“Markets can remain irrational longer than you can remain
solvent.” That was the famous quote of notorious British economist, John
Maynard Keynes. That also seems to be the theme of the US stock market over the
last 6 weeks. Technicals and momentum has taken the stock market hostage and
investors are looking for any tiny reason to sell stocks. Profit taking is
normal in the marketplace, but this is mass selling of stocks reporting great
numbers and strong future growth. Instead of selling Netflix after they
reported a huge YoY DROP in earnings, investors chose to bid it up to where it
now trades at 430x FY16 earnings (that’s right, a GROWTH company that’s been
around for 18 years is only expected to make a whopping $0.33/share in ALL of
2016). Instead of buying Apple, Gilead, Time Warner, and UnitedHealthGroup,
which all trade at ridiculously low valuations and reported great quarters,
investors sold with both hands, sending a couple of those names into a
correction.
This irrationality is actually something than a rational
investor (hopefully all of you) can use to your advantage. Instead of just
selling because everyone else is, spend time to read through the conference
calls, and often times you will find the selling is overdone. Take Disney for
instance…the company reported an earnings beat and quarterly revenues were
essentially in-line with estimates. However, since management said that they
see “some cord cutting” and anticipate less revenues going forward for their
ESPN division, the stock suffered a 9% drop in a single session. Although
everything else was great in the quarter, and everything else going forward is
going to be great, investors keyed on that one phrase and completely forgot
about Star Wars, Shanghai Disney, Frozen, Marvel, and everything else that
comes along with the company. The stock spent the next three days in the dog
house, falling about 10% and as much as 14% at one point. That sell-off gave
you (and still gives you) a great entry point.
This recent love fest for the momentum names right now is
what’s dragging the market down. Investors are taking profits where they have
them and are putting their money to work in the likes of Amazon, Netflix and
Shake Shack for fearing of missing out on the big gains. But like I said, you
should use that to your advantage. Don’t assume that because a stock is going
lower, that the company is broken. Despite what BofA says in their downgrade of
Apple this week, there is nothing to indicate that Apple should be worth 12%
less today than it was before it reported an EPS, revenue and margin beat. I’m
sorry they only sold 47.5M iPhones (the most ever in Q3, which is always their
weakest quarter) when analysts were expecting 49M. Time Warner reported a huge
EPS and revenue beat and reaffirmed FY guidance, however since they didn’t give
any Q3 guidance (which by the way, they never have), the stock got crushed on
worries that too many consumers were cutting the cord on cable bundles. If
Disney had not warned on slowing ESPN revenue, I believe Time Warner would
actually have been UP this week, not down as much as 15% in less than 2 days.
That’s why it’s important to use rationality when you’re
investing. Instead of shooting first and asking questions later, read through
what management actually says, or what the analyst report says who upgraded or
downgraded a stock. Case in point: On June 19th, Citron Research, a
notorious short-seller, put out a note on semiconductor stock, Ambarella,
saying its share price is “ridiculous” and that “Ambarella’s parabolic frenzy
has now launched it into a realm that can’t possibly be supported by reality.”
That note alone sent everyone running for the hills, dropping the stock 26% in
a day. Now, at that point, the stock had rallied about 148% this year, but it
was only trading at 31x FY17 (currently in Q2 of FY16) EPS. So Citron is
disgusted with a forward P/E of 31 for a company involved in making chips for
drones, which seems to be a big part of the future, but they’re okay with
Netflix, which is also up 136% YTD and trades at almost 450x next year’s earnings.
They must also be okay with Shake Shack rallying 110% in the first 4.5 months
of going public and trading at about 450x next year’s earnings. That makes
sense. If you listened to the folks over at Citron, you would have missed out
on a 36% rally back to new all-time highs, just 30 days later.
Along with irrationality, fundamentals have been wiped out
of the equation altogether, and instead technicals are the only thing that
investors are trading on. With Apple, all you heard about this week was that it
broke the 200-day moving average. I’m sure you also heard about the S&P
having to hold the 200-day moving average at least 10 or 12 times this week too.
While I am a strong believer in technicals, even more so than fundamentals, I
also believe that both are important and both need to be used. The fundamentals
will help you determine which stocks to buy, and the technicals will help you
determine entry and exit points. So to put you on an even playing field, the
only level in the S&P that you need to know is 2073, which is the 200-day
moving average and is a level only broken twice (three times if you include
Friday) in the last year. The first time was during last October’s sell-off,
where the market dropped 9.4% and then most recently in early July when the
market fell about 4% from peak to trough. The latter time, the S&P only
traded below the 200 day for two days before rallying back towards all-time
highs. On Friday, the S&P pierced the 2073 level, but finished the day
strong to close at 2078.
Early in the year, while analysts across the board were
calling for a market correction, I insisted it wasn’t going to happen because
the Biotech ETF (IBB) and the Russell 2000 (IWM) held their key technical
levels, the infamous 200-day moving average). However, on Friday, that all
changed when the IWM closed at $119.93, its lowest close since December.
Although, that’s a bad sign, since the Russell 2000 has been a leader during
this 7-year bull market, I am not as concerned because the Biotechs are still
holding up strong. So despite the hit to your portfolio over the last two
weeks, you should still be in pretty good shape, as long as the IBB can stay
firm. The 100-day on the IBB is $364, which held strong on Friday’s drop. If
the IBB closes below that level for three straight days, the markets will be in
serious trouble because the only support below is at $339, which would be a 15%
drop from all-time highs.
So to recap the key technical levels to watch: S&P 500 –
2073, IBB – 364, IWM – 120. Three straight closes below those levels will spell
serious short-term trouble for the stock market. But long-term, it’s a healthy
pullback. For the markets to really fall, all three have to break down, otherwise,
you’ll still in good shape, but keep your stock shopping list handy.
There is and will always be irrationality in the
marketplace. But how you handle that irrationality is what will be the
difference between outperformance and underperformance. Don’t just assume the
company is broken and the stock should be sold, just because it’s going lower
or because someone says to sell it. Do your own research and as long as nothing
has materially changed for worse, you should be a buyer.
I made some changes to my portfolio this week, most notably
cutting my big losses in Twitter and energy. I sold completely out of Twitter
on Monday and exited my entire positions in ConocoPhillips, EOG Resources and
Marathon Oil. At the same time, I took advantage of a correction in Disney
(DIS), buying shares post-earnings, along with buying Skyworks Solutions (SWKS)
early in the week on a sell-off.
My current positions: Long
Gilead Sciences (GILD), Starbucks (SBUX), Facebook (FB), Wells Fargo (WFC), Time
Warner (TWX), NXP Semiconductors (NXPI), Darden Restaurants (DRI), Celgene
(CELG), Mobileye (MBLY), Jack In The Box (JACK), Under Armour (UA), United
Rentals (URI), Regeneron (REGN), Apple (AAPL), Southwest Airlines (LUV), Dow
Chemical (DOW), L Brands (LB), Costco (COST), Amgen (AMGN), Home Depot (HD), Allergan
(AGN), FireEye (FEYE), Humana (HUM), GoPro (GPRO), Skyworks Solutions (SWKS),
Disney (DIS) and long LAS VEGAS SANDS (LVS) CALLS.
Jeff Lewison
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