The Case for a Deeper Decline in IBM Shares

There has been much speculation about why renowned investor Warren Buffett sold (through his Berkshire Hathaway operation) about a third of the $13 billion stake he had accumulated in International Business Machines Corp. (NYSE:IBM) over the past 3 years. The obvious motivating factor for Buffett (an investor known to focus on so-called "value stocks" that trade at favorable multiples to their earnings and growth prospects) is IBM's report on April 18 of a larger-than-expected decline in revenue due to weak demand for its IT services business (something akin to McDonald's reporting disappointing results for its "hamburgers" business).

But in the end, the "oracle of Omaha" may well have succumbed to phenomena very much operative among us mere mortals who invest -- greed and fear, as well as the lesser-known pull exerted on us by "milestone numbers" (in the form of certain share price levels to which we attribute more meaning than others). The "milestone numbers" we tend to have in common are the so-called "round number levels" to which we've often referred in these commentaries -- from 20,000 on the Dow, to $100 per barrel for crude oil, to the 20% corrections that allegedly mark the boundary between a "normal" bull market pullback and the start of a new bear market.

But our breakeven point for shares we've accumulated constitutes our own private "milestone number," and it is very often the case that we are moved to sell when we see a profitable position turn negative (by the share price moving below our breakeven point). And with IBM closing just ahead of its earnings report at $170.05, and Buffett's breakeven price widely reported to be a shade above $170 -- once IBM "gapped lower" after the report (falling to as low as $160), the stage was set for Buffett to engage in some good, old-fashioned, milestone-induced liquidation.

But that's not to say we of the "technical analysis persuasion" find reason to disagree with Buffett's decision to partially liquidate his IBM position -- in fact, he may have been better served to shut it all down. Because on the April 19 "down-gap day" alone, IBM managed to blow out significant support in the $165 area (at its 2016 closing price level and at its 200-day moving average). And then, after clinging for dear life to the $160 level, the Buffett liquidation announcement whacked the shares again -- this time below $157, the site of IBM's November 2016 low and 320-day moving average. So as can be seen from the accompanying chart, this leaves little barrier between the current IBM share price and the $140s (with further weakening perhaps accelerated due to additional investor bailouts below the milestone number at $150).

But the most intriguing aspect of the technical case for purchasing an IBM put option at this juncture is based on the potential for a repeat of the aftermath of the September/October 2016 phenomenon involving a price break by IBM below its 160-week moving average (as indicated by the red line on the chart) and an abnormally low historical volatility reading (as depicted by the volatility low just north of 8% in September 2016). IBM shares proceeded to gap still lower after earnings were announced in October 2016, only to decline by an additional dozen points over the next two months.

This same combination of an extreme low in historical volatility and a 160-week moving average break has played out over the past month, along with the earnings-based downside gap. And while there is no imperative for a repeat of the late-2016 downside action this time around, the combination of the complacent investor sentiment that often accompanies low levels of volatility with a repeat of the late-2016 pre-earnings break below a key moving average (followed by a gap lower) carries a very potent bearish punch that, in our view, transcends the coincidental.

A further strong indication of investor complacency on IBM -- even after the earnings report and the Buffett news -- lies in the pricing of IBM options. Data from Trade-Alert indicates that 30-day at-the-money implied volatility was, as of the market close on Friday, lower than 98% of such readings over the past year. So options speculators are suggesting that IBM's "big move" is now behind us, even as other objective indicators strongly suggest otherwise.

We believe there is downside risk in IBM shares down to the level of their rising 160-month moving average (now just below $140) -- more than sufficient for our recommended put option to reach its target profit of 100% over the recommended holding period.