in late January 2013 when the overall stock market sold off. This was unusual because it was one of the only days during the month that we saw stocks decline. We said at the time that we did not believe it was merely a coincidence that it also happened to be one of the only times during the month that the Fed was not adding liquidity to the markets. We pointed out last week that Friday, February 15, 2013 was the only time during the month of February that the Fed would not be adding liquidity to the market and we do not believe it is just a coincidence that the overall stock market fell.

Our basic view for 2013 is based on the fact that the Fed’s balance sheet has the highest correlation with U.S. equity prices and in 2013 the Fed is going to expand its balance sheet like we’ve never seen before in history. If we are going to see the market let off some steam, it is most likely to come on days when the Fed is absent, and the only day during the month of February the Fed is not supporting the markets was Friday. The rest of the time, we have to have the basic view that weakness should be bought because we know approximately $2.5 billion in new money is coming into the market every other day this month from the Fed alone.

Historically, though, the top correlation with U.S. stock prices has been corporate earnings, and even if the Fed’s balance sheet is going to go up in a straight line, we have trouble accepting that stock prices will go up in a straight line for all of 2013. For the first six weeks of 2013 we not only had the Fed providing a tailwind at our backs, but we also had improving earnings relative to the previous quarter as we previewed at the beginning of the year, and we had normal seasonality in our favor.

From here until the middle of March, if you had bought a stock three days ahead of its earnings release and held it until the close two days after, you would have lost money on average. While it didn’t prove to be much of a roadmap in 2012, most of the major turns in the overall stock market in 2011 coincided with this seasonality and so far this year, the chart appears to be lining up. With the overall stock market technically overbought and optimism near an extreme, it seems reasonable to follow this guide until we are shown we are wrong. 

That’s not the only seasonal pattern that says to sell this week. We tend to see rallies into the middle of July after a new President takes office after a dip in late winter. When the first year of the cycle has a second-term President, then stocks tend to peak in mid-February and bottom in mid-March. This is the exact same signal shown by the pattern of earnings releases this time of the year.

Of course, it is one thing to set up a plan and a strategy, but we first need to see evidence that we are right. The chart below gives us some initial evidence as breadth has been negative while stocks pushed to new highs, but with $2.5 billion of new money coming into the market every day, we need to see evidence that there is more selling than this new money is buying. Therefore, we are going to become more neutral this week and dabble a little more on the short side, but maintain a long bias until we see actual selling. For now, that means a move below 1,515 in the S&P 500.

We are short-term traders who generally hold a position between one to five days using strategies that have shown to be correct, statistically, nearly 65% of the time and where the profits are greater than the gains. Of course, that means we are going to be wrong just over 35% of the time and for every six or seven double-digit gains, you should expect to have a few double-digit losses. That’s just the nature of trading.

All of our strategies factor in three things: 1) the earnings, 2) the price action, and 3) the time. Considering the Fed is going to expand its balance sheet by $1 trillion (with a T) in 2013 and still has approximately $875 billion to go, we believe it is reasonable to look for longer-term strategies. Of course, when we trade in the short-term on a catalyst such as earnings, we take away some of the broader market risk and when we use a strategy that averages a 1.25% gain over three trading days, then we get an annualized return of approximately 100% after factoring that almost 30 of the 80 trades will be losses. That assumes only one trade at a time, doesn’t compound results, and doesn’t factor in commissions.

There are a lot of things we can buy that will probably make us 1% or so per month if the stock market is going to move higher with the Fed’s balance sheet, but to be worth our effort to trade with a longer-term strategy, we need to look for trades that will annualize to a return on par with our short-term strategies.

One strategy that factors in earnings, price action, and time is to buy stocks on positive earnings news that gap to a level above the previous quarter’s high and hold it until the day before the next earnings release. We often see companies beat consensus estimates but miss the Word on the Street   number, but without guidance, analysts lower their earnings estimates. If we only use news that results in raised earnings estimates (i.e. a  beat or positive guidance), these stocks gain 5.41% over approximately 90 days. This comes to an annualized gain of approximately 21.6% before commissions and considering this comes during a decade and a half long period where the S&P 500 is basically flat, this is a simple strategy worth looking at. But the meat of these gains comes from the 19% of the stocks that never fill the gap from the previous quarterly high and gain 19.37%. The other 81% fill the gap but still close up 1.89% from the open following its earnings release until the day before it reports its next earnings release.

A trade that has better statistical returns comes from this 81% that fill the gap because 62.6% of these still close above the previous quarter’s high on the day before they release their next earnings release. The 62.6% that close higher gain 14.16% once they fill the gap and move higher and because they tend to take about a month to bottom out before going higher, you can hold the position for approximately two months. If you simply wait for a stock to fill the gap from the previous high and buy, then you’ll average (based on past results) a gain of 4.88% over a two-month period, which comes to a 29% annual return.

Even here though, we don’t know which ones will go lower and which ones will move higher, because only 17% of these hold here at this first support level, but those gain 17.82% up until the next earnings release, so using the previous quarter’s high as support creates a favorable risk/reward for a longer-term trade.

For example, we’ve mentioned two stocks so far this reporting season that we believe are important stocks to own in 2013. One being ARM Holdings (ARMH) and the other being QUALCOMM (QCOM). QUALCOMM beat the Word on the Street   number and, while it remained in-line with consensus estimates, raised its earnings guidance. As a result, estimates were raised on the news and the stock gapped above the $65.50 level. This level was the high last quarter and the quarter before that, proving to be an important resistance line. Now, however, the stock has pulled back to fill the gap.

In every after-the-news earnings trade, we draw lines and discuss important resistance and support areas, and what makes this longer-term trade so attractive is that we have a clear line of support to use where we can limit out downside and still capture the upside. We might have some small losses trying to see if support holds, after all, as Dr. Alexander Elder said in his book Come Into My Trading Room, “… support and resistance are flexible – they are like a ranch wire fence rather than a glass wall. A glass wall is rigid and shatters when broken, but a heard of bulls can push against a wire fence, shove their muzzles through it, and it will lean but stand.” Stocks such as QUALCOMM might fail to hold at support, but they also might stretch support before holding, so a move above $65.50 should be bought with stops just below because the average gain above this support level on the day before the next earnings release is worth taking putting stops just below.

Even if this level fails to hold and the stock goes on to fill the gap from the previous close, as the majority do, this only provide a second trade opportunity with limited downside risk but very strong upside room. Of these that fill the gap to the previous close, 61.3% still go on to trade higher into the next earnings release and those that do close 13.56% for a trade lasting approximately two months.

On the chart for QUALCOMM, we’ve provided the next fiscal year’s estimates, so after the November earnings release it shifted from fiscal 2013 estimates to estimates for the fiscal year ending in September 2014. This is different than our normal chart because we wanted to show how much cheaper the stock is now after a year of basically no movement in the price, but the key is that estimates moved higher. Now that the gap has been filled, a move above $65.50 with a stop just below creates minimum downside risk in the stock with a potential annualized gain of 100% by the time it reports earnings in April. If we get stopped out, we can reenter here later, or make a similar trade at $63.50 where the average annualized gain is 81% with minimal downside risk if placing a stop just below.

TASER

We provide most of our trades on our website and in our morning emails and we use this weekly newsletter to discuss the trading environment, important setups, and expectations for heavily followed companies. When it comes to politics, we do not believe it is our view to give our views and beliefs, but rather to stick our finger in the air and determine how to make money based on the political backdrop. Time magazine once referred to President Obama as the salesman of the year for the gun industry and we’ll leave that statement alone other than gun companies were seeing strong trends nearly each month and shares of Smith & Wesson (SWCH) were a favorite trade of ours around earnings throughout 2012.

Then the horrible shootings in Connecticut changed the political environment and it appears certain that some kind of gun control is coming. That is probably a bullish sign in the near-term for Smith & Wesson and consumers buy ahead of potential bans and restrictions, but the longer-term winners are likely companies such as TASER (TASR).

TASER has already seen favorable trends over the past couple of quarters and has tracked well this quarter, with an Word on the Street   number of $0.09 per share – above the consensus earnings estimate of $0.07 per share. Shares of TASER have already hit a 52-week high during the quarter, so a strong surprise is needed for the stock to get above $9.50, but the stock still has favorable odds through its earnings release, and the longer-term trend is likely higher. Throw in an environment where guns are limited, and an alternative form or protection has added upside.

TASR

On the chart, there is near-term trend support at $8.25 and stronger support at $7.50, but as long as estimates continue to trend higher, then the stock should continue to make new highs. TASER is scheduled to report earnings before the market opens on Thursday, February 21, 2013.

Newmont Mining

We don’t use Twitter much, but have recently decided to start tweeting trade setups that have favorable statistics and risk/rewards but don’t make it on our play lists. For example, the Fed is pumping money into the market at a pace of $2.50 billion a day and stocks are drifting higher. That is not something we want to generally short against until we see price action weaken. If we were bearish the market, we would have set Newmont Mining (NEM) as a Short Play ahead of its earnings release this week on an expected earnings miss and a potential violation of a long-term support as estimates trend lower. Instead of making it on our play list, we tweeted it. On Friday after we tweeted it, the stock gapped lower by 1.68% and then traded lower by an additional 1.21% and touched below $43. Below $43, we have a near-term downside target of $40 and a potential downside move to $28.

The stock trades partially with the price of gold, but the fundamentals are much worse than a decline in the price of gold. The company is set to produce less gold during the quarter than it did during the same period last year and sell less than it has produced, meaning sales are down and inventories are building. At the same time, the cost to produce gold is up. That makes for weak results with downside risk to estimates.

NEM

The consensus earnings estimate is $1.00 per share, but the Word on the Street   number is $0.96 per share. The miss should push estimates lower and as long as estimates trend lower, we view the stock as a value trap. The company is scheduled to report earnings after the market closes on Thursday, February 21, 2013 with a conference call on Friday at 10:00 AM ET.

Wal-Mart

As we’ve pointed out a few times already this year, the second half of February and the first half of March is seasonally bearish for stocks when it comes to trade on earnings. This period is heavily weighted with companies that closed their books at the end of January rather than the end of December… and this tends to be Retailers and Consumer Discretionary stocks. The largest is Wal-Mart (WMT) it has definitely added to the downside movement. It isn’t that Wal-Mart is down all the time, it is only down in the month of February around earnings 50% of the time. The problem is that the declines have been greater than the gains, including a 5.82% decline last year and a 3.49% decline the year before.

We measure this move from three days prior to its earnings release until two days after its earnings release and, since Wal-Mart is scheduled to report earnings before the market opens on Thursday and the market was closed on Monday for President’s day, this includes the price action from Friday.

On Friday, Jerry Murray, Vice Preside of Finance and Logistics at Wal-Mart, sent a corporate email saying “In case you haven’t seen a sales report these days, February month-to-date sales are a total disaster… the worst start to a month I have seen in my seven years with the company.” Shares of the stock closed down 2.15% on Friday.

WMT

Going into the earnings release, this news seems to give little hope that the stock will rally ahead of the news, and it has brought down expectations as well. The Word on the Street  number has gone from $1.58 per share to $1.56 per share while the consensus earnings estimate remains at $1.57 per share.

As we’ve discussed before, we believe Wal-Mart has broken out from a long-term base and we doubt we’ll see the stock below $63 again, so the closer we can get the stock near $63, the better we believe our chances of a favorable trade on the long side will be. In the meantime, the risk appears to be to the downside ahead of the news and likely after the company reports.

HEICO

HEICO (HEI) also has averaged a decline on earnings during the month of February, but that’s almost entirely due to a decline in February 2009 just before the market fell towards its panic low a couple of weeks later. This quarter, we’ve seen the Aerospace industry perform well and companies such as Teledyne Technologies (TDY) and B/E Aerospace (BEAV) have all traded higher on earnings to a new 52-week high. That’s good news for shares of HEICO since its stock has recently tested its 52-week high but has yet to push through it.

In fact, every time B/E Aerospace closed higher on earnings ahead of HIECO’s earnings release, HIECO subsequently closed higher on its on earnings release and almost every time the stock managed to trade higher following fiscal first quarter results, which it is currently getting ready to report, it was preceded by a move higher in B/E Aerospace.

HEI

HEICO is scheduled to report earnings after the market closes on Wednesday, February 20, 201 with a conference call on Thursday at 9:00 AM ET. The consensus earnings estimate is $0.40 per share and the Word on the Street  number is $0.42 per share.

Kadant

While peers of HEICO are giving a positive signal ahead of its earnings release, perhaps no company has gotten a better signal this week ahead of its earnings release than Kadant (KAI) has from its pear Twin Disc (TWIN). Over the past seven years, shares of Twin Disc have closed higher on its earnings release prior to Kadant’s own earnings release eleven times. The only time Kadant didn’t gap higher on its news was in February of 2006, when the company opened lower by 0.53% but then rallied throughout the day by 4.45%. On average, when Twin Disc has closed higher on its earnings release, Kadant then gapped higher by 5.06% and then averaged an intraday gain of 1.01% (though intraday results were more mixed). On January 22, 2013, Twin Disc beat the consensus earnings estimate of $0.14 per share with earnings of $0.29 per share. This made the stock a Russell Reversal – our only long play for the day. Revenue also came in above expectations and the stock gapped higher on the news by 6.71%, closed higher by an additional 3.42%, gained 7.45% on the second trading day. Two weeks later, it was up another 7.52%.

KAI

Neither Kadant nor Twin Disc have much volume, so it may be worth noting that Kadant has been buying back shares of stock, and that alone should help the bottom line on a per-share basis. The company also only has a handful of analysts following the company but they have been conservative in the past and have given room for an upside surprise. The consensus earnings estimate is $0.41 per share and the Word on the Street   number is $0.45 per share.

We have not confirmed the release date, but it has reported results during this week in the past and we expect the company to report after the close on Wednesday, February 20, 2013.