🗞 Time for Makeup?

WHILE YOU POUR THE JOE… ☕️
Lost Decade Ahead?

If you follow our Twitter account, then you’ll know by our pinned post that the S&P 500 is probably set up for a lost decade ahead 📉, meaning that real returns (adjusted for inflation) will be so flat that they won’t even help you gain any ground.

Corporate earnings are now 11.5% of GDP, up from the normal 4%. At today’s valuations, it will be hard to justify how the S&P can grow its EPS fast enough to outpace the potential inflation resurgence.

Not to mention the close to 5% that is being priced into the ten-year bond yields.

For these reasons, and so many more, we agree that the stock market will not do much in the coming decade, as is always the case when the same factors are at play.

Speaking of strategizing and painting a picture for the future, let’s get on with today’s email 📧…

ECONOMIC BREAKDOWN
A Volleyball Underwater?

This is the ISM Manufacturing PMI index, which is pretty self-explanatory in how it measures the business activity in the United States's manufacturing sector.

Any reading below 50% means contraction; all you need to know is that the index has been in a 24-month consecutive contraction. 📉 

Now, this index is not as important as it used to be; I mean, what does the U.S. manufacture anymore? Maybe oil and a few machinery and metals?

The Services PMI index is more important today, given how the economy is more reliant on technology and other services.

With that out the way, here are some implications for the S&P 500 and trade ideas.

The S&P 500 typically has a 12-18 month lag to whatever the PMI is doing; given that we are now at a 24-month lag 📆 to the index’s contraction, we can safely assume that the S&P 500 might need an overdue correction today.

Remember that the Services PMI index is more important to the S&P 500 and its path, but that’s a post for another time.

Anyway, here’s how you can use the Manufacturing PMI and its components to come up with some trade ideas:

New Orders

One of the most important components in the PMI is new orders since they drive the potential new demand coming into the sector.

Now, these have seen a rebound from its bottom, but they are still under the 50% mark, meaning the overall sector has no new demand coming up.

If you have a bearish bias on the economy, then you might want to look for the industries that also report the worst new orders to follow this trend.

Production

Rising or falling new orders will eventually trickle down, which will be reflected in product measures. These were 50% to show contraction, worse than the past month, meaning contractions are accelerating.

Again, for a bearish bias, you might want to align your thesis with those industries that see the production contraction trend as well.

Prices

Our inflation thesis is gaining strength, so we will double down on all the trades we’ve made based on this view.

Prices have returned to aggressive expansion, going up by 6.5% on the index. If you think inflation will start to normalize any time soon, then you probably have another thing coming. 👀 

Anyway, rising prices can probably mean higher margins and earnings for the industries that see their own prices rise, especially the ones that are more commodity-dependent.

Inventories

Another factor to consider in the face of rising prices is the level of inventories. With no new orders or production, any new demand will probably worsen the price situation.

Why?

Inventories are drying up, falling to the lowest of the readings in the index at 42.6%.

This is why we think the industries with the right make up in the PMI might act as a volleyball underwater, where the tiniest change might send it shooting up aggressively. 🔥 

So, here are the industries we think represent this underwater volleyball scenario, starting from the price increase dynamic:

• Petroleum (Long)

• Food (Long)

• Textile Mills and Apparel (Short)

Now that you see the trends for these names, it makes sense to see that new orders and production in the listed industries (which also have contracting inventories and rising prices) are rising, and the picture becomes clear.

• Petroleum: There are no new orders as there is no need to produce oil right now, but rest assured, as this post explains, there are plenty of tailwinds in oil.

• Food: Rising prices and higher production mean the sector will stabilize in the coming months, helping margins stay afloat with rising prices.

• Apparel: With rising textile costs and contracting inventories, it looks like profits might get out of hand for the domestic names, given that they can’t hike their sales prices enough to offset the costs.

Now some commentaries to help our views:

What comes after this is stock selection, something we will probably cover in other posts throughout the month.

Other picks from previous PMI breakdowns have helped our followers, and we hope they work the same way for you. 🫰 

 TRADE OF THE WEEK
Dying Brand or Cheap Lottery?

"It must be cheap for a reason" is what I first thought of Estee Lauder stock when I heard how low it had sold off to.

However, the contrarian part of my brain also thought, "Hey, maybe there's something here we're not seeing." 👀 

So, after a preliminary round of research, I concluded that this stock could have a potential 20:1 upside opportunity.

Keep in mind that this is preliminary, so the final conclusion will probably be reached on our Twitter account, so make sure notifications are turned on.

Here's what caught my attention when first looking into Estee Lauder's options chain:

This is the implied volatility for the put options on Estee Lauder, notice that there’s a major discrepancy in the pricing today.

How?

The volatility for the January 2025 puts is much larger than that for January 2026. This makes absolutely no sense, as the further out you go into the future, the more volatility there should be, right?

Another factor is that the most volatility is being priced for the $285 puts, which means that markets are probably seeing a possibility of the stock reaching that high of a price not so far into the future.

So anyway, we looked into those far-out-of-the-money options on the call side to see if we could find any cheap ways to play a potential rebound.

Here’s what we got:

Notice the January 2026 call options chain, specifically their implied volatility and delta.

The $190 strike calls have a 46.2% IV, which is really close (and mispriced) relative to the at-the-money calls for the $75 strike. 👀 

More than that, it carries a delta of 7, while nearby contracts have double the delta; again, it doesn’t make sense.

** Quick Tip 💡: The delta is the probability of the stock getting to the strike price. So why would this price have less likelihood than other similar contracts?

To check this mispricing, we consulted the Black-Scholes valuation model, which gave us a contract value of $0.50, while the contracts right next to it are worth roughly double at $1.05.

Knowing that value is double the price today, you already have a “risk-free” play here.

But

Can the fundamentals in Estee Lauder back up a run to this high a price? There’s not a clear-cut answer to that, but here’s some evidence we did find:

During the past quarter, the company recognized up to $159 million in litigation charges for their Talcum line and $97 million in restructuring charges.

Okay, that has nothing to do with the core operating business, so we can add these back to get a realistic picture of what happened.

Here it goes:

Adjusted net income was more like $104 million, rather than the reported loss of $156 million.

On an earnings-per-share basis, this means $0.29 a share instead of the loss of $0.49 reported.

Not only that, but it is also a massive increase from last year’s $0.09. 📈 

So, tell me, how come the stock is down to only 42% of its 52-week high?

Compared to peers in the cosmetics industry, Estee Lauder has one of the best capacity setups at only 0.7x, so if played the right way, it can really ramp up its sales in the coming quarters.

Then there’s the debt of 66.3% of capital, the highest in the space, which is going to be an amazing makeup given the current inflationary scenario.

Not only will the debt help the company, but most of Estee Lauder’s sales are derived in Euros.

If the inflation scenarios we expect occur, the dollar will probably depreciate against the Euro, making this the best stock to be exposed to in the coming quarters.

That’s also why Wall Street analysts have one of the best EPS growth rates in the industry at 34.6% 🔥 set for Estee Lauder today and why the stock commands one of the highest price-to-book (P/B) ratios in the group today.

As far as an entry-level for the stock, we think anything below $67 🎯 is a good consideration, given that it has marked the volume point of control (VPOC) after the drop in earnings.

Remember, the earnings drop was actually an earnings beat when adjusted for the litigation and restructuring charges.

You’re welcome. 🫰 

NOW GO AND MAKE IT HAPPEN
Asymmetry is Key

Look, it’s not often that we get deals like the Estee Lauder long-term out-the-money options trade we found today.

But, when they come around, they share one thing in common, and that is they’re asymmetric bets.

I lose little if I lose but win huge if I get it right. Today’s book recommendation 📖 walks you through the same philosophy and strategy to come up with ideas like these; enjoy.

To your success,

G. 🥃