March Madness

March madness.  Stocks rebounded yesterday in response to kind words from the Fed. Traders felt like they were looking in a mirror as the Dow Jones Industrial Average proved that it could make record single-day point gains as well as record single-day point losses.

 

N O T E W O R T H Y

 

• Wax on, wax off, wax on….  Yesterday’s moves in the stock market were a ripper for sure.  By “ripper”, I refer to the dashing, rapid market up-swing and not its slashing cousin Jack, who appears to have left the building, if for at least a day. The session was an interesting one which, at first, looked like it would not make it through the close in the green.  Ultimately, the market surged late in the session proving that volatility works in both directions.  Just as I cautioned not to panic as the market went down I feel compelled to caution the opposite now.  As markets can’t go up forever, the same can be said for the opposite, they can’t go down forever either.  Several things go into a market reversal.  The primary drivers are value and seller exhaust.  First a quick word about seller exhaust.  It refers to that point where all of the selling simply relents after aggressive down moves. It is literally, as the name implies, exhaust.  It is principally driven by psychology but there are also some practical reasons. Sellers only have so much stock to sell and short sellers (who speculate on down moves) can only expose themselves to so much risk (short selling has unlimited loss potential – CAUTION: don’t do it).  Before last week’s pullback, stocks were trading at record highs and record valuations.  The PE ratio of the S&P500 was trading around 22, which means prices are trading around 22 times earnings.  It had been growing steadily in the prior twelve months and was as low as 17 at one point.  For some reference, it was as low as 12 in 2011 and rose to 23 in 2018.  Looking back further, 1999 saw PE multiples get to 30 and the average is around 15 times. The point here is that stocks were trading well above their valuation averages before this last pullback, so many believed a pullback was necessary.  Of course no one was hoping for it to happen so quickly.  That said, if you look at the formula for the multiple it is simply: Price / Earnings.  If prices go up faster than earnings, the multiple goes up making it more fully valued (expensive).  If earnings are going up faster than prices, the multiple goes down making a stock more valuable (cheap).  Of course, the reverse is true as well.  After Friday’s sharp selloff, the PE was at 19 which may have given the appearance that stocks were a value buying opportunity.  There is something referred to as value trap amongst Wall Streeters. It refers to value seekers jumping in too quickly to buy when PE falls slightly related to downward market moves.  In other words, there may be a time real soon when the stocks they bought will be even cheaper.  How can that be?  Well, stocks could go down further but let’s assume that they stay here for now. What if earnings go down? Remember that they are in the denominator of the equation and if they go down, stocks become expensive again, but without the stock even moving up.  Much of the selling that occurred in the markets last week appeared to have more to do with psychological fear of the Coronavirus and little to do with valuations.  But there is a reality that the virus will have a toll on company earnings in the next several quarters. Some companies like Apple, Microsoft, HP, MasterCard, and now VISA (WHILE YOU SLEPT) have made it clear that earnings will be affected. For other companies it is obvious (energy, travel, technology, and banks).  Once all the smoke clears, with the ‘E’ in the PE possibly going down many may find even these multiples rich. Caution.

• Stealing from the rich?  Robinhood, a venture-funded, money bleeding unicorn has become famous for starting the trend to shrink stock trading commissions. The application first became popular with younger investors who were happy to get commission-less, no-frills stock trades.  Soon other online firms followed suit lowering commissions to lure younger investors. Unfortunately, there has been an unwanted side effect.  With low or no commissions so prevalent for online trades, more and more everyday folks attempt to jump in and out of the market to take quick profits.  Call them armchair day-traders.  Many analysts believe that their emergence has only accentuated these recent moves in the markets, and this new class of trader is usually on the wrong side of the crowd.  Yesterday’s session featured another unwanted side effect as it was reported that Robinhood experienced a systemwide outage as traders overwhelmed their system. The point here is that a) market timing does not work, b) small traders are typically preyed upon by larger computerized traders, and c) you get what you pay for.  Stay focused on long term investing… leave the trading up to the amateurs.

 

THE MARKETS

 

Stocks ripped up yesterday on hopes that central bankers and lawmakers around the world will cure the financial markets from the Coronavirus.  The S&P500 climbed by +4.06%, the Dow Jones Industrial Average rose by +5.09%, the Russell 2000 ascended by +2.85%, and the NASDAQ Composite Index jumped by +4.49%.  Bonds climbed and 10-year treasury yields climbed by +2 basis points to 1.16%.  Crude oil climbed for the first time in 7 sessions adding +4.45%.  OPEC+ ministers will be meeting in Austria this week to discuss the possibility of further supply cuts to shore up prices and traders are hopeful.

 

NXT UP

 

– G7 leaders are having a conference call this morning to discuss coordinated efforts to shore up the global economy in the wake of the Coronavirus.

– Cleveland Fed President Loretta Mester, Chicago Fed President Charles Evans, and New York Fed EVP Lorie Logan will speak today.

– This morning Target, Autozone, and Kohl’s beat estimates.  After the bell we will hear from Ambarella, Nordstrom, and Ross Stores.

daily chartbook 2020-03-03