November 12, 2012 - Strategies for Post-Election Holiday
The election has come and gone and now a significant amount of uncertainty is out of the market. You are probably very glad the campaigning has ended; a clear winner has been decided and we can now get on with life. Your candidate may or may not have won, but the issue is settled for the next four years.
Overall, we know we are going to get four more years of governing like the last four years. There is no real transition to worry about and there will be no significant changes in direction of policy for the country. There are still some big concerns on the horizon that need to be taken care of. The extended Bush tax cuts are about to expire. There is the impending "Fiscal Cliff" we hear about where all those delayed cuts to the Federal Budget are due to be made. We still have $16 trillion dollars in federal debt, and an economy that is growing very slowly with a 7.8% unemployment rate. As much as we would like things to be easy, they may not be.
While home may have some issues, peace, joy and prosperity is not really being enjoyed across the pond in Europe. The ongoing European Debt Crisis could boil over at any moment and many of those countries are experiencing unemployment rates that make ours look really good. In places like Greece and Spain, 50% of the young people are unemployed, and that is not good.
Looking across the Pacific, China has elections as well. Speculation in real estate, overbuilding of infrastructure and weak accounting practices could mean that the next leaders of China will have some issues to keep them busy. Brewing tensions with Japan over a few islands could reignite old ill feelings between the countries and give China's massive increase in military spending some hard targets. Cool heads should prevail, given what is at stake.
While there is potential trouble on many fronts, there is hope as well. Our oil and gas production has been soaring in this country and unemployment has been falling. A gridlocked Congress is going to hold both parties accountable and means that whatever gets passed is going to be well argued and compromised over. Historically we have used gridlock successfully as part of the political system. It seems that it will be necessary to raise taxes or cut spending with the budget deficit and, given our tax rates are much lower than Europe already, if they rise it will not be the end of the world. America's entrepreneurs are some of the most creative around and the highly-skilled productive work force is not going away. Overall, we have peace in the land and with Thanksgiving and Christmas just around the corner, those things like family that mean the most to us will soon be coming.
It is going to be really tough on both Republicans and Democrats as they sit down to hammer out a fiscal deal. I would not be surprised if the market takes a dip as the government misses several deadlines to get a budget deal done. There are also going to be some upsetting headlines from Europe to give the market plenty of volatility. I am cautiously optimistic the sun will rise tomorrow; people will still wake up have their coffee and go off to work.
Overall, this economic environment may be great for options traders. While most investors need to see stocks rise in order to make money with stock options, we can structure investments that will make money under very different markets. We can structure the trades so that they make money with markets that are down, markets that are up, or markets that are flat. This can give us the edge to keep our investments growing while markets tread water.
With the holiday season coming up everyone will be running out to buy gifts, hopefully lifting retail stocks at the one time of the year they usually make money. One company that could do well is Limited Brands (LTD). Limited owns both the Victoria?s Secret Brand and Bath and Body Works. The stock trading near $48 has a four STARS S&P buy rating, a 2% dividend yield, and a P/E ratio of 20. Sales have been rising about 10% at the 1,000 Victoria?s Secret stores and 7% at the 1,580 Bath and Body Works Stores. The company is in a niche market with moderate competition and a well-known established brand. The company competes both with major retailers such as Wal-Mart (WMT) or Kohl's (KSS), as well as niche players like Gap (GPS), Chicos FAS (CHS), and Ann Inc (ANN).
A covered call on Limited (LTD) that is out about six months has a nice return. The May 13 48 LTD call at a 44.40 net debit has an 8% return with 7% of downside protection. The position is held for less than a year and the annualized return rate (for comparison purposes only) is actually 16%. As people go shopping for that special person this holiday season, LTD could see strong sales. The economy is likely to keep the stock from shooting up too significantly, but a covered call can add a special return onto your holdings this season. We will be back with more insights after Thanksgiving. Have a great time with family and friends!