Apple is the largest public company in the United States.

It has a market capitalization north of $2.4 trillion.

It represents 6.32% of the weight on the S&P 500.

And it’s 11.73% of the Nasdaq 100 (or the QQQ).

Apple has pretty much pulled the S&P 500 to an all-time high recently despite a broader sell-off and sideways trading of the hundreds of other stocks on the index.

Now the stock is looking quite expensive.

I want to show you a stunning chart.

More importantly, I want to talk about approaching Apple now that its earnings report is about a week away.

Apple Continues to Run to New Highs

Let’s take a look at Apple’s stock price. Shares are trading north of $147 after a slight pullback from a 52-week high of $150.00.

But pay very close attention to the Relative Strength Index (RSI). This is the line at the bottom, under the price chart.

The RSI is a momentum metric that tells you the strength of recent price changes to a stock. The indicator, developed by J. Welles Wilder Jr., ranges from 0 to 100 on a single line chart. Thus, it tells us when a stock is overbought or oversold.

When the RSI is above 70, a stock is considered overbought.

When the RSI is under 30, a stock is considered oversold.

This week, Apple climbed to $150.00 per share, and the RSI surpassed 72.

The last time that Apple had this much strength was August 2020. As you can see in the weekly chart, the stock pulled back in September of last year when the stock traded at an RSI above 70. The same happened near the end of 2019, when the RSI moved well above 70. A pullback ensued.

In both cases, we saw a sustained rise above 70 for at least two months. A pullback happened shortly after. How should you trade a stock that has this much momentum? 

Here’s How to Trade Apple Stock

When market momentum and RSI are high, we have excellent conditions to pick off as much additional income as possible.

One easy way to do this is to sell what is known as a covered call.

In this situation, you sell one call contract on a predetermined date (the strike date) at a predetermined price (the strike price). I have discussed how to trade covered calls at length in previous posts. But using elevated RSIs to determine when to sell covered calls offers another way to boost your income off existing positions.

If you own 100 shares of Apple, you could sell one call option for this Friday’s expiration. The July 23, 2021, $150 call traded last Friday afternoon for $1.12. This means that you could sell the call option for $112 total, and it would give you additional upside from the stock price of $148.00 on Friday afternoon.

If the stock climbs to $150, the person who purchased the corresponding call contract would have the right, but not the obligation, to buy all 100 shares by Friday’s expiration date.

If the stock fails to reclaim the $150 level, you will pocket the full premium.

The worst-case scenario is that you make money. Your upside would be $2 per share plus the additional $1.12 for each share from the options premium.

That represents a potential upside of 2.1% in a week from the $148 price.

Lock Up Your Trailing Stops

Remember, if the stock does climb above $150, you can always purchase the stock back at any time, preferably when the RSI is much lower. And keep in mind that earnings season is always a time of increased volatility for stocks.

With earnings approaching, now is the time to ensure that you have your trailing stops in order. A trailing stop removes the emotion of the market and will advise you, after the market closes and the stock has reached a specific stop price, to sell your shares.

The current trailing stop for Apple is $110.17 based on our Health indicator, or 25.8% lower than today’s current price.

Remember, every stock has a different historical volatility level. So, you want to ensure that you have a specific, custom trailing stop for every stock in your portfolio. For example, some stocks might have a Risk (Volatility Quotient) or trailing stop of 15% based on their historical volatility, while others might have a sky-high risk of more than 50% (Tesla’s VQ is 52.8%).

Ahead of earnings, trailing stops are always essential. We don’t want any surprises, and we don’t want to be overly emotional about any move in our favorite stocks.

We’ll talk more about Apple as the earnings date approaches on July 27. Wall Street anticipates that the company will report earnings per share of $1.00. JPMorgan Chase is very bullish about the company, with an average price target of $175 over the next 12 months.

We’ll watch what happens. But in the meantime, we can generate some income off our current position with its price gaining so much momentum. And we always want to be protected from any sudden surprises.

Enjoy your Monday,

Keith Kaplan

CEO, TradeSmith

Want a clue on when Tesla earnings season is approaching?

Pay attention to the absurdist claims around the company. Sometimes the statements will come from Wall Street analysts who cover the stock. Sometimes the off-the-wall news will come from its CEO, Elon Musk. And sometimes, you’ll even see a random post on Twitter from Musk’s mother.

This week, we got another taste of the whirlwind that is Tesla’s growth expectations. First, let’s take a look at what’s happening in the news. But then, let’s focus on what matters.

Is Tesla a “buy” heading into earnings on July 26?

What Won’t They Do?

On Feb. 7, 2018, Tesla was set to report a very important update on revenue and deliveries. Wall Street had expected that the company would report strong sales numbers and an uptick in production.

It was an ugly earnings report. Tesla did blow things out of the water on revenue, reporting a then annual record of $3.3 billion. But it also reported a staggering quarterly loss of $771 million in the fourth quarter of 2017. That loss was on top of a negative cash flow figure of $276.7 million. It also had a net loss of $2.24 billion for all of 2017.

Now, it could be a coincidence. But ahead of that earnings report, in January 2018, Musk found a way to distract from any future bad news. He announced that The Boring Company – his private geoengineering firm – had a new product.

Musk announced his company was selling propane-powered flamethrowers.

And why not? His company sold out of them in a week.

It was a perfect distraction. And it seems like there has been no shortage of distractions on Twitter over the years. Whether he’s buying Bitcoin and putting it on the company’s balance sheet…

Or his mother is posting his high school test scores on Twitter….

Or he’s talking about digging tunnels under the city of Los Angeles (in an earthquake zone, of all places)…

Tesla has always been “made of Teflon” when it comes to bad news.

And Musk has always gotten the last laugh. Tesla traded at a split-adjusted price of $68.75 on Jan. 29, 2018.

Today, the stock sits north of $645.

So, what story is the media focusing on now ahead of earnings? Well… it’s not deliveries or profits.

It’s flying cars.

Morgan Stanley Sticks to Its Guns

Morgan Stanley has one of the highest price targets on Tesla at $900 per share. Only the research firm Oppenheimer has a more bullish price target.

It’s fitting that Morgan Stanley offered a very bullish report on the stock this week. But the report wasn’t about positive business developments over the next six months.

Morgan Stanley went bullish on Tesla for the year 2050.

The investment bank says that Tesla stock could be worth $1,000 because the auto company might commercialize a flying car in 29 years.

“The chance that Tesla does not ultimately offer products and services to the [flying car] market is remote,” Morgan Stanley said.

Now, here’s the thing that is crazy about this report. Not the fact that we’re talking about central plot points from “Back to the Future Part II.”

Morgan Stanley analyst Adam Jonas admitted that neither Tesla nor Elon Musk has ever mentioned flying cars.

The reasoning comes because Musk has focused on space travel, autonomous cars, and other advanced technology. That technology includes ambitious plans to build tunnels around the country.

“So, that’s it then… We’ll have Teslas on our roads, underground in tunnels… [and] on Mars. But not in Earth’s skies? Well… we’re not convinced,” Jonas said.

The analyst says that a flying-car business would add $100 to the stock right now – adding to the existing $900 target. Combine the two, and you get the $1,000 forecast.

But let’s take a step back from this projection.

This is an important lesson for investors. The hype is real. And when we see analysts speculating on technology that doesn’t exist, it’s a good time to be a bit skeptical.

Tesla is a costly stock. That doesn’t mean it’s a great company. But around earnings season, what matters is what investors think about its prospects today. Not in 2050.

Not even the great forecasters know where we’re going to be in 12 months. So, buying and holding stock because of what one renegade Wall Street analyst said could cost you a lot of money. Instead of speculating, you can find comfort in the fundamental and technical tools that we provide you.

What’s on Tap for Tesla

We want to focus on the trend that matters the most: price.

Tesla stock is currently sitting in the Green Zone on TradeSmith Finance. That makes it a buy. But it’s important to note that it has traded in a sideways momentum trend for a while, and the risk is sky-high. The TradeSmith Finance Red Zone for TSLA starts at $423, indicating that is when the stock would be acting outside of its normal volatility range. If you buy or own Tesla, that is our recommended exit point.

Is it possible that Tesla surges to record levels? Of course – and the trailing stop will automatically rise to reflect that increase and to help protect your principal and profits. But remember, for every Morgan Stanley or Oppenheimer analyst speculating that Tesla is a $1,000 stock or more, there are TSLA bears.

Bernstein analyst Toni Sacconaghi projects $180 per share over the next 12 months.

Itay Michaeli at Citigroup says $159 per share.

And Gordon Johnson – the permabear of Tesla bears – says $67.

If you’re using TradeSmith Finance for trailing stops, you’ll never even sniff those bearish levels. Tesla would stop out well above these price targets.

We don’t know who is right or who is wrong. All we know is that analysts expect earnings per share of $0.93 on top of $11.47 billion in revenue, according to Estimize. Delivery estimates come in at 207,981 vehicles, according to the same source.

These are the numbers that matter and what investors will react to come next week. It’s a necessary time to remember that you need to have your trailing stops in order.

And you should continuously diversify your portfolio across the full electric vehicle space if this is an investment interest for you.

I’ll be back on Monday with an incredible thesis on why history has treated gold as the top store of value.

In 1925, a con man named Victor Lustig was living in Paris.

At the time, local officials were dealing with an ugly and somewhat useless structure built during the World’s Fair in 1889.

The Eiffel Tower was an eyesore that then-resident and famed writer Alexandre Dumas called a “loathsome construction.” The tower’s 20-year permit had expired two decades prior. The tower’s only use was to hold up transmission towers for radios and encourage some tourism.

A lot of people in Paris wanted the tower gone.

So Lustig pounced on the sentiment.

He found Andre Poisson, a new resident in town who operated in the scrap metal business. Lustig convinced Poisson that he worked for the city and needed to remain anonymous. He told Poisson that he was a meager city official with low pay but that he had the power to decide which business would receive a contract to scrap the Eiffel Tower. Poisson bit, paid Lustig $20,000 in cash, and gave him another $50,000 to rig the contract.

And when he realized he’d been conned, Poisson was too embarrassed to report the crime.

Victor Lustig was the man who sold the Eiffel Tower.

And that wasn’t even his most remarkable con.

His most famous con is one that can teach you a lesson about inflation.

What’s In the Box?

The Smithsonian has dubbed “Count” Victor Lustig as the smoothest con man who ever lived.

It’s hard to argue with this title. But what tops selling the Eiffel Tower?

How about a bit of an engineering feat that he accomplished dozens of times?

In the late 1920s, Lustig had perfected a scam in Europe and the United States known as the “Rumanian Box.” It was pretty simple.

Lustig would travel with a large box, about the size of a typical wooden trunk. It was ornate and made out of mahogany. Its outward appearance helped sell the con.

The box had a specific function. Lustig said it could duplicate any currency in the world. It only needed six hours to make an identical copy of the currency. The box had two slots. One to insert money into it, and the other to receive “freshly printed” money from it.

Lustig would ask a fool to hand him a $100 bill. Then he would put the $100 bill into the first slot. Then, after six hours of “chemical processing,” another $100 bill would appear.

Shazam! The box could literally “pay for itself,” as Lustig put it. He would demonstrate this several times.

To the amazement of crowds, his magic money-printing box would create “duplicates.” In reality, Lustig had just packed the trunk full of money to give the illusion that it actually worked and fool the target.

At that point, people would offer him huge sums of money for his magic money box.

He would initially refuse to sell it. But, as with any good illusion, the audience bit harder and harder. Finally, people would offer huge sums for this money box – in the typical range of $20,000 to $30,000 ($310,500 to $450,000 in today’s money). And given that he had secured enough time for the “processing” of multiple bills, he had plenty of time to escape once he sold his box.

In a few noted cases, he would sell the box on a ship before a handful of would-be bidders. Then he’d depart the boat right before it left the port, giving him ample time to escape.

He even tricked a Texas sheriff and a county tax collector out of about $123,000 for the money box in perhaps his most famous encounter with it. Incensed, the Texas sheriff tracked Lustig to Chicago. Lustig successfully talked his way out of trouble by convincing the sheriff that the man had operated the money box incorrectly.

Lustig even handed the sheriff a wad of money for his troubles.

The cash turned out to be fake.

Monetary Problems

What’s interesting about Lustig’s money scams and counterfeiting isn’t how he did it.

It was the impact that he had. His counterfeiting operations were extensive – and he even found himself working to entrust himself to Al Capone.

The Secret Service was worried that Lustig’s massive amount of counterfeit money could disrupt the U.S. monetary system in the 1930s.

That’s pretty rich, especially nearly 90 years later, at a time when the Federal Reserve has been printing money itself out of thin air. The central bank, it seems, has its own magic money box as well.

Last year, the U.S. central bank dramatically increased the U.S. supply of money in the wake of the COVID-19 outbreak.

The U.S. M2 money supply increased from $15.4 trillion in February 2020 to $20.3 trillion in May 2021. That’s a 31.8% increase in the U.S. money supply in roughly 15 months.

Not even Lustig could imagine pumping that much money into an economy out of thin air.

But that’s really what the Fed has done with its expansive monetary policy actions. Now that we’re on the other side of this crisis, inflation is kicking in.

So, it shouldn’t be any surprise that printing money and increasing its supply will profoundly impact consumer and producer prices.

Yesterday, the Producer Price Index – broadly a reflection of inflation in U.S. supply chains – increased by its sharpest levels since 2008.

And while the Federal Reserve has said that inflation will likely be “transitory,” economists are not so convinced anymore by this suggestion. As I noted yesterday, the Wall Street Journal surveyed economists across the country. Respondents argued that the U.S. economy would see inflation run above the Fed’s target inflation rate of 2% through 2023.

How to Play Inflation

As I noted yesterday, investors need to think about companies that can pass along any uptick in inflation to their customers. The most obvious is to take the simple approach in real estate. For example, real estate investment trusts (REITs) that operate with “triple-net leases” typically have step-up clauses that protect them against inflation. As a result, these operators can increase rents on their occupants and protect their bottom line and profits from inflationary measures.

I thought a lot about approaching this sector, and the one that made the most sense is the one that generates a lot of cash.

Check out casino REITs. These companies own casino properties across the country and rent these facilities to casino operators. There are three big casino REITs across the United States, and each comes with a strong dividend and reliable upside: Gaming & Leisure Properties (GLPI), MGM Growth Properties (MGP), and VICI Properties (VICI).

The first one, GLPI, is intriguing since it has a diverse portfolio of regional properties across the United States and has a 100% occupancy rate. The latter two operate larger casino properties with a focus on Las Vegas.

Regardless, it’s hard to go wrong if you’re protecting yourself against inflation through a cash-heavy industry with reliable tenants and growth potential. Companies like GLPI and VICI have strong cash flow and are always looking for new properties to purchase and generate new rents for their investors.

All three REITs currently sit in the Green Zone, and MGP and GLPI both exhibit an uptrend in momentum. However, that doesn’t mean that momentum won’t return for VICI Properties. The prospect of inflation might be the perfect catalyst that pulls many investors into these REITs.

Add all three to your watchlist and act on them should momentum bounce back soon.

When it comes to inflation, take lessons from Warren Buffett.

Back in the late 1970s and early 1980s, inflation was very high.

At the time, Buffett dedicated a lot of his time in the annual Berkshire Hathaway shareholder letters to addressing inflation’s impact on his company.

Inflation levels are nowhere near where they were in the stagflation years.

Back then, inflation hit 14%, and mortgage rates surged as high as 20%.

On Tuesday, the Consumer Price Index (CPI) for June came in at 5.4%.

Whether it’s 5% or 14%, Buffett has always been wise enough to classify inflation as what it is: a tax.

In a famous 1977 column in Forbes, Buffett wrote: “The arithmetic clarifies that inflation is a far more devastating tax than anything that our legislatures have enacted. Moreover, the inflation tax has a fantastic ability to simply consume capital. … If you feel you can dance in and out of securities in a way that defeats the inflation tax, I would like to be your broker – but not your partner.”

Buffett was saying that speculating on inflation is a fool’s errand. A broker would be more likely to make money on trades than an investor jumping in and out of different stocks.

The other thing that stood out was Buffett’s explanation that his company – Berkshire – had no solution to inflation. Simply put, “inflation does not improve our return on equity.”

Today, I want to discuss the recent inflation and highlight a few other lessons from Buffett on handling inflation.

Another Pop in the Inflation Tax

This morning, the CPI for June indicated that inflation continues to rise across the United States.

For a few months, the Federal Reserve has said that inflation will be “transitory,” or temporary.

But now economists around the country are starting to call the central bank’s bluff.

Inflation looks like it’s here to stay. A new survey by the Wall Street Journal surveyed economists about their expectations for economic recovery and the prospect of higher prices. The average forecast called for inflation (minus energy and food prices) to increase by 3.2% in the fourth quarter.

Expectations also call for annual inflation to hit 2.3% in 2022 and 2023. Keep in mind that the Fed has been desperate to get to and sustain its target for a decade.

As Federal Reserve Chairman Jerome Powell prepares to speak before Congress today, inflation will be top of mind in these meetings.

What does it say about a stock market that shrugs off a 5.4% increase in inflation, but sells off several of Wall Street’s largest banks after they beat earnings expectations and provided upbeat guidance?

Right now, inflation is running red hot. And if you need evidence of rising prices, check out this list of goods that have surged over the last year:

Year-Over-Year Changes (U.S. Statistics)

·      Car Rentals: +87.7%

·      Used Cars: +45.2%

·      Gasoline: +45.1%

·      Laundry Machines: +29.4%

·      Hotel Rooms: +16.9%

·      Furniture: +8.6%

·      TVs: +7.6%

·      Fruit: +7.3%

·      Shoes: +6.5%

·      Milk: +5.6%

And the one I can’t forgive – the one I won’t forgive…

The price of bacon is up 8.4% year-over-year.

But people forget about one other thing that is up significantly over the last year: stocks.

At a time when investors are increasingly wary about inflation, the markets largely shrugged off these moves. But that’s likely to change in the weeks ahead. After that, inflation will eat into the bottom line of companies.

And Buffett offers a roadmap on how to approach the challenge of investing when inflation rises.

How Does Inflation Impact Stocks?

Tuesday, we kicked off earnings season by releasing reports from banks such as JPMorgan Chase and Goldman Sachs. But unfortunately, those stocks sold off yesterday… despite beating profit expectations.

Will inflation concerns do the same for companies in other sectors this year? Buffett would suggest so.

“Earnings reported in corporate financial statements are no longer the dominant variable that determines whether there are any real earnings for you, the owner,” Buffett wrote in his 1980 Chairman letter.

Buffett also said during this period that “purchasing power” is what matters in periods of higher inflation.

Why? The purchasing power of a company’s cash on hand impacts its ability to invest, buy, hire, and put cash to work.

That’s Lesson No. 1: Purchasing power will be calculated and questioned during earnings calls.

Lesson No. 2 is equally important.

Buffett says investors should pay attention to the impact of inflation and taxation on a shareholder’s bottom line. The best metric for these two factors is known as the “misery index.”

The “misery index” combines an inflation rate with the income tax on dividends paid. But again, this is a similar measurement of purchasing power.

The more inflation starts to eat into the actual return on equity, the less attractive the investment will look.

Lesson No. 3: Buffett puts a significant focus on optimistic cash-flow businesses.

He likes companies that are making real hard cash every day and not consuming it. So, mature businesses that don’t need to pump a ton of money into research and development, or have turned to automation, might be more attractive investments.

Finally, and most importantly, Lesson No. 4. Look for cash-generating businesses that can pass the cost of inflation to their consumers.

Remember, when Congress talks about raising corporate taxes, I recommend that investors find companies that can pass those costs to customers.

Well, inflation, too, is a tax.

A company’s ability to increase prices quickly without fear of losing customers is essential. For these reasons, we’re always looking at companies that make must-own products and services.

Remember to think about companies in electricity generation, food and beverage manufacturing, military and defense, pharmaceuticals, and other must-own sectors.

I’ll be pulling together a large list of these inflation-proof, must-own companies and sectors in the week ahead.

For now, remember that we are entering a new period that many investors have not faced in the past. Priorities might change quickly for Wall Street, and we must remain vigilant.

Tomorrow, we’ll turn our attention back to earnings season.

Federal Reserve Chair Jerome Powell will testify before Congress for two days this week.

The head of the U.S. central bank will attend hearings before the House of Representatives on Wednesday and the Senate on Thursday.

Twice a year, the Fed Chair delivers a report to officials that provides insight into the state of the U.S. economy, the labor situation, inflation, interest rates, and much more.

Now, keep in mind that the Federal Reserve is in charge of monetary policy.

In contrast, the Treasury Department and Congress determine fiscal policy (taxes, subsidies, and general control of the nation’s budget).

Monetary policy centers on the Fed’s dual mandate to improve the U.S. labor market and ensure price stability (controlling inflation) by using specific tools like interest rates and bond-purchasing programs.

The dual mandate is the reason the central bank’s focus on interest rates is so critical. When the Fed lowers interest rates, it aims to increase borrowing and spending by businesses and consumers. It also aims to generate more business activity and more hiring.

When the central bank raises interest rates, it is generally an action to reduce inflation and “cool off” the economy.

The focus right now is heavily on inflation. This morning, the government released the Consumer Price Index (CPI). You’ll likely hear more about the increase in consumer costs over the next 24 to 48 hours. Congress will probably have a lot of questions about inflation and its impact on the economy.

However, the Federal Reserve has already signaled that it will not raise interest rates in 2021. Instead, the Fed Chair has said the central bank is willing to let the U.S. economy overheat a little to generate more inflation.

But when a rate hike comes, it’s essential to understand what it means for your portfolio.

Today, I want to explain how higher interest rates (or even the speculation of higher interest rates) would affect your portfolio and what to do about it.

What the Fed Acts

The Fed Open Market Committee (FOMC) is the policy decision-making arm of the U.S. central bank. It has a small roster of decision makers.

Seven governors for the Federal Reserve Board and five Federal Reserve Bank presidents (from the 12 Fed banks across the country) set a specific target for the fed funds rate.

This fed funds rate (or discount rate) is the basis on which all U.S. lending and market activity operates. It is a rate at which deposit-holding banks can borrow and lend to each other overnight. The Fed will raise or lower that rate to influence the amount of money in the economy.

A rate cut increases the amount of money available. A rate hike reduces the amount of money. And when there is less money available, the cost to borrow that money goes up across the entire economy.

Why?

The fed funds rate, in turn, impacts the prime interest rate in banking.

This is the rate that large banks offer to the most trusted customers with the best credit scores. Think of a FICO score of 850 combined with a perfect payment history dating back to the 1980s. It’s tough to get the prime rate.

But that prime rate is the basis for all other forms of loans based on creditworthiness. So if the fed funds rate goes up, the prime interest rate increases, and thus the cost of interest on a credit card, auto loan, and other forms of credit also goes up.

But how does that impact the stock market?

Well, let’s look at how it impacts a company’s balance sheet.

Higher Rates, Higher Costs

Rising interest rates don’t have a direct impact on the stock market themselves. However, they do have a secondary effect that can impact prices, particularly from a psychological sentiment.

Remember that each time interest rates rise, so too does the cost of borrowing. This is because corporate America primarily funds its operations by selling debt. Of course, since 2009, corporate-grade bonds and junk bonds have seen steep declines in their interest rates as the Fed moved to keep that fed rate lower and lower.

Higher interest rates mean that companies need to spend more money paying back debt. Rising interest payments impact cash flow, which affects the price of a company’s stock.

But higher rates also impact consumer spending. Remember that consumers will need to pay higher interest costs on their credit cards, auto loans, and everything else they might buy with borrowed money. The same goes for business-to-business transactions. The bulk of purchases made through U.S. supply chains are done so on trade credit. When interest rates rise, trade credit can be restricted or prices might increase. Typically, higher costs in supply chains are passed on to consumers, who will also face greater interest payments on their purchases. 

As a result, if consumer purchases decline, this too can impact the bottom line of a company and thus its stock price.

What to Do

Remember, rising interest rates don’t negatively impact every class of stocks. For example, banks, mortgage companies, and insurance companies benefit from a rising interest rate environment.

It’s important right now that you consider the prospect of higher rates as a way to potentially diversify your portfolio from any rate shock that might come. Remember, it was just a few years ago that the Fed began that dreaded “Taper Tantrum” by increasing interest rates by just a tiny amount.

Now, with the prospect of similar shake-ups in sentiment, consider firms like Bank of America (BAC), Berkshire Hathaway (BRK.B), and U.S. Bancorp (USB). All three of these companies have a buy rating in the Green Zone on TradeSmith Finance. And all three are experiencing an uptrend in momentum as we await Jerome Powell’s testimony this week.

I’ll be back tomorrow to talk a bit more about inflation. Following this morning’s release of the Consumer Price Index, it’s essential to understand other ways to diversify your portfolio should this pace of inflation not be “transitory” in 2021 and beyond.

I want to draw your attention to a story from last week.

Maybe you were too busy celebrating the Dow’s rebound and missed it.

Or you cheered the big earnings report from Levi Strauss (LEVI).

Or maybe you went away for the weekend.

But this was big; it’s a story you cannot ignore.

When Federal Reserve Chairman Jerome Powell spoke in April on 60 Minutes, most people ignored his warning.

Not about rates. Not about the economy. But about cybersecurity.

There’s a reason hackers may cost global banks $100 billion each year.

And on Thursday, Morgan Stanley proved why.

Here’s What Went Wrong                     

In April, Powell said that cyberattacks are the biggest threat to banks.

But implementing sufficient cybersecurity to protect against them has also become their largest cost.

I wrote at the time that JPMorgan (JPM) and Goldman Sachs (GS) are giant banks that can hire the best cybersecurity professionals in the world. JPMorgan reportedly paid $600 million in 2018 for cybersecurity protection, according to a letter that year from CEO Jamie Dimon to shareholders.

Yet these banks are still vulnerable to cyberattacks. What makes them the most susceptible are third-party vendors with access to their systems.

Morgan Stanley is one of the largest investment banks on Wall Street.

And hackers found a backdoor into their system. Hackers breached a Morgan Stanley vendor’s access to the bank’s server and stole personal information on the banking customers.

The vendor is named Guidehouse. It provides account maintenance services to Morgan Stanley’s StockPlan Connect business. The vendor told the bank in May 2021 that the hack occurred.

But  according to media outlet Bleeping Computer, evidence suggests that the hack likely started in January and wasn’t discovered until March.

Morgan Stanley has said in letters to impacted individuals that none of its applications were hacked.

Instead, the incident itself involves specific files in Guidehouse’s possession, including encrypted files, according to the bank’s letters.

But here’s what some of the breached and stolen documents did contain.

The names of people who participated in StockPlan Connect. Their last known address, their date of birth, their social security number, and company names.

Sure.

Morgan Stanley’s letter would make me feel “safe.”

Where Are the Vulnerabilities?

If you pay very close attention to the news, you’ll notice that hackers are rarely successful at attacking a company’s servers directly.

It’s more and more common for hackers to exploit database and customer information through third-party vendors. And these cyberattacks on third-party vendors can be extremely costly.

Back in 2013, Target Corp. experienced a massive breach. Hackers successfully penetrated the private data on 41 million customers through one of Target’s vendors. Target had to pay an $18.5 million settlement to the victims (its customers) after this breach.

Remember, it all happened because someone exploited access to the company’s payment information network through a third-party vendor. 

A 2020 study by Mastercard’s RiskRecon team and Cyentia Institute revealed that third-party vendors are an extraordinary threat to corporations and small businesses.

A survey of third-party risk management professionals said that 31% of their vendors represent a material risk of causing a breach. The most common organizations of those surveyed were in financial services, technology, and health care.

All three are industries that manage sensitive customer information.

And in the age of the cloud, companies are failing to ensure they have the proper protocols in place when sharing such sensitive data.

According to another survey by the Wiz research team, 82% of companies give third-party vendors access to ALL of their cloud data. This includes highly privileged information that could cause a huge security risk.

Even worse, 90% of the respondents said they were not even aware they had provided that level of clearance to their third-party vendors.

Here’s How to Invest in the Trend

If you’re not investing in cybersecurity by now, I don’t know what to tell you.

The United States economy has faced several massive cybersecurity attacks this year, including those on the Colonial Pipeline and meat supplier JBS. And earlier last week, there was a massive cyberattack that hit between 800 and 1,500 small and medium-sized businesses (SMBs) in more than a dozen nations, according to CNBC. Russian hackers have demanded $70 million to unlock the frozen computer systems of these SMBs.

These attacks are not slowing down. They are only getting more costly and more common.

Cybersecurity stocks are poised to benefit as institutions pour more and more capital into their coffers in the years ahead.

We talked about Unisys being an interesting stock back in April. It remains in the Green Zone, but is locked in a momentum side-trend. So, even though you might want to consider this IT supplier for financial services, there may be better choices.

FireEye (FEYE) moved back into the Green Zone in early June and has strong momentum.

Finally, look at cybersecurity stocks Dynatrace (DT), Fortinet (FTNT), and Cloudflare (NET). All three are in the Green Zone and have a solid uptrend.

This sector is only going to be more important in the future.

Cybersecurity is the backbone of the 21st-century economy. It’s time to invest like it is.

I’ve received a lot of questions recently about a potential market downturn.

When is it going to happen?

What are the warning signs? (We covered this recently.)

How should you handle your money?

Yes, stocks were down sharply again Thursday morning before a slight bounce higher in the final hours. And markets did cut some of the initial losses.

However, many people want to know down to the day if and when there is going to be a “market crash.”

I understand that sentiment. You want to protect the gains that you’ve made, and you want to protect your principal.

Here’s an important thing to remember.

Fear and pain are signs that you are investing well and making good decisions.

So, I want to give you three rules to protect yourself.

Yes, there might be a storm on the horizon. But remember the storm will likely just be temporary. And we don’t want to be focused on just the next few weeks. Instead, we want to focus on the long road ahead. So here’s what you need to know.

Rule One: Don’t Sell Because of Fear

One of the clumsiest things that people do is sell because of emotion. The truth is that you will never be a successful investor if you’re afraid of market pullbacks. There have been many temporary runbacks over the last 10 years. But the people who held the course enjoyed the benefits of the bounce back.

Charles Schwab recently did an analysis of portfolios among its investors. It found that over the past two decades, the S&P 500’s average return was roughly 6%.

However, investors might have missed the top 20 days’ performance if they had sold off and bought the stock back later. The average return for people who sold and bought back after those 20 days earned a paltry 0.1% each year.

The truth is that if you sell based on emotion and not on signals, you’re far less likely to buy back into the stocks you love to own at your sell-off price.

Remember, investing is a behavioral activity.

And mastering your emotions is essential.

There are tools in place to help remove the emotion of selling in a market. Each stock has a different volatility level, so each stock should have a different trailing stop. By using trailing stops, you protect gains as stocks go higher and ensure that you minimize your risk should they fall.

If you need to identify the right trailing stop for each stock, we’ve created a set of tools to make it as easy as reading a stoplight with TradeSmith Finance.

Rule Two: Know What You Need

You might be holding on to lots of dividend-paying stocks and others that have performed well for you in the past. Remember, the market is the best money-making machine in the world. But it’s also one designed to help preserve wealth.

So, if you’re tempted to sell, don’t sell more than you need. Think about your unique expenses. Think about your balance sheet. If you need lots of money while invested in the market, you might need to reassess how you invest.

Perhaps you should consider bonds, or safer yield-bearing assets that carry less risk. Your individual risk tolerance must match the investment strategy that aligns with your lifestyle.

Taking risks as an investor is essential. Typically, if you’re not worried, you’re not risking enough. But in down markets, reassess your goals, lifestyle, and what is reasonable for you for 18 months (the typical length of a bear market).

Rule Three: Actively Manage at All Times

If you know what you need and you have your trailing stops in place, now is a good time to start actively managing your portfolios a little more. One of the best things you can do is generate a bit more income while navigating this market.

Imagine that you have a stock that might be falling in recent days. A good example might be Enterprise Products Partners (EPD).

Let’s say you own 100 shares of EPD at $24.00 as of this writing.

The stock is in the Green Zone within TradeSmith Finance and has maintained strong upward momentum.

This stock would enter the Yellow Zone at $22.00; the Red Zone (where the stock would stop out) begins at $19.71.

Here’s what you can do.

You could sell a covered call on this stock.

This means you would sell a call option to someone else. The call option gives the buyer of that contract the right, but not the obligation, to purchase the stock on a specific date (the expiration date) at a specific price (the strike price).

Here’s why this strategy is smart. Right now, you could sell the $25 call option dated Aug. 20, 2021, for a $25 premium ($0.25 per share). This means that you receive $25 for giving someone the right to buy your shares in 42 days at a strike price of $25.

Now, $25 might not be such a big deal. But think about the scenarios that exist. First, if the stock remains under $25 by that date, you keep your shares and the $25 premium.

In addition, if the stock does go to $25 or more and you have to sell your shares, you will also receive a few benefits. First, it’s unlikely that the buyer will execute the contract before the strike price, so you should still collect the dividend paid on the stock at the end of July. It currently has a 7.36% dividend (you’d receive 45 cents per share [so $45 since you own 100 shares], or an additional 1.8%).

Next, your stock will have appreciated by more than 4% from current levels. And, as I mentioned, you will also keep the $25 premium. You’ll have the potential to make a pretty good return.

Overall, the maximum upside is $45 (from dividends), plus $100 from the share price appreciation from $24 to $25, plus the $25 premium.

That’s a total of $170, so you’re looking at a potential 7.08% return in 42 days.

But what about the downside? Well, you know your trailing stop is at $19.71. So you’re going to ride it out and not let your emotions take over. Remember, if the price of the stock falls, the cost of the option will decline as well.

If the stock drops from $24 to $23, the value of that contract that you sold will likely depreciate. And you can buy the contract back to close that position and pocket the difference between what you sold it for and what you paid to repurchase it.

You can continue to sell contracts at different strike prices on the way down (just make sure it’s one contract per every 100 shares that you own). Doing so allows you to generate additional income even if you’re buying and holding these stocks forever.

Selling covered calls is not just a strategy to make money if the stocks go higher. Instead, it is a strategy designed to help protect your money should these stocks pull back. We’ll talk more about other strategies to protect you all next week.

There’s something about stocks trading under $10 that people are biased against. 

Even some of the world’s top money managers have dismissed stocks trading in single digits. Instead, they’ll snidely remark that there must be a reason why a stock is so cheap. 

There could be many reasons why a stock trades under $10. For example, it could be a matter of how many shares are outstanding. On the other hand, it might be that the stock used to be at a very high price. 

Listen. When you eat chicken, do you honestly care if it’s cut up into 50 pieces or three? 

There’s a weird bias that many people don’t think about. But there are many companies that I would consider owning despite a lower share price. 

Let me show you two stocks that have two very similar profiles – one that’s under $10 and another that is trading near triple digits.

I’d consider owning both. 

But in today’s choppy environment, I want to ensure that I get the most bang for my buck. 

Gerdau Versus Nucor

Today, I’m looking at two steel stocks. 

Steel stocks have pulled back since the height of the mania around infrastructure stocks in May. However, with steel prices rising due to an improving economy and supply chain shocks, it was a strong first half in the steel space. 

Gerdau S.A. (GGB) is a Brazilian-based steel manufacturer. Looking at TradeSmith Finance, this stock traded at $5.68 per share early on Wednesday. The company has a solid balance sheet. It has a Piotroski F-score of 8, operating margins above 16.5%, and trades at attractive valuation multiples. 

Nucor Corp. (NUE) is a U.S.-based steel company with operations based in North Carolina. Its stock traded at $95.59 per share on Wednesday. It turns out, though, that its balance sheet is a little less attractive. Its F-score is lower at 6. Its operating margins are under 11.5%. And its valuation margins are a little more stretched than its Brazilian rival. 

Both companies are trading in the Green Zone right now on TradeSmith Finance. In addition, both are in a solid green uptrend. But even though Gerdau’s stock price is cheaper, it looks like a better overall investment based on the numbers. 

How I Might Want to Trade Gerdau

There are many ways that I could trade this company. 

First, I could purchase 100 shares for $571 as of market close on Wednesday. 

Second, I could buy a long-dated call option and take my chances that the stock will rise despite the recent volatility in the market. 

Or I could park some money on the side and collect income using something known as a cash-secured put.  I love this strategy for cheap stocks that I’m happy to own. 

A put is a contract that grants the buyer the right, but not the obligation, to sell 100 shares of a stock on a specific date (expiration date) at a specific price. 

So, if I’m looking at the options chain of Gerdau S.A., I can look out to Sept. 17, 2021. That is 72 days away (or one-fifth of the year). I can sell a cash-secured put for Gerdau at $5.00 and receive $0.20 in premium per share.

Given that each contract is worth 100 shares, I would receive $20 in cash today. 

If the stock falls to $5.00 on or before that day, the contract buyer has the right – but not the obligation – to sell me all 100 shares of the stock. I would then use the $500 that I’ve set aside when I sold the put and take possession of the stock. 

Remember, it’s a stock that I want to buy because I want to have an investment and exposure to steel stocks over the long term. 

But if it doesn’t fall to that level and the contract expires worthless, I’ll receive $20 for every 100 shares that I could have bought for $500, representing a return on my investment of $20/$500 or a 4%. Annualized, that’s a return of roughly 20%, given the initial 72-day holding period.

An Easier Way to Trade in Cheaper Stocks

It’s very important to learn how to use this strategy. Cheap stocks don’t require me to put up as much margin. But I can also build larger or smaller positions based on how much I want to buy. 

I don’t think cash-secured puts are just a way to generate income on stocks that I want to own. I see them as a way to pick the very stocks that I want to own at the price that I want to pay. 

So, I can be very conservative with this strategy by constantly focusing on stocks trading in the Buy Zone on TradeSmith Finance with positive momentum.

I’ll be back tomorrow to discuss another interesting way to use options and reduce risk across the board. 

Three weeks ago, I dove into an ongoing war of words between the United States and China. In my article, I explained that U.S. technology companies could face new pressures in China.

I wanted to follow up on that story.

The reason: Shares of one of the hottest recent initial public offerings just plunged 25% after China engaged in another round of crackdowns on domestic technology companies.

On Friday, Chinese regulators banned new registrations for the DiDi ride-sharing service. DiDi, China’s largest ride-sharing service, listed publicly on the New York Stock Exchange last week. American investors poured $4.4 billion into the stock. It was the largest IPO by a Chinese company since Alibaba listed in 2014.

Shares jumped from the IPO price of $14 on June 30 to more than $18 in a matter of days.

But on Tuesday, shares plunged.

The company said that the government’s action could “have an adverse impact on its revenue in China.” Given that DiDi generated 88% of its fourth-quarter revenue from Chinese customers, this could be a significant blow in the short term.

I want to talk more about this event, what it means for Chinese companies listed on U.S. markets, and share an important reminder about IPOs in any market.

Cracking Down on DiDi

The news is a blow to a company that has more than 377 million clients in China.

The Chinese government says that its goal is to “prevent the expansion of risk” as it conducts a “cybersecurity review” of its operations.

The fact that China decided to suspend the company’s registrations is interesting. It hasn’t been implied that China did so because it listed publicly in the United States (and will thus need to file documents with U.S. regulators). It’s certainly important.

In March, the U.S. Securities and Exchange Commission (SEC) set new rules for dual-listed companies like Alibaba, Baidu, and DiDi.

The SEC could kick those companies off American stock exchanges if they fail to comply with American auditing standards for three years in a row. The rules also require that companies not be owned by a foreign government and not have Chinese Communist Party members on their board of directors.

The bill that set the framework for the regulations – the Holding Foreign Companies Accountable Act – was signed into law by then-President Donald Trump in December. The rollout for the bill started in March.

The law angered Chinese officials.

“It is clearly discriminatory against Chinese companies, it is wanton political suppression of Chinese companies listed in the U.S.,” a spokeswoman at China’s Foreign Ministry said in March.

But its enactment has complemented a significant crackdown on technology companies.

Chinese regulators canceled the highly anticipated IPO of Ant Group, a massive financial technology company linked to Alibaba, in November 2020. They also fined Alibaba $2.8 billion and claimed that the company acted as a monopoly.

Market Power and Pride

In addition to the DiDi crackdown, the Chinese government said that it would increase the regulation of companies that list their shares on overseas stock exchanges.

Chinese regulators said they plan to punish illegal securities activities. That includes embezzlement, false financial audits, market manipulation and fraud. This has been a significant problem in overseas markets.

A prime example of this fraud is the collapse of the Chinese coffee chain Luckin Coffee. As China’s tech boom hit full stride in 2017, American investors were buying up Chinese-listed stocks in a frenzy. We saw huge gains in stocks like Alibaba, Baidu, Tencent and more.

But Luckin Coffee had a special place in investors’ hearts. The coffee company was compared to Starbucks. In fact, it was opening up stores faster than Starbucks and growing revenue at a frantic pace. It became a public company in mid-2019 and was listed on the Nasdaq.

It turned out to be a house of cards. The company engaged in widespread fraud. It invented fictitious customers and fake receipts for the purchases of raw materials. The stock fell more than 90% after it was delisted by the Nasdaq.

A Warning

Rising geopolitical tensions between Beijing and Washington, D.C., have muted expectations in the near term. A week ago, the nation’s ruling Communist Party celebrated its 100thanniversary. During the event, Chinese President Xi Jinping took a series of broad swipes at the United States.

Xi made various statements suggesting that Western nations are working to reduce their reliance on Chinese tech companies and blocking technological integration between China and the rest of the world.

“We must jointly oppose anyone engaging in technological blockades, technological division, and decoupling of development,” Xi said. As the world’s largest buyer of semiconductor chips, China is deeply concerned that it might not be able to procure the technology it needs to grow at its current pace.

But China has a state-run economy, so government influence is significant.

The ongoing crackdown of Chinese tech firms isn’t just about U.S. audits, centralizing access to raw materials, or cybersecurity.

There are analysts who suggest that Chinese leadership is worried about monopolistic behavior as tech firms expand their influence in culture and the economy. Some look at the immense power generated by Amazon, Apple, Facebook, and others in the U.S. and the inability of the U.S. Congress to regulate their market power.

Right now, this ongoing saga has hit Chinese-listed stocks. Baidu was off 4.5% as of this writing on Tuesday. Alibaba shed 3.4%. JD.Com dropped 4.9%. And bargain investors should remain very cautious about any of these big companies.

All three stocks are trading in the Red Zone on TradeSmith Finance. As far as DiDi goes, we still lack enough information on the company to make an informed decision.

Now is a good time to remind investors that an IPO is a selling opportunity for many venture capital and private investors. It’s important to take a step back and allow the market to make a decision on the health of these companies.

Investors would be smart to give this situation time to stabilize and wait for momentum to return to Chinese stocks.

I’ll be back tomorrow to discuss two other big risks to the market that require your attention.

Last week, we kicked off the second half of 2021.

And there was no commodity followed more closely than oil.

On Friday, West Texas Intermediate (WTI) crude futures prices finished the week above $75.

That was the highest price that WTI crude oil has traded since 2018.

That is also a huge reversal from early 2020 when oil futures prices crashed into negative territory.

Today, I want to explain why oil prices continue to rise and what to expect in the second half of the year. But, most importantly, we’ll check in on a few names that hit our watch list back when oil prices were trading under $70 per barrel.

Checking In with OPEC

Crude prices moved higher this week after the Organization of the Petroleum Exporting Countries (OPEC) and allies delayed their meeting on global oil production. OPEC and its allies have the nickname of OPEC+, and these global nations act as a cartel to control the global price of oil.

That’s perfectly legal. In game theory, there is a focus on cooperation and not competition.

In the case of OPEC, nations like Saudi Arabia, Iraq, Libya, and the United Arab Emirates gather to discuss how much crude each nation will aim to produce and export in a given time frame. They produce about 40% of the oil in the world.

Their exports represent roughly 60% of the crude that is traded around the world each day. They also have nearly 80% of all proven oil reserves under their control.

So, they have incredible influence.

The goal of their meetings is to ensure that they control the flow of production to meet global demand.

Last year, after COVID struck, oil prices plunged due to concerns that global demand would fall. As a result, OPEC elected to cut production by a large amount to balance out global markets’ supply-and-demand equation.

Each of these nations relies heavily on crude oil production to fund their government balance sheets. This includes – but is not limited to – social budgets for education, welfare, food subsidies, and more.

So, why would any of them agree to cut their own production in agreement with other nations?

If a country could produce 5 million barrels and receive $50 on the oil markets or 4.5 million barrels and receive $65, which one is the better deal?

In scenario one, the nation would generate $250 million in revenue.

In scenario two, where they agree to cut and control production alongside other producing nations, they help control supply and increase the price. As a result, they would generate $292.5 million.

That’s a 17% bump in revenue.

So, when you see OPEC has decided to curb production or reduce the amount they could produce, keep in mind they are doing so to help elevate global oil prices to benefit themselves.

The Impact on Prices

Given OPEC’s immense reach and influence, this cartel impacts the price of crude oil worldwide. But one of the interesting elements of their efforts to control prices is that demand continues to rise as economies reopen.

OPEC is not willing to turn the taps on completely just yet. With nations increasingly concerned about new variants of COVID-19, the cartel wants to wait and see if this global recovery continues or slows down. In a scenario where the economy accelerates, Goldman Sachs says that there could be a global oil deficit of 5 million barrels per day.

Goldman has suggested that oil prices could hit $80 at the end of the year. However, several energy executives suggested that oil prices could rise as high as $100 by the end of the year.

By that point, however, many other producers would likely hurry to produce as much oil as possible. Those producers include many OPEC nations and their allies like Russia.

There is a saying that the cure for rising commodity prices is rising commodity prices. This means that when prices are high, companies will produce more of a specific commodity. As a result, we eventually can see a glut of this commodity. In this case, oil prices might retreat quickly and rebalance to levels that we saw before the pandemic began.

How to Ride Higher Oil Prices

Remember, at TradeSmith, we’re always looking to generate high income and achieve a higher price upside on every stock we buy.

For those reasons, we recommend two ways to play the rising price of oil. First, we are looking for oil production companies. These companies own vast reserves of crude oil and sell it on the market. When the price of oil rises, so does the value of its assets on the balance sheet.

Companies like ConocoPhillips (COP) and Marathon Oil (MRO) sit in the Green Zone and maintain uptrend momentum. These companies had a solid June and will look for more appreciation should oil prices continue to rise.

Meanwhile, you know that we also like Master Limited Partnerships or MLPs. These generate huge amounts of dividends. For a primer, click here.

Enterprise Products Partners (EPD), Magellan Midstream Partners (MMP), and MPLX (MPLX) remain our favorite plays in this energy space.

All three provide dividends north of 7.4%, trade in the Green Zone on TradeSmith Finance, and remain in an uptrend momentum to start July.

I’ll be back tomorrow with insight on the major risks facing the global markets and the global opportunities. I hope you had a wonderful holiday weekend.