Prices Change When Expectations Change

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The most interest rate sensitive assets continue to be under pressure and deteriorate in an accelerated fashion, to a point that it won’t be a surprise if we see some snap-back mean-reversion later this week. The premise is that a potential QE tapering will lead to an increase in yields across the board. Notice that the FED might be months away from changing its policy, but it does not matter to the market. Financial markets live in the future and are forward looking by nature. They constantly discount events that have not happened yet. As a consequence, they will sometimes discount events that will never happen. When the expected events don’t occur, markets self-correct.

The element of speculation is an inherent part of the market and it is a major moving force. You better accept it and find a way to deal with it. Prices changes when expectations change and expectations could and often change much before fundamentals change. This is why price is considered a leading indicator – sometimes ends up being right, sometimes ends up being wrong, but it is leading nonetheless.

Why Stock Splits Beat The Market

stock splits

In theory, a stock split should not have any impact on stock market performance, let alone generate any alpha.  It turns out that in practice, it does. At least, it did over the past ten years according to Mark Hulbert and WSJ.

A company with 30 million shares outstanding earning $2 per share, will have 60 million shares earning $1 per share after a 2 for 1 split. The total earnings remain the same after the split. There should be no positive reaction by the stock market. The truth is that in short-term perspective, mood and psychology could trump math. And short-term could sometimes mean years.

The reality is that stock splits are often a side effect of momentum. Companies often decide to split their shares after they had a spectacular run. The ensuing outperformance is not a consequence of the split but a mere continuation of an ongoing earnings, sales and price momentum.

One more argument that Relative Strength is among the most consistent and reliable equity selection criteria. Relative strength is not flawless. Historically, it has worked best when measured on a 3 to 18-month basis. Beyond 3 years, it often leads to mean-reversion. With other words. The best performing stocks of the past six months, are very likely to continue to outperform in the next 6 months. But, the best performers of the past 3-5 years, are very likely to underperform in the next 3-5 years.

A Not So Subtle Change Of Character

Last week, we saw a not so subtle change of character in the markets. The indexes broke out to new all-time highs on Wednesday, only to reverse ugly lower on heavy volume. Momentum stocks underperformed. The St50 index fell 1.4%. The leading market in the world, Japan took it on the chin. It took a couple days to erase a month worth of gains. One day might not make a trend, but one day such as Wednesday is indicative that we have likely entered a very different market environment, which calls for tactical adjustment.

All major indexes are still above their rising 50dmas. Technically, the trend is still up, but it would be foolish not to pay attention to the sudden increase in short-term volatility. This is how many trends end. And by “end”, I don’t mean falling apart, but just entering a potential distribution phase, where many stocks are transferred from strong hands to weak hands, volatility is elevated, there are a lot of fake breakouts and breakdowns and short-term mean-reversion has higher probability of success.

Unusual price action reveals a lot about the current incentives and state of mind of all market participants. What did we learn from the price action after the reversal on Wednesday:

– people are still with one leg out of the door, uncomfortably long and under-invested. Most rather see and buy at lower prices, which means that the real surprise is still to the upside;

– dips to major moving averages (20, 50, etc.) are welcomed as buying opportunities. This time, there was no hesitation, fear or second-guessing. People stepped up and bought. The question is how long are they going to hold?

– markets are already discounting the gradual tapering of QE. The yield is rallying. Bonds are under pressure. Utilities and REITS were among the worst performers last week. Financial markets are forward looking. Prices change when expectations change.

In a rising interest rate environment, financial stocks are typically among the first beneficiaries. It is worth paying particular attention to this sector.

From technical perspective, the healthcare sector looks better positioned. $JAZZ$ALKS$VRX and many others from the group, held remarkably well during the market pullback and are trading near multi-year highs.

Only two months ago, the mere mentioning of solar stocks in a positive light was a sure way to receive a ton of hate-mail and ridicule. All of a sudden, in the past week, everyone loved solar and the small cap stocks from the industry just went parabolic. I will repeat what I have said several times already – solar is to 2013 what homebuilders were to 2012 – the industry that will outperform all others while surprising the majority of skeptics.

There are still plenty of stocks that are holding well and offer good risk/reward opportunities. Keep in mind that in high-volatile, range-bound environment there will be a lot more failed breakouts and breakdowns. Some of the better looking setups for next week include: $CHUY $GNC $MX $IMMR $ARMH …

This is a reprint of my weekly ST50 review. See the latest list here.

Happy People Pay Happy Prices?

If happy people pay happy prices, then what prices pay under-invested and under-performing asset managers? I will tell you what price – any price. If the rally in January was born out of an outside catalyst (less bad than expected new taxes), the rally in May has been led by pure momentum and fear of missing out, where managing career risk has gradually become more important than managing market risk.

Every couple weeks or so, bears show up and boldly try to call a top, acting like we don’t remember the last time they made the same call. You saw the ton of posts on the potential QE tapering last weekend and the potential negative consequences for equities. Guess what, there is no difference between being early and being wrong, depending on your time-frame of course. If your timeframe is eternity and you don’t take into account opportunity costs, then eventually you will be right, if this is what is important to you. I rather make money.

There are two type of markets – trending and range-bound and they come after each other in an endless cycle. Our job is not to complain about divergences and to ponder on the potential impact of central banks’ monetary policies. Our job is to take full advantage of healthy market and to manage risk.

All stocks that consolidated sideways for the past two to four weeks, are breaking out, one after another. This is what happens in trending markets. Price momentum is the catalyst. The fear of missing out trumps the fear of losing. They say that happy people pay happy prices, but bull markets persist because people don’t believe in them. Bull markets climb the proverbial wall of worry. People say that they don’t want to chase and yet corrections last a couple hours. The slightest dips are getting bought.

A bull market will bail you out and it will forgive your mistakes, but if you really want to outperform, you either have to pay attention to sector rotation or have the discipline to stick with your winners long enough to make a difference. When there are so many good looking technical setups out there, it is enticing to jump from stock to stock and chase after multiple small percentage gains, but looking back you will realize that this is not the wisest approach.

Refiners ($TSO, $CVI, $PSX…) and oil & gas svs ($FTI, $COG…) stocks started breaking out on Friday. Many of them are still close to their bases and it seems like the next beneficiary of an ongoing sector rotation, so you might want to pay attention to this sector. The success rate of breakouts will depend a lot on the price action in crude oil.

It is absolutely amazing how energy and basic material stocks could stay near multi-year highs given the strong price action in the U.S. Dollar. Other cyclicals have also been extremely strong – financials, homebuilders, industrials, even semi-conductors under the surface.

Short squeezes continue with full force and happen even in stocks with questionable fundamentals. In fact, big short squeezes always happen in stocks with questionable fundamentals. Their short interest would not be high, if everything was dandy there. I guess this is one of the reasons why two of the most controversial industries of the past few years, have been leading in the past month or so – solar and education stocks.

Large ticket stocks like $PCLN, $CRM and $GOOG are charging higher and for a good reason – the fastest way to gain market exposure is via high-liquid, high ticket momentum stocks.

There is always something to worry about. Yes, it is getting a little frothy out there with recent IPOs running wild. By no means, it is “1999-kind of” wild. Actually, IPOs outperforming is a good sign of risk appetite.

The new all-time high list is super-diverse and the number of stocks making annual highs is at levels last seen in 2010. Usually extreme levels lead to some form of mean-reversion, but trends could continue longer than contrarians could remain solvent. And as we have talked multiple times on this site, sometimes being a contrarian means staying with the underlying trend.

This is a reprint of my St50 weekly market review. You could see my latest list here.