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J.C. Penney: The Squeeze is On

Posted
11/20/2013 10:40:00 AM
By: Martin Tillier
Referenced Stocks:JCP

In September, when shares of J.C. Penney (JCP) were trading at around $13, I wrote that investors should leave the stock alone. There had been reports that several hedge funds had taken large positions and when a stock becomes a toy of hedge funds, we mere mortal investors are usually better off standing back and watching the fun. That advice worked out fairly well, as JCP lost more than half of its value as it tumbled to an October low of $6.24.

 

Since then, as you can see, there has been a slight recovery to yesterday’s close at $8.71, but news this morning has me convinced that this time the move up may have some serious legs.

Don’t get me wrong, it isn’t that JCP has actually pulled off a miraculous turnaround as a business. The company reported Q3 losses of $489 Million, or $1.94 per share. This was even worse than analysts had expected and constitutes a huge potential problem as a company that is already laden with debt continues to hemorrhage cash. There will have to be a fast and significant return to profitability before I believe that JCP is a decent long term investment. The market reaction to this morning’s release, however, does convince me that there is a decent short term opportunity in the stock.

So, let’s recap. JCP reported an operating loss of $489 Million in the three months ending November 2nd and missed expectations. They also reported a 5.1% drop in revenue so, with all that bad news it would be reasonable to expect the stock to get hammered once again, right. Erm, no….JCP is up 9.3% to $9.52 in the pre-market as I write.

Analysts are falling over themselves to explain this in terms of a slowing pace of revenue decline and optimistic forecasts for the all important Holiday season and both of these things may have an effect, but over 9%??

No, my trading room background leads me to another conclusion, and it is one that I have used before to explain seemingly illogical moves. Market dynamics and positioning will always, in the short term, trump any fundamental news or technical indications. In the case of JCP, it seems that the spectacular fall during September and October took most of the sellers out of the market; they have already sold.

This is borne out by the short interest numbers.

Settlement Date

Short Interest

Avg Daily Share Volume

Days To Cover

10/31/2013

79,047,619

38,863,964

2.033957

10/15/2013

76,825,256

43,253,960

1.776144

9/30/2013

83,522,478

62,538,581

1.335535

9/13/2013

71,720,285

22,885,276

3.133905

8/30/2013

66,893,134

31,604,844

2.116547

8/15/2013

62,547,766

31,170,092

2.006660

7/31/2013

44,518,877

8,424,916

5.284192

7/15/2013

38,587,878



The number of shares sold short has more than doubled since the middle of July. What we are seeing now, as even news that is mediocre at best prompts a move up, is a classic “short squeeze”. Traders sense that the drift up from the $6.24 low indicates that the aggressive sellers are done, and that some of them will be getting a little nervous. By buying on any hint of positivity, then, they can generate an exaggerated move as the shorts are forced to cover their positions.

Forget digging ever deeper into the report and searching for slightly positive things to explain the move….it’s a short squeeze. So, can a retail investor and occasional trader profit from that knowledge? In this case, I would say yes.

Remember, this is a short term, trading play, not an investment in the long term prospects of JCP. They could well improve and make the trade better, but for now it is important that, if you buy JCP, you do so with clearly defined boundaries. Everybody has different ideas as to acceptable risk in a situation like this, but to me, a stop loss in the event of a break back below $8, risking around 15% of your investment would be reasonable. As to the initial target, $11.43 would represent a 61.8% retracement of the initial move down. (For those of you who wonder why 61.8% is significant, see the explanation of Fibonacci retracement here).

These ratios aren’t ideal as you would be risking around 15% to make around 20%, but given the momentum and the chance that the stock could smash through that target level in the event of a good Holiday season, I believe it is well worth the risk. I don’t want to sound too much like the Financial Advisor I once was, but short term trades like this aren’t for everybody, so don’t rush in if you are unsure.

That said, however, it does seem to me that while the talking heads on TV are looking for increasingly esoteric explanations for a seemingly illogical move, they are missing the blindingly obvious explanation…there are more buyers than sellers. That is likely to be the case for a while, so buying JCP with a limited, short term profit target would now seem like a smart move.