The recent share price strength in Wal-Mart has strong fundamental backing due to dollar weakness, but may have been driven predominantly by short covering.
Wal-Mart is potentially one of the biggest beneficiaries of a strong dollar, because it buys large quantities of imported goods and resells them in dollars. Investors have jumped on this opportunity well ahead of analysts, who may be concerned about deflation or overseas earnings, or simply waiting for improved guidance from management. Meanwhile the option market may be signalling another significant move for the shares.
Since the beginning of November, Wal-Mart shares have regained all of their losses against the S&P 500 over the previous year. However, on a two year view, the shares have still underperformed by 7%.
The shares have rallied significantly ahead of the trend in forward EPS, while EPS Momentum, which is the one month revision in 12 months forward earnings, remains slightly negative*. The chart below shows that Wal-Mart shares have traded in a distinct range for much of the past two years, ignoring the over optimistic growth assumptions of analysts through Q1 2014 and the subsequent downgrades. The shares have now broken out of that range.
Short interest in Wal-Mart shares has fallen from 2.25% in mid November to 1.25% currently and may have been the primary reason for the sharp move upwards in the shares. Even in early December short interest in the name was highly elevated relative to the sector, although has subsequently fallen back to the average relative level of the past two years.
Implied volatility in Wal-Mart is 16.7, which remains below the level in the retailing sector and around 70% of the average S&P 500 constituent. This is still a large and relatively stable share, reflecting the nature of the underlying business. However, implied volatility is very high compared with peers on a two year view.
Using the the Stacked Graph function in OTAS we can see that previous periods of elevated relative implied volatility have often preceded share price rallies.
Equity and option investors can see that Wal-Mart is potentially a very large beneficiary of current macro trends, notwithstanding that over 40% of its sales come from its international operations. Analysts have been far slower to pick up on this. Wal-Mart will report full year earnings to end January on February 19. Since the end of Wal-Mart’s Q3 the dollar index has risen a further 4%, which if sustained or increased may allow management to provide improved guidance on forward earnings.
*The blue earnings line slopes upwards as analysts expect higher forward year earnings compared to current year. This remains the case even as downgrades are posted to forecasts.