Market Noise Is Hiding Big Profit Opportunities
Inflation, the Fed raising rates, market volatility, the decline of big tech stocks, and earnings prospects… It’s all noise – a cacophony deafening the markets and obscuring opportunities.
Narratives, stories, explanations, and analyses based on interpretations of headlines and economic and market data points, are chock full of noise. That’s because there are at least two sides or interpretations to every story and data point.
The only way to make sense of all the conflicting narratives pushing sentiment and markets up and down right now is to cut through the unprecedented amount of white noise to get clear, black and white buy and sell signals, on specific stocks, equity, bond, and commodity markets.
Here’s Why Investors Are Confused
The big-picture narratives are: inflation, the Fed raising rates, market volatility, the decline of big tech stocks, and earnings prospects.
This time is different. While investors have certainly faced headwinds before, economic growth appears to be slowing, and they’ve never had to deal with a highly inflationary environment while the Fed, and its immense $9 trillion balance sheet, is preparing to raise rates from the zero-bound floor they’ve resided on for a couple of years.
Amid this conundrum, market volatility has rarely ever been as high as it is. The VIX has been trending close to 28 since the start of the year, one standard deviation above its long term mean of 20, and light years away from the average of 16.75 it carried from 2012 through the end of 2019.
Investors are having a hard time discerning the myriad implications of the FAANGs and big tech selling off, and what that means in terms of growth vs. value and market leadership.
What’s more, corporate earnings, the “mother’s milk” of stock and market valuation metrics, are being cut by analysts at the fastest pace in 10 years.
So, choose your devil in the details.
“Unpacking” the inflationary forces we’re seeing, and how the Fed is or isn’t reacting to them, is essential for clearing up the signal.
Rising Prices… And a Fumbling Central Bank
The noise surrounding inflation and inflationary expectations includes gauging whether they are transitory or increasingly embedded and potentially becoming a structural component of the economy.
Pandemic lockdowns and manufacturing shutdowns started the scarcity cycle that blew up supply chains and saw container ships backed up for months outside COVID-stricken ports. Truckers and warehouse workers quit in the Great Resignation, making delivery and distribution harder.
Then, Russia’s invasion of Ukraine cut off commodity flows from Europe’s breadbasket, and caused oil prices to spike violently. Abnormal weather is wreaking havoc with staple grain planting in India, the United States, and Canada, as well.
Now, investors and talking heads are attempting to discern how new Chinese lockdowns will impact supply chains, and what planting will be done in war-torn and weather-impacted areas. They’re puzzling over how jobs in the U.S. going unfilled by a shrinking labor force will impact manufacturing, production, distribution, and prices. This is generating even more inflation talk and noise.
To douse the inflation conflagration the Fed must raise rates, that’s their number one mandate – “price stability.” Now that they’ve waited too long, mistakenly pronouncing the sudden flare up of inflation as “transitory,” their credibility is on the line. That means they’re going to have to err on the side of raising more and sooner, as opposed to being more data-dependent into the future.
The noise coming from within the Fed, too. All-too self-important regional bank presidents (no doubt envisioning a time when they exit “public service”), are clamoring for podiums and media attention, like starlets auditioning for their next big-money roles. But on top of that, or in between, like trying to toggle in an FM radio station when you’re driving through the mountains, analysts and economists are second-guessing the clueless Fed.
Needless to say, markets are caught in the middle, deafened by noise coming from all sides.
Why Stocks Are Doing What They’re Doing Right Now
They rise from short-covering when bad-news economic data is interpreted as “the Fed won’t have to raise rates so much if the economy is already slipping.” And they fall when good news, like the market rising too much, means investors believe the economy’s not so bad off and growth can continue, which of course means the Fed isn’t “dampening demand” enough by slowing economic growth and spooking markets.
It gets even noisier when markets look at the former leadership sector – giant tech companies who led the market higher for 12 years with their deepening moats, and increasing revenues, cash flows, profits, and ecosystems – and see them crushed under the weight of rising rates that undermine the discounted cash-flow models growth stocks are valued against.
The noise permeates echoing corridors, listening to analysts favor value stocks now, or cyclicals, or industrials, or materials, or growth stocks since they’re starting to look like value stocks. That’s a lot of noise.
And finally, there’s the noise coming from analysts cutting future earnings estimates at the fastest pace in 10 years.
But the market soared Tuesday, giving investors hope.
Noisy narratives held sway Tuesday. Rates jumped higher Wednesday but the Treasury 10-year was still below 3%, a good distance from the 3.20% yield it puked up a couple of weeks ago, so was good news. Oil was down Tuesday, that was good news. And all the negative sentiment and oversold conditions made it inevitable the market would bounce.
All noise, people. The truth is something else, and it’s altogether mechanical.
Markets jumped Tuesday on the heels of an options expiration cycle – one that’s seeing market-makers who sold put options to clamoring, frightened millions and shorted futures to hedge themselves against all the naked puts they sold, start to covering their own short futures hedges. That moved markets higher, which caused put buyers who are watching their put premiums collapse as we get to Friday’s expiration sell them for what they can get now, which means the market-makers aren’t at as much risk, so they buy back more of the futures they shorted, which means a noisy dead cat bounce higher.
And Tuesday has revealed to us exactly what it was – a dead cat bounce. Markets tanked on account of the earnings narrative stealing headlines, and not in a good way.
Walmart and Target, retail giants, became the poster children of this recent market drop. If they are suffering the pangs of rising input costs and margin contractions and investors are going to punish stocks, when they miss earnings or offer weak forward guidance, future downward revisions of earnings by analysts based on what hammered WMT and TGT, will take earnings noise to another level.
But just like in any market, no matter how noisy it is, there are ways to play it for profits – big profits.
So, to cut through all the noise, and really understand what’s going on and how to make money on it, stay tuned.
That’s coming next week.