Top Stocks Market & Discover Financial Services (DFS)

Brief Summary:

This article notes the lack of "Cinderella stories in the dreadful market of this past year," but says investors can still find some companies poised to bounce back. In search of an "unloved" stock investment, the Motley Fool screened for equities that are trading at least 60% below their 12-month high, boast a return on equity greater than 10%, and have a minimum market cap threshold of $100 million. This criteria helps search for top stocks that "have factored in bad news already," and eliminates some of the small-cap firms that might not have much information available.

Digging through the results - which include Eastman Chemical (EMN) and Trina Solar (TSL), amongst others - the author notes that some of the hot stocks are "duds," with the widespread pessimism completely justified. However, the Fool points to Discover Financial Services (DFS: sentiment, chart, options) as an intriguing contrarian play, as the Street seems overly skeptical of the security. For instance, many analysts are forecasting "the death of credit cards" - a prediction the columnist says seems unlikely. The author also highlights Discover's net tangible assets of $11.51 per share, significantly lower than the top stock's recent selling range, and concludes that the company could potentially "absorb a 12% default rate and still have more value than the market is giving it credit for."

Contrarian Takeaway:

As the article pointed out, Discover Financial has few fans on the Street. The equity currently harbors only 3 "buy" or better ratings, according to Zacks, compared to 8 "hold" or worse ratings. In addition, the average 12-month price target on DFS rests at $8.08, Thomson Reuters reports, less than half a point above the best stock's intraday high of $7.95 today. However, in order to be a successful contrarian candidate, the struggling shares must be on the brink of a significant rebound. On that note, let's take a look at DFS from a technical perspective.

Since grazing the 20 level in mid-2008, the shares of DFS more than halved themselves, surrendering 28% just in 2009. But, since falling to the 5 region in early March, the security has pared a fraction of its losses, advancing 50% to flirt with the 7.50 level. While this turnaround is quite impressive, the equity still faces a couple of layers of resistance on the charts. First, the stock market's 20-week moving average is hovering just overhead, and has capped all but a handful of DFS' rally attempts since mid-2008. In addition, peak call open interest in the front-month April series of options rests at the 7.50 strike. As April expiration fast approaches, this heavy accumulation of bullish bets could act as options-related resistance in the near term.

If DFS can manage to conquer resistance in the 7.50 neighborhood, the skeptics on the Street could get spooked. A noteworthy display of muscle on the charts could inspire analysts to issue upgrades and/or price-target boosts, which could serve as additional catalysts to the upside.

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Highest Option Volume for the Week Ending Monday, April 13, 2009
Ticker Symbol	Call Volume	Put Volume	Total Volume*	Put/Call Ratio
Spdrs(SPY)	536,840	717,484	1,254,324	1.34
Bank of America Cp(BAC)	738,872	315,298	1,054,170	0.43
Citigroup Inc(C)	604,885	299,647	904,532	0.50
S&P 500 Index(SPX)	327,590	545,606	873,196	1.67
Sel Sec Spdrs Fd Financial(XLF)	417,894	292,987	710,881	0.70
Wells Fargo & Co(WFC)	248,206	292,298	540,504	1.18
Nasdaq 100 Index Trckng Stck(QQQQ)	216,360	236,538	452,898	1.09
JP Morgan Chase & Co(JPM)	196,398	155,389	351,787	0.79
General Electric Co(GE)	177,458	155,156	332,614	0.87
Ishares Russell 2000 Index(IWM)	102,504	165,262	267,766	1.61

Highest Option Volume Compare to Average Volume for Week Ending Monday, April 13, 2009
Ticker Symbol	Call Volume	Put Volume	Total Volume*	5-week Avg Volume	Volume Ratio	Put/Call Ratio
Biogen Idec Inc (BIIB)	115,328	44,023	159,351	51,070	2.62	0.38
Daimlerchrysler AG (DAI)	63,547	3,060	66,607	15,961	20.77	0.05
Eagle Materials Inc (EXP)	9,234	1,552	10,786	3,451	5.95	0.17
Jb Hunt Transport Services (JBHT)	1,833	10,434	12,267	3,865	0.18	5.69
Petroleo Brasileiro SA (PBR)	832,567	45,083	877,650	272,302	18.47	0.05
Pride International Inc (PDE)	10,792	2,776	13,568	3,953	3.89	0.26
Rockwell Automation Inc (ROK)	28,080	22,040	50,120	11,779	1.27	0.78
Sepracor Inc (SEPR)	39,669	4,400	44,069	10,762	9.02	0.11
AT&T Inc (T)	1,138,607	62,491	1,201,098	327,877	18.22	0.05
Verizon Communications (VZ)	1,388,197	25,086	1,413,283	333,859	55.34	0.02

*Minimum 10,000 contracts in weekly volume

Dissecting The Sectors

Retail

Bullish

There is a growing movement within the retail sector that can be ignored no longer. While the Retail HOLDRS Trust (RTH) has bested the SPX by nearly 13% during the past 60 trading days on a relative-strength basis, specialty retailers within the group have bested the broader market by more than 20% during the same time frame. Companies such as Netflix Inc. (NFLX), Family Dollar Stores, Inc. (FDO), AutoZone Inc. (AZO), Buffalo Wild Wings (BWLD), Panera Bread Company (PNRA), and Amazon.com, Inc. (AMZN) have all appealed to struggling consumers through lower-cost goods and services, as well as product innovation � think AMZN's Kindle e-book reader. Technically speaking, NFLX and AMZN have both rallied nearly 50% so far in 2009, while FDO and AZO have soared more than 15%. By comparison, the SPX is sitting on a year-to-date loss of 8.6%. Despite this strong technical backdrop, there is a wealth of pessimism levied against these shares. Specifically, NFLX sports a short-to-float ratio of 40%, while 9 of the 10 analysts following the shares rate them a "hold" or worse. Elsewhere, 34% of BWLD's float is sold short, while 6 of the 11 brokerage firms covering the stock rate it a "hold" or worse. Should this wealth of negativity start to unwind, we could see additional gains from these select names within the retail sector.

 

Financial Exchanges
Bearish

In previous editions of Monday Morning Outlook, we have indicated that rollovers in the Financial Select Sector SPDR's (XLF) 50-day call/put buy-to-open volume ratio could have a negative impact on the sector. However, the current rollover in this ratio has had quite the opposite effect. As such, we are narrowing our bearish focus on the sector to include only financial exchanges. Specifically, Nasdaq OMX Group Inc. (NDAQ) and NYSE Euronext (NYX) look particularly vulnerable at the moment. NDAQ has plunged more than 17% so far this year, and the shares remain pressured by their falling 10-week and 20-week moving averages. Meanwhile, NYX has plummeted more than 27% in 2009, and has closed only 2 weeks above its 10-week and 20-week trendlines since December 2007. As a further testament to the weak buying support for these top stocks, both NYX and NDAQ saw short interest decline by more than 10% during the most recent reporting period. Despite this added buying pressure, neither equity has been able to take advantage of the recent rally in the broader market.

 

Pharmaceuticals
Bearish

While the health care sector started 2009 off on the right foot, developments in Washington D.C. quickly brought the group to its knees. Specifically, some analysts are speculating that President Obama's budget could cut significantly into the Medicare HMO funds put in place by the Bush administration. According to those analysts, these cuts in Medicare Advantage could eliminate 10% of the money that HMOs get from the government for covering Medicare patients. As a result, the normally defensive AMEX Pharmaceutical Index (DRG) finds itself lower by more than 12% so far in 2009. What's more, the index was recently rejected by overhead resistance at its falling 50-day moving average and its October 2008 lows. Meanwhile, sentiment toward the health care sector remains heavily bullish. Specifically, 52.93% of the 427 analyst ratings on health care hot stocks are "buys," compared to only 6.79% "sells," according to Zacks. Any downgrades for this group could have a negative impact on the pharmaceutical sector.