Dow 20,000, S&P 2260

I’m not a fan of the Dow.  It’s a weird index whose main virtues are that, way back when, it was the financial media’s first try at measuring the US market and that, despite its peculiarities, it’s easy to calculate.  It’s no longer a useful gauge of US stocks, however.  So it’s never used by professionals, only by media people who have little industry background.  (One caveat:  the Dow indices are now controlled by the same people who own the S&P–who now have a vested interested in keeping the Dow alive, despite its drawbacks.)

Still, it’s striking that for the past six weeks 20,000 on the Dow has shown itself to be a strong point of resistance to the US stock market’s upward movement.  The equivalent figure for the S&P 500 is 2260, not a memorable number.

Whether the resistance level is 20,000 or 2260 makes little economic or financial difference.  Psychologically, however, 20,000 is much more daunting, I think, than 2260.  This is especially so now that the US stock market has risen far above former highs.

My bottom line is that, whatever number you choose, the post-election rally has run into its first substantial roadblock.  It’s also at least thinkable that the Dow is developing, at least for the moment, more relevance than I’m willing to give it credit for.  This would suggest that the balance of market power is shifting away from professionals to individual investors who have little stock market experience.    I find this hard to believe, but it’s something I should keep an eye anyway.

 

what I find most surprising about Tesla (TSLA)

a concept stock

My California son got me interested in TSLA a couple of years ago.

It’s a “concept” stock.  That is, the stock trades on the dream or vision of future revenue and profit.

…like Amazon

In many ways, it’s like Amazon (AMZN) was in the late 1990s.

That company seemed to me to be on the verge of financial disaster for most of the first decade of its existence.  It only began to be profitable after it expanded from its original virtual bookstore idea to becoming an online department store.  In my view, had AMZN not aggressively raised a lot of capital during the Internet Bubble, it would not have survived.  After all, it lost money eight (?) years in a row before breaking into the black.

the center of an empire

TSLA is the seat of the Elon Musk empire.  Some say it’s a car company (me included); some would characterize it ultimately as a battery company, with cars as the wrapper that contains the principal TSLA product.

the stock

The stock is now trading at $260 or so a share, giving TSLA a market capitalization of about $39 billion.  Suppose we think, to make up a number, that the stock should trade at 30x earnings.  If so, the current price expresses investor belief that at some point the company will be making $1.3 billion a year and still have, say, 20% growth in annual profit in prospect.

back of the envelope numbers

Let’s say TSLA is a car company and that it will be making on average $7,000 a car, after tax, on its output at some future date.  If so, the current market price already factors into it that TSLA will be selling about 200,000 cars a year–and expanding rapidly.

I think that’s possible.  More important, the market says that’s what investors are willing to believe, and pay for.

risks

There are risks, yes, the most obvious of which is that the company keeps pushing back the date when it will turn cash flow positive.  What cash flow positive means is that the company will be able to generate enough cash from operations to cover costs, and will no longer be eating into its cash reserves to make ends meet.

what I find surprising

What’s stunning, though, is that less than two months ago the stock was trading at just over $141, or just over half today’s price.

New information has come out since then:

–TSLA began taking deposits for its $35,000 base price Model 3.  In less than a week, it has collected $1,000 each for about 300,000 units, with enough add-ons to bring the average selling price to $42,000. Most won’t receive their cars until 2018.  This support seems to me to show there’s potentially huge demand for electric cars, even at today’s lower oil price.

–the company announced that it missed its 1Q16 sales target because of parts shortages.  Presumably this means it did not turn cash flow positive as anticipated during the quarter.  That’s bad, especially since we’ve heard this song before.

the stock price

The stock is up $10-$20 a share on the two items, which were announced at roughly the same time.

What I find interesting is that a relatively large market cap company can move from $140 to $240 in a matter of weeks on a change in sentiment.  That’s about 70%!

So much for efficient markets and investor rationality   …not that anyone outside the ivory tower believes in this stuff.  But this is a huge move.

algorithmic trading?

I think it’s evidence of relatively naive algorithmic trading at work (based ultimately on two other wacky academic ideas–that the most important thing in investing is to control costs, and that there’s no craft skill/specialized knowledge involved in investing).

I also see it as support for my view that trading can be unusually profitable in this environment.   We should look for other instances where this may be happening.

 

 

 

the last bull standing

Being the last bull standing isn’t necessarily a good thing.  The Wall Street cliche is that the bear market doesn’t end until the last bull capitulates.  The complementary, equally hoary, standby is that the bull market isn’t over until the last bear capitulates.

To my mind, both are useful guidelines but not infallible ones.  On the one hand, markets are inherently cyclical.  So if an equity investor has a close to infinite capacity to endure pain–and if his clients don’t fire him in the meantime–persevering with a bad-performing portfolio can eventually pay dividends.

More qualifiers:

–that’s assuming the companies whose stocks the suffering-oriented manager holds are inherently sound, and not barreling down the road to bankruptcy.  They’re just poorly positioned for the current economic environment, which will sooner or later change for the better.

–a surprisingly large number of pension clients love to hire managers who have a recent hot hand and to jettison ones who are cold as ice, no matter what the long-term record.  So my “if his clients don’t fire him” qualification is a much greater risk than one might think.

On the other, there is something to the idea that until the most vociferous and publicity seeking defenders of a given position that’s going wrong give up, the situation rarely changes.  This may be as simple as that when, and only when, the buyers of what short-sellers want to offload disappear, so too does the short-selling–and hence the downward pressure on the stock in question.

…which brings me to Valeant Pharmaceuticals (VRX).

It has caught my eye that William Ackman, a long-time booster (and holder) of VRX, has joined the board of the beleaguered drug firm.  He’s also raised something like $800 million by selling shares of Mondelez, which was reportedly the largest position in his hedge fund.

To the extent that one believes in the last bull theory, and if Mr. Ackman is in fact the last bull, he’s in a no-win situation.

how high is “high” for the S&P 500 now?

One of the most reliable aspects of human behavior is that we all extrapolate from recent prior experience.  We form rules that are at first provisionary, but which gain strength as new experience seems to validate them.

This is the psychological basis for one of the few really powerful axioms of technical analysis, support and resistance.

The idea is that people buy financial assets at prices that in the past have proved profitable entry points and sell at prices that have shown themselves to be relatively high.  Put in more negative, but still psychologically valid, terms, I think, people who have previously sold at low points and bought at highs rue their decisions and reverse them if given another chance.   This provides, as it were, a built-in clientele of buyers at previous lows and sellers at prior highs.

How do we apply this insight to today’s S&P?

Simple.

The S&P 500 peaked at:

2110 on February 20, 2015

2108 on March 20, 2015

2130 on May 25, 2015

2124 on June 23, 2015

2128 on July 20, 2015

2102 on August 17, 2015

2110 on November 15, 2015

2102 on December 1, 2015, and

2078 on December 29, 2015.

 

We closed yesterday at 1986.  Fundamentals aside, about 5% – 6% higher than that we run into a wall of people who have been trained that 2100 or so is a time to sell.

Such resistance levels aren’t insurmountable obstacles.  Breaking through them, and therefore beginning a new buy/sell training regime, would be a hugely positive sign.  But the large number of recent instances when 2100-2130 has proved a market high water mark argues that this is a formidable barrier to advance.

dealing with high daily volatility

To state the obvious, we’re in a period of high daily volatility in the trading of stocks around the world.  What I find particularly striking is that we’ve had two days recently–January 20th and yesterday–where stocks in the US made dramatic intraday shifts in direction.  In both cases, heavy early selling that pushed indices down sharply was followed by a late reversal that wiped out most, or all, of the previous losses.  In my experience, this rarely happens once–to say nothing of twice, and within a couple of weeks of each other.

I’ve got little clue as to why the going is so choppy.  I imagine that algorithmic trading has something to do with it.  Sovereign wealth fund selling may be playing a role.  Investment banks reining in proprietary trading, thereby removing liquidity from the market, could be a factor, too.  I don’t believe that either oil or China are much more than straws the financial media are clutching to.

Still, I find it very strange.  The closest analog I can think of is the period following the collapse of the internet bubble in early 2000.  But even that wasn’t that much like the present.

My thoughts:

  1. The intraday reversals may be significant technical events.  Sometimes, they signal market bottoms.  In both recent cases, the market did bounce up off important support lines.  Time will tell, especially since markets have a habit of returning to prior lows after a month or so before resuming a new direction.
  2. Blackrock, the largest investment manager in the US, seems to be calling into question whether daily volatility really has any significance for ordinary investors.  Presumably, we all have equity investment horizons of three to five years.  So what do daily ups and downs matter? This is just common sense, in my view, and harks back to traditional Wall Street beliefs.  It is, however, heresy to devotees of the (wacky) academic theory of finance taught to in MBA schools.
  3. As a practical matter, you and I will never be able to outtrade high speed computers, or even low speed ones–or professional human traders, for that matter.  We don’t have–or want–the mindset.  We have lives; we aren’t interested in watching stock price feeds all day.  Our main advantage over traders is that we are willing and able to take a longer investment horizon.  We try to be aware of the shape of the forest, not the height and width of each individual tree.
  4. We can look for anomolies, though.  Yesterday is a case in point.  We can look for stocks that didn’t follow the herd.  Issues that went down less than the market in the panicky morning selling and rose more the the average during the afternoon rebound are probably worth looking at more closely as buy candidates.  The reverse is also true.  Stocks we own that sold off more heavily than the average in the morning and rebounded less have got to be reexamined for whether we still want to hold them.
  5. It’s conceivable that high daily volatility is the new normal.  Who knows.  But if so, we should consider what else we can to to turn this to our advantage.  More limit orders when we trade?  More aggressive limits?

 

Jim Paulsen: lower lows, but not by much

Jim Paulsen, equity strategist for Wells Capital Management, an arm of Wells Fargo, gave an interview on CNBC yesterday.  It’s well worth listening to.

His main points:

–the stock market decline we’ve seen since November is all about adjustment to lower future earnings growth prospects.  This is being caused by the resumption of “normal” growth as the bounceback from deep recession is completed.  Another aspect of the return to normal is the economic drag from gradual end to extraordinary monetary stimulus, at least in the US.

In Mr. Paulsen’s view, the S&P 500 can trade at 16x trailing earnings in this new environment, not the 19x it was at two months ago.

–we may have seen the lows for the year last Wednesday at midday (1812 on the S&P 500).  More likely, the market will revisit those lows in the near future.  It will break below 1800 on the S&P, creating a fear-filled selling climax.

–assuming, as he does, that the S&P will end the year flat, i.e. around the 2044 where it closed 2015, a buyer at yesterday’s close would have a 9% return (11% dividends) from holding the index by yearend.  A buyer at 1800 would have a compelling 14% (16%) return.  11% might be enough to attract buyers; 16% surely will be.

–2017 will be a stronger year for earnings growth than 2015, implying that the market will rise further as/when it begins to discount next year’s earnings growth.

–the current selloff will trigger a market leadership change.  The new stars will likely be industrials, small-caps and foreign stocks.