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Lies, Damned Lies, Statistics and the Employment SItuation Report

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(A much less geeky version of this article appeared in TheStreet)

On Wednesday morning the monthly Automatic Data Processing (ADP) Employment Report was released.

Ever since they started doing so there’s been lots of disagreement over how accurately ADP’s numbers parallel or will reflect the government’s Non-farm Payroll statistics that are contained in the Employment Situation Report that comes out two days later. Regardless of the validity of the ADP Report it still has the capability of moving markets.

After last month’s disappointing official numbers the ADP number was pretty much on target for expectations but the market showed some mild disappointment in the pre-open trading, however, it got over that disappointment very quickly.

At this point we’ll have to wait until Friday to see whether there is concordance between the two reports and to see how the market reacts to the official numbers and revisions.

I recently collected some historical data looking at the relationship, if any, between the Employment Situation Report and market performance. Watching the release of that most recent government report and seeing the market react to very disappointing numbers by pushing the market higher had me realizing that it seemed as if the market always went higher with the announcement of those official numbers.

Who knew that in the comfort of my retirement I would actually once again find myself dusting off a statistics program and running t-tests? That is the sort of thing that nightmares are made of, rather than dreams.

Contrary to my supposed realization, beginning with January 2011 there were no associations between the reporting of data, regardless of its content and how the market did, neither in the week leading up to the report nor the week following. Neither did the day before the report release have any predictive value.

That is unless you looked at the past 18 months.

During that time period there was a statistically significant likelihood that on the week preceding the report and the day preceding the report that the market would move higher. The following week simply performed no differently whether preceded by an Employment Situation Report or not.

For those interested in such things, the random chance that the market went higher on the day of the Employment Situation Report release was less than 4% and less than 2% when considering the prior week.

While that seemed compelling, as with all statistics it helps to look beyond the numbers and try to have an understanding of possible confounders or environmental factors that may have played a role.

Perhaps coincidentally the past 18 months reflected the beginning of the third and final phase of Quantitative Easing.

Because of that possibility I wasn’t terribly excited about being further long the market in anticipation of an additional Employment Situation Report fueled run higher, considering that there appears to also be an association between the announcement of the taper and the market’s fortunes. Certainly the past month causes one to rethink a bullish thesis and the environment may now be substantively different with the taper in place.

Additionally, In hindsight, starting the week with a 325 point loss seemed to indicate that playing the market for a weekly advance in anticipation of Friday’s report wouldn’t have been a very good idea.

However, about half of the weekly gains seen in Employment Situation Weeks came on the day of the report, suggesting that there might be some advantage to adding long positions prior to Thursday’s close, even in the face of a market teetring and looking for direction and even in the face of losses earlier in the week.

Based upon the pattern of the past 18 months, while I generally don’t consider index ETF trading, I may look at the possibility of purchasing some SPDR S&P 500 Trust (SPY) shares with the anticipation of closing the position at the end of Friday’s trading by selling slightly out of the money call options on the position, as premiums are beginning to reflect increasing volatility and could enhance any report related advance in the index.

While statistics may have a wonderful ability to confirm whatever thesis one wishes to expound the relative benign reaction to a benign ADP report gives me reason to suspect that optimism may be warranted from 3:59 PM Thursday until 4 PM on Friday.

 

 

 

Is Jeff Bezos Killing Capitalism?

Lenin and Bezos

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A version of this article appeared on TheStreet)

My guess is that if you asked people to describe the face of the individual most tied to the idea of destroying capitalism you would evoke images of Marx, Lenin or Castro, men of distinctive features and great bluster who made no secret of their disdain.

Ask me and I see a man who is softly spoken, clean shaved, spares the bluster, lacks distinct or memorable features, although possesses a distinctive laugh and has greatly benefited from the system he is destroying. I see Jeff Bezos as the anti-capitalist who is methodically destroying the foundations that allowed the United States to thrive.

First, let’s acknowledge that Amazon (AMZN) is an American success story. Financed by family funds and embracing technology as none had before, it survived an era that many did not and turned a concept into reality that has subsumed retailing, forcing retailers to create online shopping strategies.

Amazon will report its earnings on January 30, 2014. While I don’t invest with items such as P/E, in mind, I know enough that Amazon’s P/E of 1414 puts to rest the derisive comments about it being a non-profit. But I also know that no one believes in the axiom “we make it up in volume” more than Amazon, which had a 0.19% profit margin last year, compared to a sector average of 9.5%. Of 20 national retailers, only four had profit margins lower than Amazon; JC Penney, Sears Holdings, Best Buy and Aeropostale.

And that is precisely the problem. That is how Amazon is killing capitalism in its methodic march to eliminate competition, beginning with the already wounded. As the saying goes, “the market can stay irrational longer than you can stay solvent.” Bezos, though, isn’t being irrational, as demonstrated by competitors that are slowly melting into irrelevancy. With size comes power, in this case pricing power, which to a degree has been supported by an asymmetric application of sales tax collection requirements. In essence, indirect government support undermining existing capitalist structure in support of a venture evolving toward a monopolistic or market controlling position.

At a time when consumer discretionary spending doesn’t appear to be consistent with an expanding and improving economy price sensitivity remains an important motivator and Amazon maintains its advantage by aggressive pricing at the expense of margins. With over $70 billion in revenues it trails Wal-Mart, but exceeds the combined revenues of Sears, JC Penney and Kohls, while matching Target’s revenues. The latter two companies have scarce cushion in their profit and operating margins to withstand further erosion by an energized Amazon, ready to continue decreasing its margins, as it has done over the past 3 years.

AMZN Profit Margin (Quarterly) Chart
AMZN Profit Margin (Quarterly) data by YCharts

Don’t get me wrong. I am a capitalist through and through and believe that competition is what drives us forward, while other systems are left to the ash heaps of history along with the dodo. The same fate should befall businesses that simply can’t compete on the basis of that blend of price and quality that appeals to varying segments of the population.

Competing against Amazon, however, is somewhat like the Aztecs being faced with gunpowder propelled projectiles.

Admittedly, I shop Amazon and will probably continue doing so even as it increasingly loses the sales tax advantage it held over brick and mortar retailers. However, it is now that next phase, as that artificial pricing advantage disappears, that Amazon can only do one thing to maintain its position. It has to further reduce its profit margins.

While Bezos may not be acting irrationally, investors may be accused of doing so, particularly in light of margins. Most any other retailing CEO would have been shown the door with performance such as Amazon delivers. However, it’s share price that talks and you can’t argue with a P/E of 1414, except that it’s 1414. The realization that profits and return on equity are important concepts is currently suspended as there is implicit buy-in from investors that the strategy of driving the competition out of business is a sound one in anticipation of even greater share appreciation rewards. Clearly the vision of near monopolistic existence has its perceived reward.

While Amazon may not solely be to blame for the woes at JC Penney (JCP) and Sears (SHLD), it may not be entirely coincidental that JC Penney and Sears profit woes began in earnest at the time that Amazon’s own profit margins began decreasing in 2011. Amazon is undoubtedly a contributor not just to those growing losses, but also to the degradation of the shopping experience as so graphically illustrated in a recent series of articles by Rocco Pendola. When you can no longer compete on the basis of price and are unable to generate sales revenues and cash flows, the only recourse remaining is to cut costs.

Fewer employees, bare shelves and lack of facilities maintenance are the natural next stages. As predictable as the “Five Stages of Grief,” except there may be no end stage healthy resolution in sight.

While Bezos is on a path that endangers capitalism, his continued success may really jeopardize Amazon’s own shareholders whose fortunes are predicated on a model that history has shown can’t be sustained. Eventually, profits and not promises, are the engine that drive companies and their stocks. Sooner or later, cash flow is no substitute for profits.

If you want to see capitalism saved, the answer is a plummeting Amazon share price and subsequent investor pressure to increase profit margins, restoring balance to the retail sector and giving the likes of JC Penney and Sears the ability to dodge those projectiles.

Taking Solace in an Earnings Challenged Coach

 

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(A version of this article appeared in TheStreet)

It has been very easy to be disparaging of Coach (COH) these days.

In 2013, including dividends, an investment in Coach shares witnessed a 3.1% ROI, as compared to 29.6% for the S&P 500, exclusive of dividends.

Perhaps the root cause of the quantitative disappointment has been the near universal acknowledgement that Coach was no longer a very interesting place to shop, as Michael Kors (KORS) had displaced it in the hearts and more importantly, the literal and figurative pocketbooks of shoppers.

The first hint of trouble presented itself in August 2011 when shares plunged 6.5% after announcing earnings, following years of running higher, that took only a short rest in June 2010. While shares went bacl to their old ways of climbing higher under CEO and Chairman Lew Frankfort that climb came to a decided halt shortly after the Michael Kors IPO.

COH ChartIn 2013 Coach knew only large price moves following earnings reports, following the pattern that began in 2012. The difference, however, was that in 2013 all but one of those large price moves was higher, with -16.1%, +9.8%, -7.8% and -7.5% earnings related responses greeting increasingly wary and frustrated shareholders.

Coach reports its second quarter earnings on January 22, 2014 prior to the market’s open. The option market is implying a nearly 10% move upon that event, which comes on the heels of a 6.3% decline in shares in the past week.

For most, that may mean that this would be a good time to steer clear of Coach shares or even consider exiting existing psoitions, especially as the retail sector has been struggling to get consumers to part with their discretionary cash.

In the past year, while Coach has been a non-entity, I have owned it and sold calls on shares, or sold puts on eight occasions. Included in those trades were three sales of put options on the day prior to earnings and one purchase of shares and sale of calls on the day following disappointing earnings.

COH data by YCharts

During that time Coach has fulfilled two of my cardinal requirements in that it has been a model of mediocrity, but still has something to offer and will do more than simply make a pretense of maintaing a business model.

My goal with Coach, as with all positions upon which I use a covered option strategy is to make a small rate of return and in a short time frame. My ideal trade is one that returns a 1% profit in a week’s time and surpasses the performance of the S&P 500 during the time period of the trade.

During 2013, the cumulative return from the eight Coach trades was 25.4% and the average holding period was 28 days. The average trade had an ROI of 3.2%, which when adjusted for the average holding period was less than the 1% goal, consistent with the lower premiums obtained in a low volatiity period. However, during the same time periods for each trade, the results surpassed the S&P 500 performance for the same time periods by 18.5%.

Coach 2013 Performance - Option to Profit

While I don’t place too much credibility on annualizing performance, the annualized performace of Coach, utilizing the serial covered option strategy, with some trades timed to coincide with earnings was 41.5%, while the annualized S&P 500 return was 34.7%. A longer period of observation also yielded similar favorable results

In the case of potential trades seeking to reach those objectives when earnings are to be released, my preference is to see whether there is an option premium available for the sale of puts that is at the extreme end of the implied volatility range or beyond. For Coach, the implied volatility suggests expectations of a price move in the $47.50 to $57.50 range, based on Friday’s closing price of $52.56.

The $47 January 24, 2014 put premium satisfies the quest for a 1% return and is at a strike price slightly outside of the implied volatility range. Essentially, the risk-reward proposition is a 1% return in the event of anything less than a 10% drop in share price. Anything more than a 10% price drop creates additional possibilities to generate returns, but extends the period of the trade.

As always, the sale of puts should only be undertaken if you’re prepared to take ownsership of shares at the strike price specified. While I wouldn’t shy away from share ownership in the event of a larger than anticipated price drop, I would be inclined to consider rolling over the put sale into a new expiration date and ideally at a lower strike price, if possible, repeating that process until expiration finally arrives.

While not everyone appreciates leather, everyone can appreciate investment profits, even if they come at the expense of corporate losses and a fall from grace.

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