Our last two commentaries were spent on the very topic that is unfolding now. That being the seeming breakout above 4,200 was premature with a likely pullback to follow, says Steve Reitmeister, editor of Reitmeister Total Return.
And then how the market goes through a normal cycle to wash out excess, which helps store up energy for the next bull leg higher.
As much as I hate repeating myself, I will need to do a bit of that this week to get your heads properly wrapped around the current market environment, and thus prepared for what lies ahead.
Market Commentary
As shared last week, the break above 4,200 was not as solid as it seems. Sure enough the script was flipped Monday with a pretty broad-based market sell off with the S&P 500 (SPX) declining over 1% to a close of 4,188.43.
Even worse was the tech stocks in the Nasdaq, down -2.53%...and even worse was just the state of all riskier, smaller, growthier stocks in the Russell 2000, down -2.59%. And yes, the downward trajectory continued Tuesday with the S&P being trimmed by almost another 1%.
What does it all mean?
Business as usual.
Long bull runs > points of resistance > consolidation/sector rotation (sometimes that degenerates into 3-5% pullbacks or even 10% corrections > build energy for the next breakout to new highs.
Yes, that is a long chain reaction...and yes, it doesn’t always go in a logical progression. Yet the general idea of how it happens is what is taking place now.
This also aligns well with the technical picture where one would not be surprised by a 3-5% pullback at this stage of the game. That percentage decline is spot on with where the 50 day moving average stands now at 4,046. That would represent a 4.5% correction. And just a little jaunt down lower to the psychologically important 4,000 could be all this market needs to wring out excess and ready to move higher.
Reity, should we trade this move?
No. I have no intention to do so. Because this is what MAY happen. Not what WILL happen. In fact, without a crystal ball or time machine, there is no way to know with certainty how this will play out.
For example, what MAY happen is that stocks don’t retreat anymore and its really just more sideways trading and sector rotation and then lift off above 4,200 in the not-too-distant future.
Or maybe we just blast off higher tomorrow given the non-stop train of positive economic reports. Or the fact that we are coming off the “Best earnings season in 10 years” according to my friend Nick Raich at EarningsScout.com.
This gets back to the heart of the commentary last week. So again, I hate to repeat myself...but it’s really vital information that deserves repeating:
“So yes, 4,200 will prove to be a spot of resistance followed by some combination of pullback, consolidation, sector rotation. Or in other words...VOLATILITY.
We have seen this 1001 times before. And we will see it 1001 times more in the future. The point being this is the natural way of the market.
Rally > Resistance > Consolidation/Sector Rotation (aka volatility) > Build Energy to Breakout to New Highs.
Reity, why are you so confident this time isn’t different?
First, it is rarely different. And when it is you will see greater bearish catalysts at play.
Second, because I have been investing for 40 years so I have seen this 4004 times or more.
Third, low interest rates still make stocks 2.5X more attractive than bonds. (really...this is the biggest reason making it fairly unnecessary to continue the conversation...but we shall to lock this lesson into place).
Fourth, coming off yet another strong earnings season.
Fifth, economic data continues to show improvement across the board. I have detailed this week by week in commentary. And most recently you have another strong monthly ISM Manufacturing report. No doubt ISM Services and Employment reports later this week will continue to point to continued economic expansion.
Sixth, the coronavirus numbers in the US are dropping as vaccine adoption is well ahead of pace.
Seventh, Biden’s State of the Union address was filled with lots of items that would spark economic growth. This is not Steve Reitmeister, or other Wall Street experts, agreeing that these are the RIGHT policies. It is simply a clear-eyed view that the government checkbook is WIDE OPEN, which is stimulative to the economy > corporate earnings > share prices.
There is no reason to go beyond this point because the above is plenty good enough. So, our game plan is to keep our calm and act like we have been there before (because we have)
This will allow us to not get shaken out of our quality stocks during this volatile period. Instead, we will hang on with great confidence that they will rebound with gusto when the next bull run emerges. And if any great buy-the-dip opportunity emerges, then we will quickly take action.”
The only thing to add beyond this is that indeed the economic data continues to sing a song of steady improvement. Last Wednesday ISM Services came in at a very impressive 62.7. Even better was the 63.2 reading for New Orders. And even better is the continued rise of the Employment part of the index.
The Small Business Optimism Index rose for the third month in a row after hitting a low of 95 in January. The truth is that Republicans dominate the ranks of small business people and they were not a very optimistic group in January for obvious reasons.
Gladly now, the further we get away from the oddities of this election, the more they see the positives taking place in the economy. This optimism generally translates into higher spending and greater levels of employment. Those have clear benefits in helping to fuel the future growth of the economy.
The only oddity of last week was how ADP Employment impressed with 742,000 jobs gained. While the government report on Friday was lackluster at only 266,000 jobs gained.
Again, I hate repeating myself, but this one is easy. The for-profit report from ADP is right and the government report is wrong. Why? Because for-profit companies are ALWAYS better than the government at EVERYTHING. (I will now descend from my soap box.)
So yes, we have hit resistance at 4,200. Many ways this can play out. But the most likely way is a fairly shallow and short-lived pullback followed by making our way to new highs this summer. And likely end up 4,500+ by year's end. Even 5,000 is not out of the question given how low rates makes stocks the vastly superior investing choice. And thus, we continue to have a bullish bias in our portfolio.
Portfolio Update
Rough and tumble week, but nothing we can’t withstand. And gladly we saw ourselves on the right side of the market action today with a much smaller loss than the S&P.
It certainly helps with eight of 14 picks in positive territory. Best of which was JCOM coming off another great earnings report. However, we now have more red on our screen than we are used to in 2021.
Historically we have discussed not overreacting to market volatility as the stocks that fall the most, typically bounce the most. And indeed, I am trying to keep that historical perspective in place. Yet, QFIN is just the antithesis of everything I look for in stocks.
Meaning there is no rhyme or reason to its movement. Up 25%...then down 25%. And lord only knows what comes next. I am trying to hold on with hopes of seeing that next big up move unfolds. And today’s resilience was appreciated. But I have to admit there is not too much more patience to watch QFIN on my screen much longer.
Here are some additional insights on the rest of our picks.
J2 Global (JCOM): Last night was just a wonderfully typical JCOM beat and raise. I am most impressed by the 10% revenue beat. Not an easy feat. Shares were up early and continued to stay aloft even with the market in the red. Nothing to report from the analyst community yet. However, with the company raising guidance we should expect a steady stream of estimate increases and target price raises.
Add on top their future plans to split into two companies to unlock the value of their cloud services business, and I see little need to sell till prices are more like $140-$150.
General Motors (GM): As we suspected, expectations were pretty low coming into their 5/5 earnings report. And thus, easy to leap over that low hurdle leading to +4.05% gain on the day. There has been a parade of analysts increasing the earnings outlook for the future along with higher target prices $69.08 average.
So why are shares down the past couple sessions? Read the Market Commentary section again and hold on with great expectations of more GM gains ahead.
Kulicke & Soffa (KLIC): The initial read of the earnings report was clear beat and raise. In fact, the raised guidance for next quarter was truly breathtaking. And yes, initially shares were up 3% in after hours. Then it opened up down a little. And then tick by tick it headed down...and then all the way down by 15.2% on the day. WTH!!!
Gladly there was a bounce back to only 10% loss at the finish line. And then shares rebounded more from there. In looking at the stream of earnings estimate raises and analyst love letters with fresh targets of $64 and $76 I would call this an aberration mostly caused by the nefarious computer trading types who target small- and medium-sized stocks to toy around with. And yes, in many cases they beat down the very stocks they want to buy allowing them to profit on the way down...and the way back up when the stock finally rebounds back to fair value.
We were right for not being scared out of our shares and should start to see green arrows on a more regular basis once this tech sell off has run its course. Note that the current average target price is $68. Not many growth stocks are that far from fair value. Let’s have the patience through this storm to see the rightful gains for these shares to roll in.
Alibaba (BABA): They are next up to report on the earnings parade this coming Thursday. Indeed, they have a history of mixed reports. Somewhat like Amazon and Google. Typically, when numbers come up short it’s because of massive investment in R&D and future growth initiatives. As investors learned with Amazon and Google it was worth looking past these cost surges as they were typically great investments for long-term growth. I come into this report with very few concerns as the price is already beaten down enough. Any ray of hope should put shares back in the sunshine.
Shutterstock (SSTK): Our initial timing into shares was great as it immediately bounced higher. Then Mr. Market served up a tech sell off that took everyone in the group to the cleaners. These shares are still easily worth $105 to $110. However, we also need to adhere to some price action discipline. If we are pushed to sell in coming days due to more downside, then it is only because I believe we can switch the money to another stock that provides equivalent value and growth prospects.
Shorting Treasury Bonds (TBT): Rates have been moving higher for a week. And virtually impossible to imagine all the elements at play to stimulate the economy without inflation unfolding. And with that, higher rates are a natural outcome. In fact, I will consider handing my economics degree back to the University of Wisconsin if 10-year rates don’t touch 2% by the end of the year. And if that 2% handle does come true, which it sure as heck should, then TBT is the right place to be.
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