We’re going to attempt two separate operations today. First, to address (briefly) the current state of the equity market and second, to offer you a unique trade on a single company we’ve come to like over the last few weeks.
We’ll start with the equity market.
1. KEY REVERSAL DAY
We’re not going to belabor the point – just let you know that we saw it.
Last Tuesday, June 27th, the S&P 500 notched a new intraday high before turning over and closing below the previous day’s close.
This is how it charted –
Does every key reversal day formation result in a change in trend?
No. But a lot of them do. So we’re monitoring things closely, with the expectation that we’ll see a bout of near term weakness, at worst, before the bull resumes in force.
2. RUBBER BURNING!
It’s a corner of the market that doesn’t get a lot of attention, save for the odd company earnings report that shows some zip, but that shouldn’t dissuade us from lifting the hood and peering a little deeper into its pneumatic interior.
It’s a sub-sector of the auto and auto-parts industry we’re interested in, and it’s up on the year nearly 18%, despite an S&P 500 that’s gained just 6% over the same period.
Don’t get too spun around, Jerry. Just listen.
There aren’t a vast number of companies in the sector, but the best ones do a great business and taken together, giants Goodyear, Bridgestone, Apollo Tyre, Cooper and Continental have a combined market cap of some $180 Billion.
It’s the baby of the bunch, however, Cooper (NYSE:CTB), that we’re going to focus on today.
But before we do, let’s first take a look at a longer-term chart of the Dow Jones US Tire Index for the last three years.
The story is clear from the chart.
After a flat 2012, the sector picked up steam and coasted to a checkered flag performance in 2013, with a 50% rise in that calendar year.
Since then, however, investors have applied the brakes, leading to a 17% gain YTD for the road grabbers, still a superior ride to the S&P500’s 6% rise over the same time frame, but not on track to best last year’s performance.
Technically, there’s little on the chart for long-term investors to fret about.
• Weekly moving averages are unwinding and should be treading higher in tandem within a month or so (black circle).
• Price is above them all and volumes are constant (red box).
• RSI and MACD indications have been bullish for two full years, with neither showing signs that we’re nearing an overbought event (black lines).
• The only potential concerns here are 1) that price has spun too high above the longer term MAs and will have to skid sideways a little while the moving averages race to catch up, and 2) RSI and MACD are diverging against price for the last three quarters, indicating a slowing of momentum (black lines).
As for that last point, we believe the slowdown was inevitable after the sector’s fuel-injected performance of 2013, and the consolidation we’re witnessing is textbook behavior before any run at resistance at 95 (red line) can be attempted.
Back to Cooper Tire, our pick of the sector going forward.
We like the current technical setup of Cooper’s chart, and we’ll have a peek at it in just a moment. But first a quick word about the company.
Cooper Tire is exactly 100 years old this year. They’re globally diversified, with plants in the U.K., Serbia and China, as well as in their home base of Findlay, Ohio.
The company has a market capitalization of $1.9 billion, trades with a P/E of 18.8 and offers an annual dividend yield of 1.41%.
The dividend, by the way, has been paid uninterrupted for 168 consecutive quarters.
But it’s the recent history of the company that we believe provides the best reason to climb aboard and head out on the highway.
A Deal Gone to Hell
Cooper was recently in merger talks with rubber behemoth Apollo Tyre of India that eventually went sour and just last December were officially annulled. As you can imagine, the episode made for a very volatile stock performance, but since the deal was cancelled, investors have had clarity, and the stock has performed wonderfully.
Take a look at the chart –
Following the troubles with Apollo and an eventual termination of the deal, the stock rose 38% (in blue). But what excites us most is CTB’s move above all her moving averages in early May. A subsequent test of support a few weeks later passed favorably, and the stock has been edging higher ever since.
We like, too, that first quarter earnings for Cooper were the company’s second highest on record, trailing last year’s first quarter profits by only a slight margin. A labor dispute in the company’s Chinese plant slashed what might otherwise have been a record setting term.
Technically, the chart is neither too hot nor too cold. RSI and MACD are above-waterline, with neither looking overbought. And the 137-day moving average (deep red) – now above $25 and rising – should shortly retake the longer term MAs, leading to a fully unwound, bullish moving average formation that will give technicians even more reason to buy.
Heading into the summer, demand for replacement tires is strong, according to MTD (Modern Tire dealer), a widely read industry news outlet, and prices are inflating commensurately. We expect to see some modest movement higher from CTB in the weeks ahead and then a burst once the 137 DMA punctures above her longer term moving averages.
And the best way to play it, we believe, is with a covered CALL and sale of a PUT. It looks like this –
Wall Street Elite recommends you consider the following trade – sell one August 31 CALL for every hundred shares of CTB purchased. The CALLs sell for $0.70 and the shares go for $29.87. In addition, sell one August 27 PUT for an additional credit of $0.30.
Your total take should the stock be called away in August is 7.1% in 45 days.
With kind regards,
Hugh L. O’Haynew, Senior Analyst, Normandy Research