Nasdaq Set to Splat

I am going to start a new series where I occasionally share actionable picks related to my subscription-based newsletter Wall St. Cheat Sheet. Recently, I have been watching Nasdaq OMX Group Inc. (NDAQ). Sellers have become more aggressive since October. However, buyers have been protecting the ~$18.10 area since the start of 2009. When this happens, it sets the stage for a potential breakdown if the line of defense breaks. Psychologically, many who were buying at $18.10 and remaining calm will decide to cut losses if we head lower. Additionally, those who are profitable from the lows ($14.96) will look to lock in profits as they fear a disappearing act. When this fear-fueled supply hits the market, we are presented with a low risk trade.

In this case, the first price target is $16.57,the second is $15.65, and the third is $14.96. So, if you enter a short or put position at a break below $18.10, you will look to take profits at these targets. Of course, you should take profits whenever you want. These are just suggestions and change in real-time depending on how the market behaves (you must make those determinations because I will not be there to tell you when to sell). You can set your stop-loss at $20.50 or $21 depending on your risk tolerance and outlook for the market. Once your trade is firmly profitable, you can always lock in profits by lowering your stop-loss to first break-even and then other profit levels that make you smile.

The risk-reward for this trade is not the ideal 2-to-1, but the setup is strong. Remember, NDAQ will only breakdown if the market continues lower. In the event the rally resumes (which is possible during volatile earnings season), all bets are off for now.

I am not recommending you make this trade. I am simply sharing a trade setup that I plan to take if the market conditions dictate an edge. For example, if you got short NDAQ today in the last 5 minutes of trading, there is a reasonable chance we could open higher tomorrow. Thus, it was a high risk trade (i.e., not my style). However, if we break below the entry tomorrow morning and the markets confirm weakness, the odds are much more favorable — and this game is all about trading with the odds, and watching when they are not on your side.

If you find this type of information valuable, please follow me on Twitter and consider subscribing to Wall St. Cheat Sheet for many more money-making ideas.

Book Review: The WallStrip Edge

I have long said that the underlying theme to all the greatest investment ideas is simplicity. Railroads connect geographic locations to facilitate commerce and travel. Cars get us from one place to another. Energy powers everything we need. Microsoft Windows makes computers functional for the masses. Google is our guide to searching the Internet.

In Howard Lindzon’s The Wallstrip Edge: Using Trends to Make Money–Find Them, Ride Them, and Get Off, Howard adds practical investing strategies to this core investment philosophy extolled by other world-class investors including Warren Buffett, George Soros, Peter Lynch, and Carl Icahn. The book is easy to read, full of fun stories, and Howard has an entrepreneurial spirit which will leave you excited and inspired to apply his advice.

If I was forced to summarize Howard’s book, I would say:

Ignore distracting opinions in the financial media so you can better see true trends as opposed to hyped noise. Once you spot genuine trends, follow up with due diligence on the company and stock. When the stock exhibits certain characteristics (you must buy the book for Howard’s secret recipe — see below), jump aboard and ride the train while using professional risk management techniques to take profits and cut losses.

The last part of the book is like bonus material. Howard offers his seasoned view on which trends he thinks are timeless, and others that seem to be on the cutting edge. This section gives readers a feel for Howard’s trend-spotting framework and sets the stage to find your next great investment candidates.

Most investment books claim to be for investors of all skill levels, but they are truly more suited for either beginners or pros. On the contrary, Howard’s book is actually a gem for beginners and pros alike. I would be equally comfortable recommending this book to my teenage cousin or a hedge fund manager. Both will walk away with value.

Lastly, Howard has his hands and cash in many interesting companies. I sat down with him (in the virtual world) to learn more about his ventures, how he got started, and some bright new prospects he has uncovered since publishing his book. You can read our exclusive interview in next month’s addition of my popular newsletter Wall St. Cheat Sheet. (Follow me on Twitter).

To purchase Howard’s must-read book, click the first link below ($16.49 new). To purchase the electronic edition for your Kindle, click on the second link below ($9.99):

Retailers on Viagra and Amazon’s Blindside Threat

The following article is a reprint from this month’s issue of SmartGuyDH’s popular newsletter Wall St. Cheat Sheet:

Retailers are performing better than Wall St.’s most pessimistic predictions. So, the stocks have helped fuel the recent rally. Regardless, this is truly a matter of “very shitty” outperforming “shittiest.” Thus, don’t get caught sprinting into the headwinds of continuing unemployment and increasing savings rates. Walmart (WMT) continues to be the only low-risk play in the sector.

The internet version of Walmart, Amazon (AMZN), has been a Wall St. darling lately. The killer app Kindle evolved to 2.0 and consumers are on a waiting list to sip a fine Pinot while caressing Oprah’s favorite new gadget. But, I think valuations (e.g., PE ~50) for the stock are now in the emotionally euphoric zone. Uber-cool Apple (AAPL) has announced a new tablet device launch sometime later this year, and those with a fetish for AMZN don’t seem to understand the implications. Read my lips: if AAPL releases a device with book reading capabilities like the Kindle, and they use content leviathan iTunes to sell digital books, AMZN shares will fall faster than Bernie Madoff’s reputation. Thus, AMZN may be a great day trading vehicle, but the risk-reward is not great for holding overnight.

The Retail Holders ETF (RTH) really transformed from limp to stiff this month. However, unlike my wife, they are not pregnant with anything special.

Viagra-style Move:

Earnings season should be a roller coaster ride for retailers. There will be real winners and losers. However, before making any long term investments, make sure your picks have strong business activity. Most people are piling into the sector simply because companies may start beating heavily reduced expectations. In other words, analysts have assumed something near a nuclear holocaust, so anything like a depression will “beat the Street.” Caveat emptor! It is better to be out of the market wishing you were in, than in the market wishing you were out. If you are not a short term trader, your time will come.

To subscribe to Wall St. Cheat Sheet and read the entire April issue, please visit wallstcheatsheet.com.

Book Review: Technical Analysis Using Multiple Timeframes

If you follow my trades and comments, you know I am more of a trader than investor. Given the recent per se deceit flowing from the mouths of government officials and CEOs, I have been spending increasingly more time honing my trading skills because investors (and the public at large) are apparently nothing but suckers.

I have learned this lesson perpetually since graduating during the dotcom bubble, experiencing the bubble’s implosion, watching Fortune 500 companies lie and steal (e.g., Tyco, Worldcom, Enron, etc.), realizing the Federal Reserve purposefully caused new bubbles in the housing and credit markets, and now witnessing the new wave of legal con artists at Bear Sterns, Merrill Lynch (MER), Lehman (LEH), Fannie Mae (FNM), Freddie Mac (FRE), et al. Rather than get angry and fill my days discussing moral hazards, I’ve decided to accept reality and enjoy myself while reading Brian Shannon’s Technical Analysis Using Multiple Timeframes.

First, let me preface my first book review by noting that I am extremely skeptical of marketing experts who sell trading systems and technical analysis products. However, I believe the Internet will allow a handful of successful investors and traders to build a loyal following if and only if said followers can make money. Brian is going to be one of those success stories.

When I first received Brian’s book, my wife joked, “How’s your textbook?” However, I think she was spot-on with her accidental compliment. Like a short textbook, Technical Analysis Using Multiple Timeframes is laid out in a very logical fashion and offers loads of practical knowledge. I would classify the book as intermediate level material, although it’s an excellent resource for technical analysis newbies.

For purposes of this review, the book has four sections. In the first section Brian introduces technical analysis, explains the four stages of a market cycle (accumulation, markup, distribution, and decline), and details the major variables in his methodology (price, support and resistance, trends, volume, moving averages, and time). In the second section he shares his secrets about how and when to buy long and sell short.

In the third section Brian addresses news and fundamentals concerning companies and their stocks, then he has a very nice intermediate/advanced analysis of short squeezes (and how to profit from them). In the fourth section he offers invaluable wisdom on risk management and exit strategies, his personal rules and insights, and an excellent conclusion entitled “Putting It All Together.”

It’s hard for me to go into too much detail because I don’t want to explain Brian’s system and defeat the purpose of reading the book. So, here are some core characteristics to consider:

• Brian is a pure trend trader. If there’s no trend, he ain’t trading.
• Brian possesses professional insights into market structure and the psychology of supply and demand.
• Brian is religious about risk management.

If you are serious about becoming a better trader or learning how to improve your buy and sell decisions, Brian’s book will pay for itself the next time you make a transaction. Unlike countless “classics” that spend 200 pages preying on our get-rich-quick tendencies, Brian skips the infomercial and delivers a practical framework we can use to make money or preserve capital.

If you are interested in purchasing his book or learning more, please visit:

Lehman Buyout Rumors Don’t Pass the Laugh Test

In the legal world, an incredibly illogical argument is said to “not pass the laugh test.” Last week an anonymous source told Reuters that the Korean Development Bank had Lehman (LEH) on their watchlist. LEH and shares of other financials rallied nicely on the news. However, no one stopped to question the absurdity of a savvy prospective buyer literally showing its cards to the entire world.

For those who did not take Econ 101 or Negotiations 101, here’s a quick primer:

If you are going to bid on an asset, do not tell anyone because then those people will buy in anticipation of the bid. As a result, the price will increase proportionally with increased demand, and you will be forced to pay a higher price for the same asset.

In this case, we are supposed to believe that a major financial institution would rather have everyone and their grandparents bidding up shares of LEH so Korean Development Bank could pay a higher price than they otherwise would have if they simply kept their mouth shut. For example, if the bank was planning to offer a 15% premium for LEH, they can either offer that premium on $12 or less, or they could offer that premium on $14 or more after alerting the entire world of their plans.

I honestly feel sorry for the average person who is investing their savings in the stock market on the bare trust that the financial media and SEC are actually doing their jobs. I’m glad longtime readers of SmartGuyStocks never buy on absurd rumors, but I can’t imagine how many hard working middle class folks bought LEH last week and are sad to see the results today. When Wall Street PR spin doesn’t pass the laugh test, those who are laughing hardest are those laughing their way to the bank as they pass the bag.

The Price is Light: Market Weighing a Skinnier Load

There is a famous American game show, The Price is Right, during which contestants attempt to guess the correct price of a certain item. The winning contestant guesses closest to the true price. A somewhat similar game is occurring with the stock market’s financial companies. However, rather than observing a familiar item and guessing the price based on a few simple known variables, many complicated and obscured variables affect the true value of financial companies.

Let’s attempt to play a simulated version of this game with the headlining stock Lehman Brothers Holdings Inc. (LEH). A little over a year ago, LEH was trading near $80 a share. The company was coming off a multiyear bull run and was profiting from investments related to the strong real estate market, the roaring global boom, and tons of private equity deals and IPOs. The market looked at LEH’s financials and imagined every investment providing superior returns, the global boom spiking without fail, and the deal flow continuing ad infinitum. Although none of those projections were connected to reality, they were included in the stock price nonetheless.

So, in our simulation we are now staring at a share of LEH trading at $80 in 2007. We are bright-eyed and having idealistic fantasies like parents do while staring at their newborn babe. LEH is our little darling. LEH can do no wrong. LEH is genius! We are guessing that the price of LEH is “right” at $80 - for sure.

While we are staring at our simulated computer screen enjoying the beautiful ascension of our darling, simulated LEH employees are making trades, signing contracts and checks for more projects, and marketing their services to prospective clients. As all the aforementioned booms started losing momentum, the quality of the then current deals began to erode. Long trades in real estate related securities started to sour. Deal flow came to a screeching halt. But all the while, LEH bulls kept demanding shares because they were living in a deluded intellectual world where LEH was invincible.

Last summer a handful of people snapped out of their daydream. So, LEH shares started to slide. Despite the mounting evidence that the boom had peaked, LEH management and their well-paid PR machine told the public, “Although you can’t see behind our veil, trust us that things are just fine.” And since most analysts, fund managers, and individual investors are too far removed from the company’s reality, they drank the Kool-Aid and guessed that the price for LEH was “cheap.”

This is the point when most people are simply investing based on the inertia of the market (e.g., “buy the dips”). Although any reasonably discerning person could find plenty of data to support that major problems were manifesting in the economy (if you are lazy read Barry Ritholtz’s brilliant blog The Big Picture), the inertia bots piled back into shares and kept them stable until February of this year. At that point, reality was harder to conceal and the protectors of the veil (e.g., CEO, PR team, Federal Reserve, National Association of Realtors, etc.) were forced to concede a host of problems. Thus, the next wave of sellers dumped their LEH shares.

Despite the concessions and selling, the protectors of the veil followed all their negative revelations with positive rhetoric and spin. They are, after all, trying to prevent us from accurately repricing the market all at once - because that’s what we call a “crash.” So, once again plenty of inertia bots started buying shares. As a result, we had a little rally from the middle of March until the middle of May. At that point, more of reality was revealed, and the next wave of selling began.

At this point, we are in the present moment: Monday, July 14, 2008. LEH has taken a hard beating down to $12.40. The mainstream media is finally reporting that LEH owns ghost towns and has an enormous amount of possibly valueless illiquid assets on their books. However, despite all the negative data about LEH’s reality, there are still people who continue to buy. And, despite those who continue to buy, the reality behind LEH’s veil has still not been fully disclosed - not to mention the economy is getting worse.

This same issue is true for the market as a whole. Although companies have revealed some things about the cancers growing on balance sheets, they haven’t revealed everything. And we definitely don’t know how much worse that cancer will be as the economy continues to slow. But, like contestants who know results of a reality show that was filmed but not yet aired, those who can see behind the veil are very well aware that share prices are not yet based on reality.

Legendary investor Benjamin Graham said, “In the short run the market is a voting machine, but in the long run it is a weighing machine.” So, we will continue this classic Bear Market game where insiders are forced to give us nuggets of reality and prices reduce another leg based on weight. Then protectors of the veil will find a statistic or two and claim things are bottoming, and we will have another bounce based on votes. Maybe LEH execs will even consider going public to end the slaughter? But until we know everything and get to stare at the naked skinny horror behind the veil, LEH and the market will continue to be inaccurately priced as a heftier load. Therefore, I recommend staying out of this volatile market unless you are an incredibly skilled trader. As the maxim goes, “When in doubt, stay out.”

Stay tuned for SmartGuyDH’s upcoming article about how to play this market …

Steal shares of Metalico, not church organs

• Buy MEA around 14.03

In the latest sign of the global commodity craze, churches in England are seeing increased thefts of metal from roofs, statues, and plaques. And last week, someone even stole the organ pipes from a 13th century church, presumably to cash it in for scrap.  Here in America, we have a little more respect for our religious institutions-so we limit our larceny to kegs and manhole covers.

The bottom line is that metal prices are soaring, especially in the scrap and secondary markets. And as iron ore prices increase (Rio Tinto recently announced it secured an 85% price increase for the current contract year), scrap metal becomes an even more appealing alternative. This is not likely a passing trend- Dan DiMicco, the CEO of Nucor, the largest metal recycler, stated last month of CNBC that he sees 15-30 years of a strong continued upward trend in metal demand and prices. He acknowledged that there may be some short-term blips, but the overall trend would be sharply positive.

Nucor is putting its money where its mouth is, gobbling up scrap metal operators. In February, it bought scrap broker and processor David J. Joseph (”DJJ”) for $1.4B. In April, its newly acquired DJJ platform acquired two smaller scrap processors for an undisclosed price. According to the company, it plans to use the DJJ platform as a “a platform for continued growth in the scrap processing industry.”  It also sees an opportunity for more consolidation in the industry as prices rise. And Nucor’s acquisition strategy appears to be on the fast track, as the company raised $2.05B through a recent stock offering and plans to raise an additional $1B by selling bonds for acquisitions, capital expenditures, and general corporate purposes.

So who might be a beneficiary of high scrap metal prices and a dominant industry player hungry for M&A? My bet is on Metalico (AMEX: MEA). The ~$500M New Jersey-based company operates a number of ferrous and non-ferrous scrap processing facilities as well as a lead-fabrication business. The company has been acquisitive in its own right, and its blowout 2008 first quarter was a result of successful acquisitions and high demand for scrap.

The street has begun to take notice: in the past few weeks, analysts have upped their price targets on the stock to $20 and $21, citing increased worldwide demand for scrap. And although the stock has risen over 40% this year, it is currently more than 20% off its high. Analysts currently expect revenue to increase by 135% this year and at least 13% the next. Given MEA’s recent track record, this latter number seems potentially very light.

Shares of steel-related companies, including MEA, tanked last week on worries over GM’s production cutbacks.  This despite an earnings announcement from Schnitzer Steel a few days earlier, whose CEO stated that “Global demand for recycled metals remains robust, driven by economic growth in developing countries.” Dan Dienst, CEO of Sims Group (another large metal recycler), appeared on Cramer’s show Tuesday night to dismiss any worries. He cited the “voracious” demand for metal, both ferrous and non-ferrous, that his company continues to see. He specifically addressed the GM issue, noting that “a couple million tons in diminished production” from automakers is not going to come close to offsetting the huge infrastructure demands from BRIC countries.

An analyst from UBS was out yesterday with a note to buy steel companies on last week’s overdone drop.  I agree, and believe that this is one of those aforementioned negative blips in a company with a clear positive trajectory. Between the strong demand for scrap metal and the possibility of a buyout, Metalico is a buy.

Disclosure: SmartGuyStocks is long MEA

SGS Five Investing Pitfalls: #3 The One-Dimensional Thesis

Savvy investing is tough. Success requires solid due diligence and constant observation of the economy. However, many investors like to oversimplify a thesis and then buy-and-hold with total confidence.

Since last fall I have received many emails from readers who challenged my assertion that the bull market was finished. On December 31, 2007, I wrote an article Banking Crisis: No End in Sight. Some Seeking Alpha readers passionately argued that banks were in as little trouble as their CEO’s alleged - despite the troubling mortgage and commercial loan data I provided.

The constant theme I noticed was that some people bought into stocks like Wachovia Bank (WB) on the general thesis that finance is the engine of capitalism and therefore will be fine in the “long term.” This is the same bullish rhetoric I quoted in my article as stated by Rich Pzena of Pzena Investment Management (PZN): “Citigroup is everywhere. It is a massive global franchise that will grow in line with global financial growth …” Try to explain that to the poor investors and employees who have seen WB and C shares erase all gains from the past 16 and 10 years, respectively. That, my friends, is as “long term” as long term gets.

The lesson here proves that developing a general thesis is not enough. In fact, a general thesis is merely a starting point for the savvy investor. The next action step is due diligence, and the following step is constant monitoring of the situation. When investors execute step one and ignore steps two and three, multiyear gains can evaporate quicker than Lake Lanier during a drought.

I can tell investors are ignoring steps two and three when they tell me broad-based statements like, “WB is a steal at 40 because it’s already down over 20% from its highs,” or, “With WB’s dividend, you can just load up the truck and get paid to wait.” Wait for what? The stock to go to 15 and the dividend to get slashed or suspended? If you find yourself ignoring important reports displaying a company’s exposure to a major problem (e.g., WB’s exposure to toxic debt), you are deluding yourself into the land of hope and dreams. And once you start using hope as support for your thesis, your investing days are limited.

Another perfect example of the one-dimensional thesis is Whole Foods Market (WFMI). A very oversimplified thesis states that organics are a growing trend. True. WFMI was the first-mover in the space and delivered an excellent retail experience. WFMI also had nearly zero competition. With those supporting data points plus the awesome financial metrics, WFMI was a screaming buy.

However, over the past several years many world-class companies have entered the still growing market for organic products. Traditional grocers such as Kroger (KR), Walmart (WMT), and Target (TGT) created isles dedicated to organic foods, while other organic retailers such as Wild Oats and Trader Joe’s simply attacked the niche - and companies such as Safeway (SWY) and Publix (PUSH) did both. Thus, WFMI lost its first-mover advantage as well as its pseudo-monopoly (i.e., pricing power). Once you add food inflation, rising shipping costs, merger costs (Wild Oats), and decreasing consumer spending, WFMI looks like a very ripe target for multiple contraction and decreasing earnings. But the one-dimensional thesis (i.e., increasing demand for organics) is still intact. If you relied on this sound thesis without due diligence and constant observation, you probably watched 6 years of gains disappear like organic double-chocolate brownie samples on the bakery counter.

So, next time you find yourself conceding to cognitive dissonance and ignoring new data points, take a step back and make sure you’re not succumbing to the pitfalls of the one-dimensional thesis. If you are the preventative type (which I highly recommend), then apply your trusty three-dimensional framework - sound thesis, due diligence, and constant observation - during all your prospective and current investments and trades. The added dimensions will blow your mind when you preserve and grow your hard-earned cash.

Water ETFs are Correlated to Market Tide

• Sell PHO and PIO around 22 and 24 respectively

Eleven months ago I recommended the water ETFs PowerShares Water Resources (PHO) and PowerShares Global Water Portfolio (PIO). I was specifically seeking an asset class uncorrelated to the broader stock market. However, I think too many traders and funds are buying and selling these assets based on the same signals as broader market indicators. Therefore, the investments have not met my thesis and need to be sold.

This is a good lesson for investing. We have many prospective investments, yet only enough cash to buy a tiny fraction of assets. As a result, we must consider our opportunity costs when holding investments that under-perform. Moreover, we want to cut our losses when a thesis has been proven incorrect. If for some reason these water ETFs start trading as if water is a scarce commodity, then I will happily jump back in the pool.

SmartGuyDH no longer owns shares of PHO or PIO

Putting PETS to sleep

• Sell PETS around $13.79

They say you can’t teach an old dog new tricks. Well, two-time SmartGuyStocks pick PetMedExpress (Nasdaq: PETS) seems to have one impressive trick down pat: beating earnings expectations, as it again bested analysts’ guesses this week for the fourth quarter in a row, growing sales 11% and profit 39%.

But there’s another trick that PETS can’t seem to learn- sustained stock price appreciation. Despite a long history of top and bottom line growth, a quick glance at PETS chart shows that it just can’t seem to remain in the market’s favor. Sure, it jumps after its predictably great earnings, but then it either seems to trade in a range or slowly trend back down.

So with the stock up over 20% in the last two weeks on the back of strong earnings and a shaky market rally, its time to cash out for now and take our gains. Advertising inventory will tighten up in the second half of the year with record dollars being spent on the upcoming election, and PETS could find margins slightly squeezed with increasing marketing costs.

We still stick to our original thesis that has proven true at each PETS quarterly report: pet medications are a growth market, and PETS will benefit. PETS has three secular trends working in its favor:

1. Pets are becoming a more integrated part of the modern family

2. Pharmaceutical companies are pouring more money into new drug breakthroughs

3. People are becoming increasingly comfortable ordering all sorts of products, including medications, over the internet

So while we reluctantly put PETS to sleep, its only because of the risk/reward benefit at this point. If the stock drifts back down to ~11, which it almost certainly will unless we see a true bull market, we will again be buyers.

SmartGuyAB no longer owns shares of PETS