Increasing bearish market sentiment = positive news

With all of the gnashing of teeth last week about everything from Fannie Mae and Freddie Mac, the fate of Lehman Brothers, and Hurricane Ike to falling commodity prices and slower worldwide growth, most major market indices still managed to hold above their July lows. More important, bearish market sentiment is once again rising to levels approaching those of previous market bottoms.

This suggests a couple of possible scenarios:

•  A climactic move lower, perhaps to the 1170-1180 level (or lower) on the S&P 500, from which a significant rally could develop,

•  Or, a move up from current levels to above the recent highs of about 1310-1320 on the S&P 500.

This weekend’s news of a likely Lehman Brothers’ bankruptcy coupled with that of a Bank of America takeover of Merrill Lynch certainly seems likely to be a catalyst for a significant move – at the moment, the direction appears down. A break below about 1210-1220 (S&P 500) and ~11,000 (DJIA) would suggest the first scenario, while a move above about 1270 (S&P 500) and 11,600-11,700 (DJIA) would suggest the positive, latter scenario.

New positions
Freeport McMoran (FCX) – On Thursday morning I sold some February 45-strike puts on FCX in my IRA as the stock continued its free-fall along with other commodities-related stocks:

FCX is clearly in a strong short- and intermediate-term downtrend, but is also clearly “oversold,” and bouncing back strongly after testing support in the 65 area. While I would be quite comfortable owning FCX at a price in the low 40s (which would be my net cost basis (along with a 4+% dividend yield) if it’s ultimately put to me), I may choose to take the profits in this position if the stock continues to rally, and await another put-selling opportunity further down the road.

Kinder Morgan Energy Partners (KMP) – On Tuesday I sold some March 52.50-strike puts on KMP as this Master Limited Partnership (MLP) dropped below the 55 level:

I’ve been interested in owning shares (or, more accurately, “units”) of this particular MLP for some time, but didn’t want to pay over 50 for them. By selling the March 52.20-strike puts here I was able to both generate some immediate cash in my account and create an opportunity to own KMP at a net cost basis of under 50 (and at an annual distribution yield of 8%) if it’s ultimately put to me – a reasonable likelihood as the MLP is currently in an intermediate-term downtrend that might see the 40s at some point.

Precision Drilling (PDS) – On Monday I sold some September 17.50-strike puts on this Royalty Trust as it continued to fall along with crude and the rest of the oil sector:

PDS is clearly in a strong short- and intermediate-term downtrend, but is also clearly “oversold,” and, like most commodities-related securities, rallied off of support levels late in the week. Near-term support is at the 17 – 17 1/2 and 15 1/2 – 16 levels. Over the intermediate term, questions related to the company’s acquisition of oil driller Grey Wolf could weigh on PDS, although the deal appears to be positive on a longer-term basis. PDS currently has an annual dividend yield of over 8%.

Watchlists
The following stocks showed up on this week’s “upside strength” scans of stocks of interest, suggesting that they may be headed higher and may represent good buying opportunities on weakness: Cabot (CBT), Consolidated Edison (ED), International Paper (IP)*, Nicor (GAS), Pepsi Bottling Group (PBG), PepsiCo (PEP), PG&E (PCG), PPG Industries (PPG), and US Bancorp (USB).

The following stocks showed up on this week’s “oversold” scans of beaten-down stocks of interest, suggesting that likely further near-term weakness may represent a buying opportunity: Applied Materials (AMAT), Boeing (BA), Energy Transfer Partners LP (ETP)*, Enterprise Products Partners LP (EPD)*, General Electric (GE)*, Kinder Morgan Energy Partners (KMP)*, Magellan Midstream Holdings, L.P. (MGG)*, Nucor (NUE), Penn Virgina Resources (PVR), Plains All American Pipeline LP (PAA), Southern Copper (PCU), and Sun Life Financial (SLF).

* I currently own and/or have an options position on this stock.

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