2022-11-03

AWKward Trades

In general, stocks that seem safe such as a water utility are no longer safe in a rising rate and inflationary environment.

Utilities stocks are in a tightening financial vise.

Their yields are low because of asset inflation. AWK yields 1.80 percent. Their “target” buyer is a conservative or income investor who can buy bonds yielding 4 percent or more now.

They are capital-intensive industries. Most use debt financing. Their cost of capital is rising and that will weigh on earnings.

The move in yields is going to hurt them coming and going, plus hit earnings. Many have bearish looking charts. If the charts break, assume the market is pricing this all in.

Finally, I suspect populism will negatively impact utilities. Some parts of the country will lean on regulated utilities as a way of transferring wealth to the middle and lower class, while others will allow higher rates, but probably only if the utilities invest most of it in new infrastructure. Both bad and good policymakers will be negatively impacting utilities’ bottom lines.

The most conservative way to trade is with a straight up short position. Sell the rips in a bear market and then cover on the dips, or simply go short and wait for the target about 50 percent lower. A stop on AWK would be at the $150 level, because it would break this week’s high and indicate the rally is not over.

Options offer more potential upside, with major risk of bad timing and bad pricing. The conservative approach is in-the-money (ITM) options as a directional play. Taking on more time and moving out-of-the-money (OTM) doesn’t look bad here either. The March 2023 strikes all the way down to $120 are all very risky as a trade, but if this goes, I think the stock goes far lower than $120. The next drop, if the pattern holds, will go below horizontal support again. I think that time will be for good.

The March $120 is about $3.25 and at $150, it would probably trade down to around $1.50, a loss of 53 percent. The best case for bears is a nice bounce that allows a March entry at a better price.

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