last Friday’s US stock movement

Last Friday the S&P 500 opened at 2436, rose to 2446, fell to 2416 and rallied at the end of the day to close little changed at 2432.  Volume was maybe 10% higher than normal.  Sounds ho-hum.

Look at Financials, Energy or Technology and the story isn’t one of a sleepy summer-like Friday.  It’s violent sector rotation instead.

According to Google Finance, the Energy sector was up by +1.4% for the day and Financials by +0.8%.  Technology fell by -2.7%.

But that understates what happened beneath the calm surface.

Oil exploration and production stocks, which have been in free fall recently, rallied by 4% or more.  Large internet-related names fell by an equal amount.  Market darling Invidia (NVDA) rose by 4% in early Friday trading, then reversed course to fall by 15%, and rallied late in the day to close “only” down by 7%+.  That came on 5x recent daily volume.

What’s going on?

Well, to state the obvious, Friday’s stock market action in the US runs counter to recent trends.  To my mind, the aggressive buying and selling are both based on relative valuation rather than any sudden change in the fundamental prospects for any of the companies whose stocks are gyrating around.  It’s an assertion by the market that no matter how grim the outlook for oil, the stocks are too cheap–and no matter how rosy the future for tech, the stocks are too expensive.

This is part and parcel of equity investing.  There’s always someone, usually with a long investment horizon, who is willing to bet against the current trend, on grounds that current price movements are being driven by too much emotion and not enough by dollars and cents.

what’s unusual

What’s unusual about last Friday, to my mind, is how sharp the division between winning and losing sub-sectors has been and how aggressively stocks have been both sold and bought.

For what it’s worth, I also think it’s odd that this should happen on a Friday. Human buyers/sellers of this size tend, in my experience, to worry about whether they can execute their plans in one day, preferring not to let the competition mull the situation over on the weekend.  But that’s a minor point.  (One could equally argue that if the buyers/sells were looking for maximum surprise, Friday would be the ideal day to act.)

If this is indeed a counter-trend rally, meaning that after a period of valuation adjustment the prior trend will reassert itself (which is what I think), the most important investment question is how long–and how severe–the pro-energy, anti-tech rotation will be.

My experience is that it’s never just one day and that a counter-trend movement can run for a month.  On the other hand, this doesn’t look like the typical work of traditional human portfolio managers.  It looks to me more like trading done by computers.  If that’s correct, I’d imagine the buying/selling will cut deep and be over relatively quickly.  But that’s just a guess.  And I know my tendency in situations like this is to act too soon.

For myself, I’ve been thinking for some time that US oil exploration companies have been battered down too much.  As for tech, I still think it will be the most important sector for this year.  So I’m happy to use this weakness to rearrange my overall holdings, nibbling at the fallen tech names and offloading a couple of REITS I own that I think are fully valued.



oil? ebola? the dollar?–why stock prices have been falling

In many ways, stock market commentators have an unenviable task.  At any given moment they have to come up with new and interesting reasons why stocks are rising or falling.   The media gurus’ difficulties are compounded by the fact that most are story presenters who have little understanding of investing and are therefore reliant on sources whose statements are many times influenced by their own private agendas.

After peaking in mid-September, US stocks have fallen by about 7% through yesterday/  This has erased most of their year-to-date price gains, although with dividends factored in the S&P is still up about 4% since New Year’s Day.

Among the current “explanations’ for the fall are:

–a falling oil price.  I don’t think this makes sense.  It would be one thing if world GDP were turning negative and demand were sagging as a result.  The current issue, however, is oversupply, being caused by the rise of shale oil/gas production in the US.

Yes, 10% of the S&P 500 consists of oil-related stocks, many of which are hurt by lower prices.  But, to simplify a bit, the other 90% of the index is a beneficiary.  Lower prices are bad for oil-producing nations in the Middle East, for Russia and for the rest of OPEC.  But they’re great for consumers.

Another point:  today’s production contracts with national oil companies provide that virtually all revenue from oil price increases above a certain level goes to the host country, not to the international oil firm that is developing the petroleum deposits.  Although this has been true for decades, my sense is that many investors still don’t get this.  The dynamic is much more consumers gain/emerging countries lose than the consensus thinks.

–ebola.  More about this tomorrow.  Ebola is scary.  The only model we have for what happens to stocks once investors become aware of pandemic possibilities is SARS.  On the other hand, Doctors Without Borders has been handling ebola patients for many years without a single infection of their own.  In my view, stocks would be way lower than they are today if investors viewed ebola a real threat.

–the dollar.  This is an issue, although almost no one is talking about it. The US dollar has risen against the euro by almost 10% since early May.  In back-of-the-envelope terms, 25% of the earnings of the S&P 500 is sourced in euro.  A 10% fall in the dollar value of the euro means that overall S&P earnings–without factoring in current Euroland economic weakness–will be 2.5% lower than previously thought.  Discounting this outcome would explain about half the recent market decline.

my take:

–technicals.  At the peak a few weeks ago, stocks had already discounted all the S&P earnings growth that’s likely for 2014.  In addition, the market had already also factored into prices, let’s say, a third of the expected earnings growth for the index next year. This is normal market behavior, granted, though, that we haven’t seen “normal” for the better part of a decade.

By September, potential short-term buyers couldn’t justify paying higher prices for stocks.  In addition, euro weakness + a lot of other miscellaneous stuff had put 2015 profits under threat.

We’re now in the process of determining how low prices have to go to bring buyers back.

Looking at past levels where lots of buying and selling has taken place ends up being a surprisingly effective tool for figuring out where buying will emerge again.  Don’t ask me why.  If this rule of thumb holds true, as I read the charts the key levels are 1840-80 (i.e., where we are as I’m writing this) and 1800.