what to do on a rebound day

It doesn’t appear to me that the economic or political situation in the US has changed in any significant way overnight.  Yet stocks of most stripes are rising sharply.

What to do?   …or if you prefer, what am I doing?

Watching and analyzing.

A day like today contains lots of information, both about the tone of the market and about every portfolio’s holdings.  Over the past month, through 2:30 pm est today, the S&P is down by 4.8%.  The small-cap Russell 2000 has lost 7.7%, NASDAQ 7.8%.   All three important indices are up significantly so far today—NASDAQ +2.2%, Russell 2000 +1.9%, S&P 500 +1.8%.  So this is a general advance.  Everything is up by more or less the same amount, meaning investors aren’t homing in on size or foreign/domestic as indicators for their trading.

What we should all be looking for, I think, is what issues that should be going up–either because they’re high beta or have been beaten up recently–are shooting through the roof and which are lagging.  (“Lagging” means underperforming other similar companies or underperforming the overall market.)  The first category are probably keepers.  The poor price action for the latter says they should be subjects for further analysis to figure out why the market doesn’t appreciate their merits.  Maybe there aren’t any.  

We should also note defensive stocks that are at least keeping up with the S&P.  That’s better than they should be doing.  They may well be true defensives, meaning they stay with the market (more or less) on the way up and outperform on the way down.  This is a rare, and valuable, breed in today’s world, in my view, and can be a way to hedge downside risk.

 

 

Another topic:  Over the past few days, I’ve been in rural Pennsylvania filming my art school thesis project–yes, I’ve gone from stills to video–so I haven’t kept up with the news.  I’m surprised to see that the UK, which still remembers the enormous price it paid a generation ago resisting fascism, has done an abrupt about-face and allowed Mr. Trump to make a state visit.  The anticipated consequences of Brexit must be far more dire than the consensus expects.

Trump, tariffs, trading

There’s no solid connection among the three topics above, but the title gives me the chance to write about three only-sort-of connected ideas in one post.

The crazy up-and-down pattern of recent stock market trading in the US is being triggered, I think, by Mr. Trump’s tweets about trade–and about tariffs in particular.  I think a lot of the action is being caused by computers trading on the President’s tweets themselves, or some derivative of them–likes, media mentions, reflexive response to stock movements (or a proxy like trading volume).

my thoughts

–it’s hard to know whether the misinformation Mr. Trump is spewing about tariffs is art or he simply doesn’t know/care.

Tariffs are paid to US Customs by the importer.   In some small number of instances, a Chinese exporter may have a US-based, US-incorporated subsidiary that imports items from the parent for distribution here.  In this case, a Chinese entity is paying tariffs on imported Chinese-made goods.  To that degree. Mr. Trump is correct.  Mostly, however, the entity that pays a tariff on Chinese goods is not itself Chinese.

This is not the end of the story, however.  The importer will attempt to recover the cost of the tariff through a higher price charged to the US consumer and/or through a discount received from the Chinese manufacturer.  In the case of washing machines, which I wrote about recently, for example, all US consumers ended up paying enough extra to cover the entire tariff  …and some paid more than 2x the levy.  The prime beneficiaries of this largesse were Korean companies Samsung and LG.

–one of the oddest parts of the current tariff saga is that Mr. Trump has decided not to work in concert with other consuming nations.  In fact, one of his first actions as president was to withdraw from the international coalition attempting to curb China’s theft of intellectual property worldwide.  The Trump tariffs are only bilateral, so there’s nothing to stop a Chinese company from shipping a partially assembled product to, say, Canada, do some modification there and reexport the now-Canadian item to the US.

The administration has been artful in selecting intermediates rather than consumer end products for its tariffs so far.  This makes it harder to trace price increases back to their source in Trump tariffs.  However, the fact that the administration has taken pains to cover its trail, so to speak, implies it understands that tariff costs will be disproportionately borne by Americans.

 

–in trading controlled by humans, a lot of tariff developments should have been baked in the cake a long time ago.  Continuing volatility implies to me that much of the reacting is being done by AI, which are learning as they go–and which, by the way, may never adopt the discounting conventions humans have employed for decades.

 

–I think it’s important to examine the trading of the past five days (including today as one of them) for clues to the direction in which the market will evolve.  Basically, I think the selling has been relatively indiscriminate.  The rebound, in contrast, has not been.  The S&P and NASDAQ, for example, are back at the highs of last Friday as I’m writing this in the early afternoon.  The Russell 2000, however, is not.  FB is (slightly) below its Friday high; Netflix is about even; Micron is down by 4%.  On the other hand, Microsoft and Disney are 1% higher than their Friday tops, Paycom is 2.5% up, Okta is 5% higher.

No one knows how long the pattern will last, and I’m not so sure about DIS, but I think there’s information about what the market wants to buy in these differences.   And periods of volatility are usually good times for tweaks–large and small–to portfolio strategy.  This is especially so in cases like this, where the movements seem to be excessive.

One thing to do is to confirm one’s conviction level in laggards.  Another is to check position size in winners.  In my case, my largest position at the moment is MSFT, which I’ve held since shortly after Steve Ballmer left (sorry, Clippers).   I’m not sure whether to reduce now.  I’d already trimmed PAYC and OKTA but if I hadn’t before I’d certainly be doing it today.  I’d be happiest finding areas away from tech, because I have a lot already.  On the other hand, I think Mr. Trump is doing considerable economic damage to American families of average or modest means, with no reward visible to me except for his wealthy backers.  Retail would otherwise be my preferred landing spot.

–Even if you do nothing with your holdings now, make some notes about what you might do to rearrange things and see how that would have worked out.  That will likely help you to decide whether to act the next time an AI-driven market decline occurs.

a day like today

Stocks are down today.  The ostensible reasons are trade war fears + the administration’s distinctly un-American decision to seize and imprison the children of asylum seekers at the border.

It’s not clear to me that–important as these issues may be for the long-term attractiveness of the US as an investment destination–they are the reasons for the market’s decline.  (Personally, I think the mid-term elections will give us the first true read on whether ordinary Americans approve of the UK/Japan-like road Washington has set the country on.)

But I don’t want to write about macroeconomics or about politics.  Instead, I want to call attention to the useful purpose that down days, or strings of down days, for that matter, serve for portfolio management.

There are two:

 

–portfolio realignment.  This is as much about psychology as anything else.   Typically during a selloff stars go down more than the market and clunkers underperform.  Because of this, clunkers that have been hiding in the dark recesses of the portfolio (we all have them) become more visible.  At the same time, stars that we’ve thinking we should buy but have looked too expensive are suddenly trading a bit cheaper.  The reality is probably that we should have made the switch months ago, but a down day gives us a chance to tell ourselves we’re better off by, say, 5% than if we’d made the switch yesterday.

 

–looking for anomalies–that is, clunkers that are going down (for me, this is typically a sign that things are worse than I’ve thought, and a sharp spur to action), or stars that are going up.   Netflix, for example, is up by about 1.4% as I’m writing this, even though it has been a monster stock this year.  I already own enough that I’m not going to do anything.  But if I had none (and were comfortable with such a high-flier) I’d be tempted to buy a little bit and hope to fill out the position on decline.

 

 

~$70 a barrel crude (ii)

Two factors are moving the Energy sector higher.  The obvious one is the higher oil price during a normally seasonally weak time.  In addition, though, the market is actively looking for alternatives to IT.  It isn’t that the bright long-term future for this sector has dimmed.  It’s that near-term valuations for IT have risen to the point that Wall Street wants to see more concrete evidence of high growth–in the form of superior future earnings reports–before it’s willing to bid the stocks significantly higher.  With IT shunted to the sidelines for now, the market is not being a picky as it might be otherwise about alternatives such as Energy and Consumer discretionary.

The fancy term for what’s going on now is “counter-trend rally.”  It can go on for months.

 

As to the oils,

–a higher crude oil price is clearly a positive for the exploration and proudction companies that produce the stuff.  In particular, all but the least adept shale oil drillers must now be making money.  This is where investment activity will be centered, I think.

 

–refiners and marketers, who have benefitted from lower costs are now facing higher prices.  So they’re net losers.  Long/short investors will be reversing their positions to now be short refiners and long e&p.

 

–the biggest multinational integrateds are a puzzle.  On the one hand, they traditionally make most of their money from finding and producing crude.  On the other, they’ve spent very heavily over the past decade on mega-projects that depend for their viability on $100+ oil.  This has been a horrible mistake.  Shale oil output will likely keep crude well short of $100 for a very long time.

Yes, the big multinationals have all taken significant writeoffs on these ill-starred projects.  But, in theory at least, writeoffs aren’t supposed to create future profits.  They can only eliminate capital costs that there’s no chance of recovering.  As these projects come online, they’ll likely produce strong positive cash flow (recovery of upfront costs already on the balance sheet) but little profit.

The question in my mind is how the market will value this cash flow.  As I see it–value investors might argue otherwise–most stock market participants buy earnings, not cash generation.  Small companies in this situation would likely be acquired by larger rivals.  But the firms I’m talking about–ExxonMobil, Shell, BP…–are probably too big for that.  Will they turn themselves into quasi-bonds by paying out most of this cash in dividends?  I have no idea.

Two thoughts:

—–why fool around with the multinationals when the shale oil companies are clear winners?

—–as/when the integrateds start to show relative strength, we have to begin to consider that the party may be over.  So watch them.

a rainy Friday in August in New York

August is the month when many senior portfolio managers are away from the office on vacation.  So big decisions on portfolio structure tend not to be made.

Friday is the day of the week when short-term traders’ thoughts turn to flattening their books so they won’t carry risk over the weekend.

It’s raining, which sparks thoughts in traders of sleeping in or leaving work early.

Add all that up, and the heavy betting should be that US stocks will likely move sideways in the morning and fade off toward the close.

That means this is a good day to stand on the sidelines and size up the tone of the market.

 

In pre-market trading, tech is up and bricks-and-mortar retailing (on the earnings miss by Foot Locker) is down.  …nothing new about this.  At some point there will doubtless be a fierce counter-trend rally.  But the negative earnings surprises are still provoking severe selloffs.  So I don’t think today is the day.

Pundits are speculating about the damaging effects on his political agenda of Mr. Trump’s apparent defense of neo-Nazis in Charlottesville.  …but the Trump trade has been MIA since January, with the US a laggard among world stock markets during Mr. Trump’s time in office so far.  Yes, there may be residual hope for corporate tax reform from the administration, which this latest demonstration of the president’s ineptness as a executive could arguably undermine.  My guess is, however, that he is already well understood.

Two questions for today:

–will the market perform more strongly than the season and the weather are suggesting? This would be evidence that there’s still an untapped reservoir of bullishness waiting for somewhat better prices to express itself.

–should we be buying in the afternoon if it’s weaker than I expect?  My answer is No.  I think there is a lot of untapped bullishness, but we’re in a slowly rising channel whose present ceiling is less than 2500 on the S&P 500.   That’s not enough upside for me.  I’m also content to wait for any incipient bearishness to play itself out further.

It will be interesting to see how today plays out.

 

market rotation: two types

market/sector rotation

Market rotation, sometimes also called sector rotation, is a shift in the pattern of sector outperformance in the stock market.  In 2016, for example, the S&P 500 favored defensive sectors over aggressive ones.  2016 produced the opposite result.

why

The market rotates for two basic reasons:

change in economic circumstances.  In early 2016, for example, Wall Street began to believe that the price of crude oil, which had been in free fall for two years, finally hit bottom at around $26 a barrel.  So oil stocks began doing better.  Similarly, investors now believe that the election of Donald Trump as president, meaning both houses of Congress and the White House are all Republican, signals the end of Washington dysfunction.  This implies a significant turn for the better in the US economy.  As a result, the most economically sensitive areas of the stock market have been doing better since Election Day.

valuation.  Professional investors often say that “trees don’t grow to the sky,” meaning that at some point sectors that are enjoying an economic tailwind become too expensive relative to those being buffeted by temporary headwinds.  At such times, they will begin to buy stocks in left-behind sectors almost entirely on the idea that as financial instruments they are relative bargains.

short/shallow vs. long/deep

Sector rotations based on valuation tend to be much shorter and shallower than those based on a change in economic circumstances.

the 2015 -16 example

In 2015,  the Healthcare sector rose by +5.2% and Energy fell by -23.6%.  The difference in performance between the two was a whopping 28.8 percentage points.

In 2016, Healthcare fell by 4.4% and Energy rose by +23.7%.  The performance difference between the two was 28.1 points.

what about today?

To me, the extent of the outperformance of the most economically sensitive sectors since the election has been so strong as to invite a market rotation away from them.  My guess is that this will be based mostly on relative valuation.  If so, the turn away from current market leaders will be relatively brief and the correction in these sectors relatively shallow.

For day traders, this will be a big deal; for you and me, not so much.  Our main concern will be the buying opportunity in cyclicals a correction in them will present.