By: Steve Smith
Stocks jumped yesterday on news that Moderna (MRNA) was a repeat of last week when Pfizer announced 90% efficacy in Phase III of a Covid vaccine. There was a huge dispersion among the major indices and sub-sectors rotation out of tech/work-at-home stocks and into ‘recovery’ stocks. The small-cap Russell (IWM) jumped over 2%, while SPDR 500 (SPY) was just 1% and the Nasdaq ( QQQ) fell 0.08%. I reacted just as I did last week; namely to short the travel/leisure names by employing the options strategy of bear call spreads.
Before I get to my trades, let me share an analogy as to why I think the market, which is currently pricing — in a scenario where the ‘epicenter’ stocks will suddenly be ‘better than ever’ — is simply wrong. At around age six or seven, one of the first serious questions you get from well-meaning adults is, ‘what do you want to be when you grow up?’ My answer was ‘ a stuntman.’ For a Manhattan-dwelling, private school-attending Jewish kid, this was not the expected answer. But at the time, my older brother and I were infatuated with 1970s action/disaster movies such as Poseidon Adventure, a multiple Oscar winner, Earthquake, Towering Inferno, etc). We were armed with a Super 8 movie camera and a never-ending supply of fake blood ordered from the back of comic books — no Amazon (AMZN) needed.
My brother liked to be behind the camera, I liked jumping off stuff and riding my bike into walls or water or whatever would bring me to a dead stop. We did big productions blowing up plastic miniatures, slow-motion shots interspersed with quick cuts to a cast of friends writhing in pain covered in blood. Real artists, we were. This hobby came with bruises and scrapes that were easily brushed off at a pliable age. However, injuries started to elevate to needing stitches and casts. Amongst my family, a little joke developed. After each emergency room trip, they’d chirp, “you’re all better” and I’d respond, “than ever.” When I broke my neck at 17, the repair work moved from cosmetic to a more substantial fix of the infrastructure supporting my mortal coil — paralyzed and ‘locked down’ in a halo brace. The optimism of my family’s call and response took on a grimmer tone. We knew I’d live. But in what capacity?
Six months later, the halo was removed and after a few months of rehab, I fully recovered, as I have from ensuring hip replacements, cancer, pancreatitis, and other sundry surgeries. After each, we’d continue to joke how I was ‘all better’, and for the most part, I was and am. But, I certainly don’t pretend or try to play pick up games of basketball with any 20-year-olds. So, to affix “than ever” to that statement, would be nothing short of delusional. Although I’m perfectly healthy and active, each incident took a toll, and sometimes it now feels I’m being held together with spit and glue; don’t think I could withstand another Poseidon, Earthquake, or Towering Inferno.
This is where I think we find both the broad clapboard Main Street economy and the narrow-but-reinforced steel world of Wall Street finance. Many companies simply won’t be able to withstand another few months of the current conditions, and a setback such as renewed lockdowns will be a fatal blow.
In the wake of the 2008 financial crisis, which was basically a bad broken bone, the best operators made changes, calling it a pivot in their diet, by giving facelifts or remodeling properties, investing in backend technology, and shoring up their balance sheets. And the low rates of drugs and bail-outs allowed most to survive, get healthier, and power on. In some cases such as Wal-Mart (WMT) or Microsoft (MSFT), they truly are ‘better than ever.’ However, across many sectors and major industries, i.e. retail, travel/leisure, energy, finance, and even legacy, tech had already been dealing with the bumps and bruises that come with time while competing in a changing and competitive landscape. Now, Covid lockdowns have attacked the vital organs of the economy and it’s life-threatening. I understand that given the market structure and nature of money flow.
If money managers who need exposure to ‘recovery’ stocks sell just 1% of the ten largest tech names with market caps approaching $1 trillion-plus, they now have $100 billion to plow into the ‘epicenter’. That sum is more than the entire cruise industry, even equaling the top four airlines’ current market cap. Meaning, a small rotation out of ‘work-from-home’ stocks can cause an outsized move in ‘recovery’ names. But many of these ‘epicenter’ stocks have been inflicted with damage that might prove fatal if it’s not fixed in the next few months. Or, at best, it will take years of recovery before getting back to earnings levels they were pre-Covid. Yet, the market’s pricing them as if they’re better than before right now.
I accept the notion that the market’s forward-looking and will discount current conditions on the condition that a vaccine’s around the corner. But, given the structural challenges, fundamental shifts in consumer behavior, and battered balance sheets, it seems a bit risky to downplay the next 2-3 years as a convalescence period needing to be waited out. Yesterday, based on these assumptions, the Option360 established a bearish call spread in Expedia (EXPE) after the stock initially popped over 5% to $128. This is when we sold the Nov (11/27) 131/134 call spread for a $0.75 Net Credit. In my opinion, there’s no way this company is ‘better than ever’ as the stock price suggests. While it’s trading above pre-Covid levels, it isn’t expected to regain the same earnings power until 2025!
Today, EXPE has already pulled back some $4% to the $122 level and Option360 members were sent an alert to close the position at $0.25; a one-day 50% gain of the maximum, or a 23% return on risk — a great and extremely conservative strategy. Where we go from here is anyone’s guess. The Federal Reserve and Congress have been injecting a potent, and experimental dual cocktail of monetary liquidity and fiscal stimulus, helping to mask the pain but not provide a cure. And like most drugs, the effects are likely to be diminishing, as supply runs out, especially for those that need it most.