Our last Stock Exchange took a closer look at how understanding the franchise value of a business can help frame your trades, as well as the create opportunities in changing market conditions. If you missed it, a glance at your news will show that the key points remain relevant.

This Week – Should You Buy This Dip, Or Should You Abandon Ship?

To frame this week’s discussion, here is a look at the percent gain for the stock market volatility index (The VIX, also known as the “fear index”) and the S&P 500 (SPY) over the last week.

The VIX shot up more than 53%, and the S&P 500 gave up around 1.3%. Interestingly, some traders view these moves with frustration and despair, while others see it as an opportunity. According to Dr. Brett Steenbarger:

“One of the most striking differences among traders I have encountered is their grounding in a problem-based mindset versus an opportunity-based mindset. The problem-focused trader is chronically frustrated, battling one challenge after another. The opportunity-focused trader is inspired, finding meaning and direction in setbacks.”

In this edition of The Stock Exchange, we review four examples of how we view stock market moves as opportunities. However, not all of our opportunities have formed over the last week. In particularly some of them have been forming over many weeks. Further still, our time frame for getting in and out of these opportunities varies depending on the different positions and depending on which of our models generated the idea. Specifically, it depends on where we get our “edge” for each trade.

According to David Bergstom at See It Market…

“Everyone talks about edge and every successful trader I know has one (most have a few trading edges or more). However, what does “edge” actually look like?”

David goes on to explain four popular ways to quantify edge, and his write-up is worth a read.

Also, another interesting write-up comes from Georg Vrba in his article: Profiting From Market Volatility With The ‘Anti-VIX’ ETF SVXY. Considering the spike in volatility this week as measured by the VIX, SVXY could be an increasingly valuable tool for traders.

Expert Picks from the Models

This week’s Stock Exchange is being edited by our frequent guest: Blue Harbinger (also known as Mark Hines). Blue Harbinger is a source for independent investment ideas focused on value and high-income opportunities (for example, today’s Blue Harbinger article: 100 Stocks Down Big This Week: These 3 Are Worth Considering). And this week’s diverse group of model picks have been selected based on each model’s distinct “edge” in identifying attractive trading opportunities.

Road Runner: My most recent pick is Take Two Interactive (TTWO). I look for attractively priced stocks within a rising trading channel and if you look at the chart below you can see why I like Take Two. It’s been in a steady rising channel for over 1-year and may easily rise over $100 soon. I get in at opportune times, but only hold my position for so long.

Blue Harbinger: Take Two seems fairly risky to me. I agree the price has been rising steadily, but the company is barely profitable (in fact, net income was negative in 2015 and 2016), and the entire franchise is heavily dependent on the success of one video game, Grand Theft Auto. Any missteps with the next release of that game could spell disaster for Take Two. Plus its price-to-sales and price-to-(forward)-earnings ratios are already very rich.

RR: I really don’t care about fundamentals like P/E ratios and net income, but I can appreciate that Take Two isn’t the pick for everyone right now.

BH: Further still, Take Two is a consumer discretionary, and considering the recent spike in the VIX, that sector could feel more pain than a lot of others if the recent selloff continues.

RR: That’s interesting that you’re considering something you like to refer to as the “fear index,” and our readers might care about that too, but I simply look at the chart and like what I see! How about you, Holmes, what have you got?

Homes: This week I like Medtronic (MDT). This stock’s dip over the last month is the sort of set up I like to see when sniffing out a good deal. From the chart below you can see MDT is below its 50-day moving average, and reasonably priced relative to its 200-day moving average. It’s also received support in the low-$80’s level in the past. The price moving above the 50-day average at $86.62 would be encouraging. With limited downside and plenty of upside potential, I hope I’ve brought the humans a solid pick.

 BH: I agree you have identified an interested opportunity, but my reasoning is based on fundamental factors (in addition to the recent price decline you have described). In particular, I think a lot of the Affordable Care Act “Repeal and Replace” efforts have been subdued recently, and this is a good thing for the healthcare industry, and for Medtronic. And even though the chance for repealing certain medical device taxes seems off the table for now, the long-term demographics of this sector are powerful. I too like Medtronic, so thanks for bringing it to my attention, Homes.

Holmes: Your healthcare law narrative might be interesting to some of our readers, but I like to stick to the more quantifiable data. And from a pure numbers standpoint, Medtronic looks good. Specifically, my style is dip-buying mean reversion, my average holding period is six weeks, I exit when my price target is achieved, and I control risks based on macro factors and stops.

BH: I also like Medtronic because its valuation multiples (e.g. price-to-earnings, and EV/EBITDA) are increasingly attractive, and its 2.2% dividend yield is respectable.

Holmes: That’s all great, but my edge is based on quantifiable mean-reversion and dip-buying, and I’ll stick to that.

Felix: NRG Energy (NRG) looks attractive. It appears to have some powerful momentum at its back, and the recent dip over the last several weeks is providing a compelling entry point. Have a look at this chart of the past 12 months.

I’ll admit this one has been choppy, but I can see a powerful trend in momentum. I could easily see some appreciation over my extended time frame.

BH:  NRG s an integrated power company, and I don’t like the stock. The big jump in price last month was due to its announced “transformation plan” to cuts cost and sell up to $4 billion in assets. NRG’s products and services are basically a commodity with essentially no switching costs for customers. And its upcoming asset sales will likely be at somewhat “firesale” prices as its just trying to get its debt under control.

Felix: Okay, that’s interesting.However, I can tell you that I like the current price as an entry point and that I would be looking for a long-term holding. There are plenty of companies and stock prices that have successfully completed transition plans, and I’d much rather buy into the momentum at this price than try to time market bottoms and then wish for a lucky rebound.

BH: I can appreciate your strategy, and I agree that companies can and do successfully execute transformations. In fact, NRG is trying to use the transformation to improve its credit position, as well as generate more cash to return to investors. I just don’t think this is an attractive opportunity considering it’s leading this turnaround from behind, as in they’ve not been proactive enough, and they’re not likely to get great deals on their asset sales. It just seems like there are much better opportunities elsewhere.

Felix: Fair enough, we shall see.

Athena: This week I like Hertz (HTZ). Similar to Felix, I generally like to see attractive momentum, but my holding period is shorter, usually only about one month. This stock has been experiencing some upward momentum recently, and I like the current price entry point.

BH: This is an interesting pick, and there is a lot going on here. For starters, Hertz is a car rental company, and the shares have been an absolute disaster recently, down more than 60% over the last year, and current short interest is around 39%. The company recently reported a quarterly loss of $0.63 per share, and the company is working to reduce its fleet size.

However, Hertz is interesting because as much as this stock is hated, there has been a lot of recent talk about how car rental companies (like Hertz) could be transformed into potential vehicle fleets for the likes of Uber and Lyft. Further still, according to a recent article by Richard Pearson, “shares of Hertz could still go much higher from here” because:

“as Apple, Google, Uber, and Lyft seek to eventually eliminate drivers completely by using autonomous vehicles, their need for fleet management becomes even more critical (because there will be no more drivers to supply their own cars). Autonomous vehicles are still a few years away. But even as these programs develop in the test phase, they will need fleets of thousands of vehicles across the country.”

Hertz’s efforts to right-size its fleet, combined with potential new uses for the fleet altogether, could be a game-changer.

Athena: It sounds like we may be on the same side of this trade, but our time periods are not the same. I am not waiting a few years for this to play out, I’m interested in holding this position for only about a month.

Conclusion

This week’s spike in volatility creates an opportunity for some traders and frustration for others. Whether you should buy this dip or abandon ship depends on your trading strategy and your timeframe, as well as your personal trading edge.