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Richard Croft.
Richard Croft.

BNN Market Call

Three top stock picks from Croft Financial’s Richard Croft Add to ...

Richard Croft is president of RN Croft Financial Group. His focus is on options and ETFs.

Top picks:

Covered Call on Facebook

Buy Facebook Inc. at $46.95 (U.S.)
Sell Facebook Inc. Dec 50 calls at $3.50

Two reasons for a covered call on Facebook:

  • The stock appears to have momentum both in terms of the stock price and the earnings projector;
  • The options on Facebook are expensive due to its very high intraday volatility.

PowerShares S&P 500 BuyWrite Portfolio

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This is an index-based ETF that consistently writes covered calls on the S&P 500 composite index. In short, the ETF holds a long position in the S&P 500 and writes short-term at the money calls against the position. The S&P 500 has had a solid run and while I think investors should stay exposed to the U.S. market they might want to hedge their bets with a covered call strategy.

iShares S&P TSX 60 Index Fund

The Canadian market has underperformed the U.S. market over the past two years. I believe the U.S. market has been pumped by stimulus (i.e. QE III) something that Canadian market has not had. As such I believe the Canadian market is being priced on the fundamentals and one of two scenarios will unfold:

  • 1) the US market will slow and pull back as tapering begins, or
  • 2) the US economy will begin to pick up steam in which case the Canadian market will play catch up.

Past Picks: October 29, 2012

Calls on Toronto-Dominion Bank
Actual Recommendation: Buy TD January (2015) 90 calls at $4.75
Then: $4.75
Now: $6.00
Total return: +26.32 per cent

Straddle on SPDR S&P 500 ETF $152.11
Buy SPY Feb 143 calls at $3.50; Buy SPY Feb 143 puts at $3.45
Then: $6.95
Now: $9.11
Total return: +31.08 per cent

Bull Put Spread on Apple
Long AAPL Feb 500 puts; Short APPL Feb 500 puts
Then: $9.25 credit
Now: Expired
Total return: ---

Total return average: +19.13 per cent

Market outlook:

A Question of Credibility

Towards the end of the third quarter, we saw something that we haven’t seen in some time – and no, I don’t mean that investors got panicky about the imminent shutdown of the U.S. federal government. In fact, what we saw in September was a market that completely misread the actions of the U.S. Federal Reserve Board. This is particularly noteworthy in that Fed chairman Ben Bernanke has been a proponent of transparency, preferring to telegraph the Fed’s intentions to the market long before action is taken. That changed when the Fed decided not to begin tapering its bond-buying program in September.

Markets were taken aback, first soaring on the news, only to give back most of their gains after the dust had settled. Traders had been expecting, and in fact had planned for, tapering to begin. Home owners and those looking to buy homes were prepared. In fact, it seemed like a foregone conclusion to everyone – except of course to Ben Bernanke and the Fed. Given that the Fed’s credibility is now on the line, what’s next for investors?

Ultimately, this all may not mean much to investors as – sooner or later – the Fed has to begin tapering.

Inflation or lack thereof

Could we be returning to a market environment where good news is bad news for the market? Could bad news like tepid GDP numbers or disappointing employment reports be good for stocks, because it implies more liquidity fixes from the Fed?

When you consider the big picture, it all comes down to inflation or the lack thereof. The fact is that the Fed can pump as much money as it wants into the system as long as it does not trigger an inflationary spike. And so far, the Fed is not worrying about an inflationary spike. In fact it is more concerned that the lack of pricing power might impede growth. If the Fed keeps borrowing costs low, it could spur hiring. At least that’s the theory.

St. Louis Fed president James Bullard is an influential advocate of the low inflation thesis. The lack of inflation allows the central bank to be patient in deciding when to act. According to Reuters, Bullard takes the position that the Fed’s decision to sit tight actually “enhanced credibility in the sense that it showed we really are paying attention to data and not on some automated program to cut quantitative easing (QE) to zero.” Bullard, who is considered a moderate among committee members, went on to say that the Fed can opt to taper at any time if the data warrants it. And that is why analysts will be trying to dissect every nuance from every economic report until third-quarter earnings shift into high gear.

Markets have priced in tapering

The markets have already adjusted interest rates in anticipation of a withdrawal of quantitative easing. Even with the Fed’s surprise September (non)announcement, fixed term mortgage rates remained steady and U.S. 10-year interest rates initially fell on the news before rising again. We suspect rates will settle in a range slightly above the 3-per-cent demarcation line for 10-year U.S. Treasuries. Most analysts believe that a 10-year rate above 3 per cent would make U.S. Treasuries very competitive and might cause investors to rethink their allocations between bonds and stocks.

Despite the variability in the U.S. Treasury market, Canadian fixed-term mortgage rates remained steady, which is positive for banks, and for that matter the Canadian stock market.

Still, Fed doublespeak has a cost. The Fed’s credibility has been drawn into question although the governors seemed split in terms of how it will impact the markets.

Credibility at stake

Credibility, or the lack of it, is what’s at stake from the Fed’s dithering, especially when you consider that the Fed’s decision comes at a time when overall U.S. government credibility is at all-time lows. Already the budget impasse between House Republicans and President Obama (supported by a Senate Democratic majority) resulted in a partial shutdown of nonessential federal government operations. At the beginning of October, Congress had already begun circling the wagons in preparation for an all-out debt ceiling debate. At this stage, the fog surrounding the three branches of U.S. government is so contaminated that Congress is on track to enact the fewest pieces of legislation in history.

If traders believe that, then the Fed has lost credibility which could increase volatility as markets are pulled and pushed by those who support the Fed or this or that position in the budget debate and those who do not.

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