The Week Behind

Before diving into the broad market sell-off that dominated the Thursday and Friday sessions, let’s quickly recap the three earning prints I mentioned last week: BAC, TSLA, and CLF.

• BAC – American households have strong balance sheets and appear strong.
• TSLA – The semiconductor shortage is alive and well in automotives.
• CLF – The steel market continues to boom.

Thursday and Friday both featured similar action. Indices opened higher on strong earnings from bellwether companies, only to gradually fall 1-2% into the close. VIX was above 25. Oil prices cooled slightly and the 10 year hit 3%. These conditions made it so that even energy, utility, and REITs failed to provide a safe haven. On Friday, all 30 DOW stocks were negative. The NYSE experienced 87-13 declining-advancing equities (87% of listed stocks were negative for the day). 

What caused the sell-off?

Honestly, I’m not sure. Powell blessed a 50bp hike, and Bullard advocated a 75bp hike. If you recall, I suggested Bullard might make such comments if CPI was hot and that the market wouldn’t take those comments well. However, I don’t think Bullard’s comments are what caused this two day sell-off. 

I happen to agree with Steve Liesman, a head economist at CNBC, who hypothesized the market is tired of playing catch up with the FED. Consequently, the market is trying to price in what the market deems the most feasible hawkish outcome. It would explain why Friday’s FED Fund Rate Futures priced in more aggressive tightening than the FED has projected.

What did we learn?

• The market is more focused on the FED and macroenvironment than earnings. It explains why we started Thursday and Friday up, only to come tumbling down. 
• Given the decrease in REITs and Utilities once the 10 year hit 3%, TINA does not apply beyond the 3% threshold. 
• We have a new VIX regime between 20 and 30. Stocks begin to behave like commodities as you approach either limit, indiscriminately trading in the same direction without respect for the unique companies represented. At 20, everything is green; consider trimming. At 30, everything is red; consider buying. 
• The head and shoulders inverse pattern on the NASDAQ is broken. 

The Week Ahead

If earnings season had a main event, it would be this week. We have MSFT, GOOG, FB, AAPL, and AMZN reporting. While NFLX’s print was extraordinarily poor, it suggests any earnings weakness could result in headline-worthy selling. Furthermore, given their weighting in the major indices, selling in these names could beget selling in the indices, taking a bunch of indice components along for an even bumpier ride. 

The most important would probably be AAPL. If AAPL cannot hold $150, prior low, the S&P, for which AAPL is the largest component, could be in for a ride. AAPL has a lot of business in China, which has been on lockdown during the quarter. It could be what kills the report. Also worth watching are MSFT and GOOG. GOOG, featuring the cheapest PE valuation of the mega-caps, broke major support on Friday. MSFT is battling its March low of ~$275. 

Sentiment will be more bearish to start the week than it was at the start of the last. Overall, I would expect a small bounce to occur at some point given how rapidly we’ve become oversold. However, a small hiccup from any of the mega-cap names could spill over into the broader market. Furthermore, we get PCE, the FED’s favorite inflation barometer, on Friday. With so much going on, here are some guidelines to consider if deploying capital. 

Company Specific

• Company should be ex-earnings. The upside reward of a beat is much less than the downside pain of a miss. Furthermore, gains tend to be fleeting, while loss appear to multiply in the days following.
• Company should be growing net income and free cash flow.
• Company should be returning capital to shareholders via dividends or a proven track record of buybacks that reduce share count. 

Market Barometers

• VIX greater than 27.
• Greater than 85% declining issues on the NYSE. 90% is ideal and is the sign to do some buying.

It won’t feel good to pull the trigger. I don’t think there is anything wrong with waiting. I think it might be wise to wait until Thursday or Friday to deploy any new capital. If you do, do so in a gradual manner. Save some dry powder. This ride is far from over, but we may see a good opportunity to buy some companies this week that won’t show as much weakness in the future.