February Headlines

• California removes Covid mask mandates
• UK removes Covid Restrictions
• Goldman Sachs Sees 7 Interest Rate Hikes in 2022
• Goldman Sachs Sees 11 rate hikes through 2023

March Headlines

• Russia invades Ukraine
• Coordinated global sanctions imposed on Russia
• Corporations withdraw from Russia
• Oil prices spike
• China Covid spike, Shenzhen shuts down production

MARKET PSYCHOLOGY

The stock market is like any other market, it is comprised of buyers (demand) and sellers (supply). Buyers ‘bid’ for a certain quantity of shares at a certain price and sellers ‘ask’ for a certain price for a certain quantity of shares. The price that they agree to represents the ‘value’ of the stock at that instant.

There are millions of participants in the market and the reasons for buying or selling are infinite and can be complex. Maybe a ‘buyer’ has money to invest, maybe they heard a rumour at the yacht club. Maybe the ‘seller’ is anxious about the market or needs money or maybe they didn’t like the latest company earnings report. It’s the combination of those reasons that creates the supply/demand balance and prices change when there is a change in the supply or demand or both.

The supply/demand balance can be further described through five concepts

Expectations – Investors buy because they have an expectation that they will profit as the stock price rises. Investors are human and expectations come from decisions based on information (real or rumoured), emotions (hope, greed and fear) and behavioural biases.

‘Price Discounts Everything’ – was a concept introduced by Charles H. Dow (creator of the Dow Jones Industrial Average Index) around 1900 which expresses that a stocks price is the result of buyers/sellers acting on their knowledge of information, the interpretation of information and expectations.

Prices are not random – Prices are specifically and mutually agreed to.

‘History rhymes, it does not repeat’ (Mark Twain) – humans will behave similarly to the way they have in the past in similar circumstances which forms patterns that have predictable results.

Behaviour patterns are independent of time – buyer/seller behaviour patterns will be similar regardless of the time period. Whether there is a headline that affects a stocks price for a day or an event that affects the market for months, the buy/sell pattern will be similar. This is because ‘day traders’ are the investors trading on a daily basis, a monthly investor will have no effect on a daily move because they are not buying or selling. Likewise, a ‘day trader’ will have no affect on the monthly price change because the ‘monthly trader’ is trading that time period. Behaviour patterns are independent of time.

Understanding the psychology of buyers/sellers helps understand why individual stock prices fluctuate, why market indexes fluctuate, the patterns that can be recognized, opportunities that can be capitalized on and when to protect capital.

MARKET DYNAMICS

Now that Market Psychology is a little better understood, it can be applied to the market dynamics.

For the past eight weeks we have been watching three issues which have been affecting stock markets.

1. Russian invasion of Ukraine
2. US Interest rate increases
3. Company earnings reports

As a reminder, at stockmarketHQ we assess an issue and escalate it through three levels to determine it’s affect on the portfolio

1. Risk
2. Threat
3. Event

All three of the issues are the same issues from mid January. There have not been any new issues brought to the forefront of investor concerns, however the information on each issue has changed which means evaluating that information against each stock in the portfolio.

Russian Invasion of Ukraine

This issue is escalated to level 3. Event

Price discounts everything and Big Money Managers, investors and traders are acting on the information they have (headlines) and the interpretation of that information. Until there is a change to that information the behaviour pattern of investors/traders can be expected to be similar.

Big Money Managers follow a playbook. When there is a war, they buy defence stocks. When oil supply is constrained, prices go up and they buy oil producers. If prices stay elevated and drilling is stimulated, oil services companies will be bought. Investors/traders follow the trends of the Big Money Managers which pushes stocks in those sectors higher.

Money always rotates. In order to buy stocks in the oil sector, that money has to come out of a different sector, for example technology. For technology to go up, money has to rotate out of another sector, for example oil.

There are two primary concerns this issue has on the effect of stock prices.

1. Commodities price – increases input costs which negatively effects earnings/profitability of corporations.
2. Consumer consumption – Brazil, Russia, India and China are referred to as the BRIC economies and were designated as ‘Emerging Markets’ with high growth rates in their secular trend towards ‘Western’ consumption.

Since the beginning of this issue, money has flowed into oil and commodity related stocks.

US Interest Rate Increases

Over the last twelve weeks the US Federal Reserve started in December with a statement that it expects three interest rate hikes in 2022. This was followed by the February Policy statement which signalled that the first rate increase could be announced at the mid-March Policy meeting.

The media headlines have provided their own interpretations of the policy statement increasing progressively from 3 hikes to 4 to 5 with a 0.5% increase and most recently to an expectation of 7 interest rate hikes in 2022 with up to 11 hikes through 2023 by a Goldman Sachs analyst.

Investors take all the headlines, real or perceived, interpret the information, form expectations and then follow similar behaviour patterns to past interest rate increasing environments.

The effect has been that money has flowed out of interest rate sensitive stocks like tech and into non sensitive stocks like consumer staples. This is consistent with the past investor behaviour pattern during interest rate increases.

The US Federal Reserve meets on March 15/16 and will release its policy statement which is expected to include an interest rate increase as well as commentary on expected future rate increases.

Earnings Reports

In the stockmarketHQ Market Update 30-1-2022 we discussed how earnings reports would separate the companies who are making profits from those that are not and in a rising interest rate environment investors would rotate towards companies that are building their businesses using profits and away from businesses that are building their businesses using ‘free money’.

Companies that have missed earnings estimates or provided lower forward revenue guidance were punished immediately after reporting.

The focus now changes to the effect of the current concerns on the earnings reports which start in mid-April.

MARKET CATALYSTS

There are no directly positive market catalysts for the next several weeks which will change the trend in the market.

Indirect market catalysts that can change the trend in the markets will be 

1. de-escalation headlines in the Russian invasion of Ukraine
2. desensitization by investors to continuing war headlines (similar to investors tiring of covid headlines so the market just went up anyways)
3. interest rate increases ‘not as bad as feared’
4. Earnings season starting in mid-April with results ‘not as bad as feared’ 

TECHNICAL ANALYSIS

what does all that mean at stockmarketHQ

Markets Psychology and the supply/demand balance can be described by 5 concepts

1. Expectations
2. Price Discounts Everything
3. Prices are not Random
4. History Rhymes, it does not repeat
5. Behaviour Patterns are Independent of Time

At the moment, all ‘market players’ have taken into full consideration all information, strategized and positioned themselves accordingly and the market is in a balance. Markets don’t stay balanced for long.

There are three primary concerns which exist

1. Russia/Ukraine conflict
2. Interest rate increases
3. impact on future earnings (reported mid-April)

As information on those concerns changes, ‘market players’ will fully consider the new information, re-strategize, reposition and the market will find a new balance (up or down).

There are 5 primary ‘Market Players’ in the market at the moment.

1. Big Money Managers – don’t like uncertainty or risk. They are long term investors who have been selling shares slowly and steadily on any strength or rally to reduce risk.
2. Computer Algorithm Hedge Funds – have been using negative headlines to drive down prices and ‘Short Sell’ the market.
3. Short Sellers – have a perfect storm of low institutional buying, negative headlines, no news flow from companies on the effect to their business – they can drive prices lower.
4. Day traders – trade on a daily basis, buying and then selling for small profits, but closing positions by the end of the day, which adds to volatility.
5. Retail investors – in 2020/21 they dominated the market through speculation based on the ‘stocks only go up’ expectation. About 80% of that money has left the market, the remaining 20% has little influence on stock prices.

Those are the players, those are the concerns, that is the ‘Market Psychology’ behind the market moves.

The Technical Analysis reflects that the trend has been down but forming a base in a ‘Descending Triangle Pattern’. This pattern will change, either up or down very soon, based on the market players reaction to a change in the available news.

There always has to be a catalyst to that change. The US Federal Reserve interest rate announcement on Wednesday is the next potential catalyst.

The stockmarketHQ strategy is to try and catch a change in the trend as early as possible with a 90% probability of success. Statistically the current probability of a market breakout up from the descending triangle is only 36%, and the probability of a breakdown is 64%. 

The most effective strategy is to

1. Buy the best quality companies at or near technical support levels and maintain a ‘stop loss’ strategy if prices break lower or
2. Wait until any potential seller who is going to sell at a loss based on the emotion of ‘fear’, sells, and the market reaches a deeply ‘Oversold’ condition, or
3. Wait until the market reverses with positive confirmation of an upwards trend.

In all cases it is important to maintain a disciplined stop loss strategy.