Key Points
- Rising Interest rates affect the investment strategies of Big Money Managers and it’s important to understand how a shift in strategy will will affect your portfolio stocks.
- Earnings season begins this week. Stocks will follow predefined price patterns in the lead up to, and following the reports, as price swings create volatility and opportunity.
- Technical Analysis reflects a market that is ready to breakout or breakdown in the coming weeks.
INTEREST RATES VS EARNINGS
In the December Market update we took a look at how the US Federal Reserve Bond Tapering Program and how interest rate hikes through 2022 would change ‘Free Money’ to ‘Cheap Money’ and this would change the investing dynamic for Big Money Managers, Hedge Funds and traders/investors.
The following video gives a good insight into how Big Money Managers look at the impact of interest rate hikes on stocks and their investment decision process. Take note of how Gene Munster explains that each 1/4 point rate hike affects the ‘multiple’ or ‘valuation’ of a stock.
To explain that a little further, a stocks price is generally based on a simple formula
Price = Earnings Per Share (EPS) x Multiple (M)
Earnings Per Share = total profit (Revenue – Cost) divided by the total number of shares in the company.
EPS is pretty straight forward as it is tangible and easily calculated or forecast by analysts. As EPS rises the stock price has to increase. If EPS declines then the stock price declines.
Multiple – this is defined as the value that investors are willing to pay for the future earnings of the company. In effect, this is really an arbitrary number or value which investors assign to a stock. It is generally forward looking and it is tied to the growth rate of the company’s earnings or revenue, for example
Tech stock growing revenue at 100% might have a multiple of 100
Apple growing at 30% might have a multiple of 30
Utility company growing at 4% might have a multiple of 4
As a companies growth rate accelerates, this is called ‘Multiple Expansion’ (good). In the formula M increases, therefore the stock price must increase. When growth rate decelerates it is called ‘Multiple Contraction’ (bad). M decreases, therefore the stock price must decrease.
The formula P= EPS x M is what causes the big price movements and volatility during earnings season as companies report their profitability and revenue growth. Analysts simply take the reported number, plug it into the formula and the stock is ‘revalued’.
As Gene Munster discusses in the video, as interest rates go up, ‘multiples’ in the ‘high multiple’ stocks come down. The focus of Big Money Managers transitions from companies with high growth rates, to companies with actual Earnings Per Share growth.
Effectively as Free Money changes to Cheap Money and then turns to Expensive Money, there is a rotation into companies that actually make ‘stuff’ and do it profitably.
EARNINGS SEASON
Earnings season starts with the banks reporting the week of January 14 and the bulk of stocks should be finished by the end of the first week of February.
This is a period of high volatility where companies that beat analyst estimates or forecast higher profitability will be rewarded and companies that miss analyst estimates or provide poor forward guidance will be punished. There are opportunities to lock in profits, buy great companies that go on sale, or make Fast Trades based on the technical setups leading up to the reports.
CEO commentary can be expected to include
- effects of omicron on December sales
- impact of supply chain issues on current and future production
- impact of logistics
- impact of future interest rate hikes
- inflation pressures and the effect on material input costs
During Earnings Season stock prices follow one of three patterns7
- 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.
stockmarketHQ EARNINGS CALENDAR
BOEING (BA) JAN 26
JPMORGAN JAN 14
GOLDMAN SACHS(GS) JAN 18
TESLA (TSLA) JAN 25-31
APPLE (AAPL) JAN 27
MICROSOFT (MSFT) JAN 25
PHILLIPS SIXTY-SIX (PSX) JAN 28
ALTRIA (MO) JAN 27
DISNEY (DIS) FEB 9
FERRARI (RACE) JAN 31-FEB 5
FACEBOOK (FB) FEB 2
DEERE (DE) FEB 18
EXPEDIA (EXPE) FEB 9-14
NVIDIA (NVDA) FEB 22-28
All dates subject to change.
TECHNICAL ANALYSIS
What does that mean at stockmarketHQ
“YOU CAN’T FIGHT THE FED”
It is a cliche, but it is true. The US Federal Reserve controls the flow of money.
Big Money Managers control the investments the money flows into and they follow consistent strategies based on US Federal Reserve Policy.
As interest rates change, the ‘Multiple’ or ‘valuation’ is affected.
In 2020 and 2021 interest rates declined to near 0%. The US Federal Reserve opened the Free Money flood gates and Big Money Managers put that money into companies which had the potential to accelerate revenue growth due to pandemic related shifts in consumer spending and government stimulated programs.
That Accelerating Revenue Growth (ARG) pushed the stock Multiple (M in the formula Price = EPS x M) in speculative companies to levels that would otherwise have taken 4-5 years to achieve.
As the US Federal Reserve tries to slow down inflation and correspondingly the economy, Accelerating Revenue Growth changes to Decelerating Revenue Growth and the ‘Multiple’ will contract.
As Interest rates rise, Big Money Managers will adjust their investment strategy.
This effect can be seen in many previously ‘high multiple’ growth stocks which have declined 30%-50% and is reflected in the following article
The Technical Analysis reflects a market that is ready to either break out or break down in the coming weeks, but there needs to be a catalyst, or a reason, for Big Money managers to add new money to the market or sell to protect their profits. That catalyst could be positive or negative, sometimes the absence of a positive catalyst is enough of a reason for investors to turn cautious.
As Earnings Season begins stocks will make volatile moves based on the reported results and CEO commentary on forward guidance.
It’s important to watch for the earnings Season run-up patterns to help with investment decisions to lock in profits or capitalize on opportunity.
As a trader, you have to be aggressive to make money, but if you don’t have a defensive strategy you won’t keep your money.