KEY POINTS
- Every once in awhile there is a combination of conditions which are perfect for Short Sellers to drive down the market. This can create buying opportunities, but can also be a precursor to a broader change in the market.
- Headlines on three key issues will drive the volatility in the market until they are resolved this week.
- Technical Analysis reflects a market that is at an ‘Oversold’ condition.
WEEKLY HEADLINES
- U.S. draws down Ukraine embassy presence as war fears mount
- Inflation surge could push the Fed into more than four rate hikes this year, Goldman Sachs says
- S&P500’s worst week since March 2020
MARKET DYNAMICS
The past week saw the S&P500 have it’s worst week since March 2020. There are a number of geopolitical and economic concerns and it’s important to understand how they affect the decision making process of Big Money Managers, and how those decisions affect stock prices and recognize whether a broader market pullback is a Bear Raid, the start of a Market Crash or a Buying Opportunity.
At stockmarketHQ we assess an issue and escalate it through three levels to determine it’s affect on the portfolio
- Concern
- Threat
- Event
Russian Invasion of Ukraine
Every US President needs a war to solidify the perception of leadership in the eyes of the voting public. Reagan had the war on drugs, the Bush’s had Iraq, Trump had the economic war on China. Will Biden’s war be with Russia? More on that question in a moment.
A large part of the week’s sell-off was the result of Big Money Managers selling (high supply) as well as not buying (low demand) in order to minimize risk on a Friday in the event that Russia did make an invasion move over the weekend.
At this point the issue of Russia invading Ukraine remains a ‘Concern’. Russia has amassed troops along the Ukraine border. Nations are issuing ‘posturing’ headline statements publicly expressing the follow on actions if Russia makes a move.
A large part of trading is conducted by Hedge Funds which use High Frequency Trading Computers programmed with algorithms that trigger massive sell or buy orders based on keywords in headlines. These programs are most effective, and dominant, in a ‘low demand’ market, that is, when nobody is buying. This strategy will remain as long as ‘posturing’ headlines sell news.
Back to the first question, ‘Will Biden’s war be with Russia?’ The answer is, it doesn’t matter.
As investors/traders, the correct question is ‘how will Russia invading Ukraine affect the number of iPhones sold in China, the number of mortgages taken out by Americans to buy houses or the impact on technology infrastructure development as consumers’ behaviour patterns change’.
As the Issue is assessed, the impact should be minimal if any.
With that in mind, however, one of the rules at stockmarketHQ is that if any war starts, it’s best to get out of the way when the first missile is fired.
US Interest Rates
The US Federal Reserve is scheduled to meet on Tuesday and Wednesday of this week. Those meetings conclude with a monetary policy statement and a media question and answer session with US Federal Reserve Chairman J Powell.
In the Market Update 15-1-2022 we discussed the formula which determines a stocks price
Price = Earnings per Share (EPS) x Multiple (M)
We elaborated on Gene Munster’s video discussion on how each 1/4 percent interest rate hike affects the multiple of a stock and explained the affect on its stock price. The ‘Multiple’ is generally tied to the growth rate of a company. As ‘free money’ turns to ‘cheap money’ and then becomes ‘expensive money’ this reduces the capital that high growth companies can access to further fuel their growth. Growth rate decreases, therefore the ‘Multiple’ decreases and by correlation the future stock price estimate must also decrease. Big Money Managers will sell.
At the December US Fed meetings, the policy release stated there would be the end of the bond purchase program PLUS an expected THREE rate hikes in the second half of 2022.
From the Article “Inflation surge could push the Fed into more than four rate hikes this year, Goldman Sachs says”,
“Traders are pricing in nearly a 95% chance of a rate increase at the March meeting, and a more than 85% chance of four moves in all of 2022… Chances of a fifth rate increase have moved to nearly 60%, according to the CME’s FedWatch gauge.”
Throughout January, prices in high growth companies were revalued based on the impact of three rate hikes on the ‘Multiple’ (M). The selling was reflected in the Article ‘https://www.cnbc.com/2022/01/06/hedge-funds-are-selling-tech-shares-at-their-fastest-pace-in-a-decade-as-rates-spike.html’
IF the US Federal Reserve changes their policy to four or even five rate hikes or begins sooner than expected then Big Money Managers will once again revalue stock prices, most likely lower.
EARNINGS REPORTS
It’s a very big week for earnings reports. 25% of the value of the S&P500 is made up of
only 6 companies (source investopedia)
- Microsoft (MSFT): 6.43%
- Apple (AAPL): 6.36%
- Amazon (AMZN): 3.92%
- Tesla (TSLA): 2.36%
- Alphabet Class A (GOOGL): 2.22%
- Alphabet Class C (GOOG): 2.09%
- Meta (FB), formerly Facebook, Class A: 2.05%
The Market will move based on the results and forward guidance of those companies.
This week we will be watching the following companies report earnings.
- Tesla January 26
- Boeing January 26
- Apple January 27
- Microsoft January 26
- Phillips Sixty Six (PSX) January 28
- Altria (MO) January 27
SHORT SELLERS
Short Selling Hedge Funds use a strategy where they ‘borrow’ massive numbers of shares from large financial institutions then sell them on the open market at a high price with the objective of buying them back at a lower price and returning the shares to the original financial institution they borrowed them from. The profit is the difference between the high selling price and the lower price that they buy them back at. Short Sellers make money as stock prices decrease.
The market moves as a function of the supply/demand equation.
When Short Sellers dump shares on the market this increases supply and price decreases. As price decreases, investors’ (natural sellers) Stop Loss sell orders are triggered, which further adds to supply. As financial institutions begin to sell to protect their capital, this creates even more supply and prices decrease even further. Short Sellers come in hard and fast and the strategy becomes a self sustaining downward cycle until there are no more ‘natural’ sellers, and then the Short Sellers have to buy back the shares and the cycle is reversed.
There are a combination of conditions which are perfect for Short Sellers to ‘raid’ the market.
- Negative Headlines or Catalysts
- Big financial institutions not buying
- A large number of shareholders at the level where the market equals their breakeven price
MARKET ANALYSIS
What does that mean at stockmarketHQ
Is the current market pullback a Bear Raid, the beginning of a broader market decline or a buying opportunity?
Last week we expected a market move within the next 1-3 weeks, all the market needed was a catalyst, this week there were three issues
- Russia Invasion of Ukraine Headlines
- Federal Reserve Meeting on Interest Rate Policy Tuesday/Wednesday
- Big Tech Earnings Reports
Short Sellers use a very defined strategy which can drive the market down when conditions are just right.
IF those issues escalate to the next level as a ‘Threat’, Short Sellers will be able to drive the market lower.
IF those issues don’t materialize, short sellers will be forced to buy back shares, big financial institutions will view the market as on sale and begin accumulating shares and the market will ‘bounce’.
It’s important to note that two of those issues will come to a conclusion this week once the US Federal Reserve issues its policy statement and Big Tech reports earnings. This will remove the ‘Uncertainty’. The third issue, a Russian invasion of Ukraine, has little impact on corporate sales or profitability.
The Technical Market Analysis reflects that the market is following past monthly patterns of a pullback lasting 5-9 days in the final week of the month or first week of the subsequent month. It is currently near an ‘Oversold Condition’ and the Volatility Index or ‘Fear Gauge’ is at a peak level where 1.75%-2% daily moves, up or down, can be expected until the catalysts are resolved.
During Earnings Season stock prices follow one of three patterns
- Stocks run up in anticipation of strong results, then selloff when earnings don’t meet high expectations.
- Stocks remain neutral until the release then either move up or down based on the actual results
- Stocks decline as a selloff due to uncertainty of the results, then climb when results are not as bad as expected.
Most of the Big Tech stocks are currently in Pattern 3 and are at ‘Oversold’ levels.
On the surface, this weeks action looks like a Bear Raid and a buying opportunity. However, it is Earnings Season and individual stock prices will make big moves, up or down, based on earnings reports.
However, longer term a stocks price is determined by the formula
Price = Earnings Per Share (EPS) x Multiple (M)
As interest rates rise, the ‘Multiple’ (M) will decline and it can already be seen that Big Money Managers and analysts are revaluing high growth stocks with low Earnings Per Share.
This changes the environment from an ‘Everything Goes Up Forever’ market to a ‘Stockpickers Market’ where a very disciplined strategy must be followed. As a trader/investor you have to be aggressive to make money, but if you don’t have a defensive strategy you won’t keep your money.