Buyback Perplexity? Try Italy. (EWI,GLIBA)

Buyback Perplexity? Try Italy. (EWI,GLIBA)

Buyback Perplexity? Try Italy. (EWI,GLIBA)


Our partner in crime here at The Modern Bull, Her Majesty’s Senior Liege, Hugh L. O’Haynew, earlier this week outlined a quasi-criminal project so widespread in corporate circles today that the Securities Exchange Commission felt compelled to investigate it.


The transgression?


Corporate insiders selling their holdings on the heels of share buyback announcements.

And one might wonder, what’s the big deal?  Fellow wants to turn a buck; let him sell into strength.  Hell, let him sell whenever he wants!


But there’s more to this little trickster play then meets the eye, my innocent little doe-eyed peach.  For the endgame may not be so straightforward as ‘turning a buck’, or cashing in to pay for daughter Wilma’s graduation dress.  Oh no…

Conspiracist Banter

There are those of us in the investment game who are more jaded, you might say, and can’t help but think that these sales are coming precisely now because corporate players are worried that the highland jig is up.  And they’re implementing the buybacks as a prop to get out of their positions at a time when confidence is thinning and mom and pop market participation is thin-thin-thin.


Now, our good friend, Hugh, is no stranger to the straight-armed Irish Jig.  In fact, he rather excels at something that approaches what the Emerald Isle refers to as dancing.  And he can even pull it off after multiple steins of Guinness.


But he’s no wide-eyed watcher of things financial.  Huey now says that he’s on the alert for some steep moves in the market during both the current buyback frenzy and directly thereafter.


And he’s offered us the following to prove it –

This is a chart generated by Merrill Lynch’s monthly Fund Manager Survey, detailing how many of those 235 big-wig allocators (with roughly $650 billion in assets under management) view corporate America’s balance sheet.  And the verdict is altogether negative, with 42% indicating there’s too much debt on the books, a worse result than that which preceded the Lehman crash.


At the same time, survey respondents also reported an unusually high number (64%) that believe the U.S. market has the “most favorable outlook for profits” – a 17 year high!


And they’re acting on it.  Managers have gone overweight U.S. equities for the first time in five quarters, adding to their exposure by 16% since the last questionnaire went out.

Forget About Debt! Buy, Buy, Buy!


In other words, the smart money interviewed for the survey could care less about a company’s debt load – traditionally a harbinger of equity weakness.  So long as money is flowing into stocks, they’re saying ‘damn the torpedoes!  Full-bore buying ahead!’


Not only that, but they’re doing so at a time when they believe there’s little hope for the global economy!


Look here –

Now, Hugh has an explanation for all this, and it coincides, we’re sure, with the thinking of many of these mega-asset managers.


And it goes like this –


A great proportion of the debt on corporate America’s balance sheet is there precisely to fund those aforementioned buybacks.  That is, while money was cheap, the biggest businesses were borrowing en masse in order to repurchase shares and make windfall profits – from which, the plan went, bondholders would be repaid both interest and capital.


In the meantime, it was also understood that this afforded insiders an unprecedentedly easy means of cashing out of their holdings, after which their shares could quickly be replaced on the cheap via stock options.


The whole circle of greed was thereby complete and certain, and in the end, those on the hook for any losses – or even stagnant prices – were those same bondholders (or stockholders, it didn’t really matter), because management would be filthy freakin’ rich either way, and who really cares about anyone or anything else.

And that’s why fund managers are dancing.  The band is playing the buyback tune, friends, keeping the shimmy alive while everyone else skips toward the exits.


One Trade and We Cut Loose


We’ll have more to say on how to play this complete scam-disaster in the making.  But before we do, we’ve got one open initiative to deal with.  It was opened last August 25th in a letter called When Liberty’s the Target.  Then, we urged you to buy the TGT October 20th 55 PUT for $1.18 and sell the LVNTA October 20th 60 PUT for $1.45.  Total credit on the trade was $0.27.


The TGTs expired worthless, but the LVNTAs were in-the-money at expiration, so we owned them at $60.


In our November 9th issue, Investor, There’s A Bug In Your Olive Oil, we sold the LVNTA June 15th CALLs for $3.50, thereby reducing our cost base for the shares to $56.50 per.


And today we’re selling again.


LVNTA went through a reorg earlier in the year and now goes by ticker GLIBA.  Note it down.  Then sell the December 21st 45 CALLs for $3.20 and the December 21st 45 PUTs for $4.10, and your adjusted cost base for the shares falls to $49.20.


We’ll keep an eye on GLIBA moving forward and post any necessary moves as they arise.


We Cut A New Rug


This week we admit that the variables we’re confronted with paint a picture more confusing than a drip-drunk Jackson Pollock.  And that makes it difficult to commit to the domestic scene altogether.


Rather than guess regarding immediate market direction – who will win out in the short term, the ‘buybackers’ or the ‘bearscreamers’, a proposition we view as silly in the extreme – we’re going to venture abroad (no, not to Ireland) for this week’s bet, to a land that currently offers tremendous opportunity.


A land of blood in the streets.


A land, for the time being, still called Italy.


The following chart sums up our position on Italian shares, which have been subjected to the worst abuse of late, following that country’s latest controversial elections.


Have a look –

This is the iShares MSCI Italy ETF (NYSE:EWI) for the last six months.  The chart boasts a deeply oversold signal some three weeks back (in red), on a massive volume spike (in black), after bouncing off long term support (in blue).


The move higher now registers at 10%, and we say there’s more to come.


Italian weakness is overdone in the near term, and we believe rotation out of US equities on any weakness in the months to come will accrue to the benefit of Milan.


And we’re playing it with options – we’re going long EWI and short one of the most overbought shares on the planet, Netflix (NASDAQ:NFLX).


And it looks like this –

- Content protected for Normandy Executive Lounge, Option Trader Elite, Executive Lounge members only]

Note well: the EWIs are at-the-money and expire at year end.  The NFLXs are nearly 20% OTM and expire in six weeks!


Many happy returns,


Matt McAbby

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