What’s Up with the Market- August 2018
Bold Prediction Update: Check out our bold prediction from April of 2017 where we identified the potential for a short squeeze on TWLO stock. The stock has more than doubled since the article. In addition, TWLO reported earnings earlier this week and the shorts were finally shaken out. The stock saw a 20% increase in after-hours trading following the earnings beat. Follow us on social media so you don’t miss our next bold prediction!
In last month’s newsletter, we looked into the market’s “trading range” and the technical components that helped define it. This month we have broken out of that range and the S&P 500 has already established significant support at 2800. To be exact, it has already tested 2800 to the downside three times and it has held. Further it has been moving higher since the last test. As mentioned before, the market likes nice round numbers, and 2800 is another prime example.
With this new support level in place, I am wondering what is going to take us higher. I’ve felt for a few months now that the market needs new leadership for this rally to continue. The market has marched to all-time highs largely on the back of a five mega cap technology firms: Microsoft, Facebook, Apple, Google, and Amazon. Let me make that clearer, the S&P 500 is made up of 500 companies and the market cap of these 5 is larger than the bottom 282 companies in the index.
Historically, value stocks, which are typically companies with solid earnings and low price/earnings multiples, tend to outperform growth over longer periods of time. However that hasn’t been the case for the last few years as growth stocks, which are companies with more uncertain cash flows and selling at a high premium to their earnings, have significantly outperformed value primarily due to technology’s dominance.
In my opinion, in order for this rally to continue and this breakout to prove warranted, I would like to see a rotation from these high flying technology stocks into more stable companies like financials, energy and consumer staples. Multiple expansion has gone on for years in the growth names but this earnings season could finally be the one where investors expect companies to deliver with strong free cash flow numbers. So far we have seen market darlings Netflix, Facebook and Twitter all being sold off nearly 20% after their lackluster earnings. Investors coming out of these crowded names may start looking for some of the other areas that haven’t participated in the rally to the extent of technology like VALUE…
It doesn’t take a financial expert to tell you that the current market climate is a virtual minefield of catalysts that could move the market drastically in one way or another. From interest rates to trade wars to real wars, now may be a great time to focus on companies that have predictable cash flows.
Jamie Dimon made comments that echo my feelings about what the market may not be pricing in at the moment. In response to the Great Recession, central banks embarked on quantitative easing (QE) which is a new concept and was employed for the first time in history. Central banks around the world bought trillions of dollars of bonds for the purposes of preventing a collapse of the financial system. Dimon’s major point is that since QE was a new concept that had never been seen ever before and now this is about to be the first time in history central banks will reverse it.
As we have mentioned before, markets HATE uncertainty and this QE reversal should be very uncertain. It seems very unlikely to me that we will see central banks around the will be able to unwind this massive program without the markets having a tantrum.
So in conclusion, as the market breaks higher I am looking to see if this recent move is justified. I would mainly like to see the focus shifting to actual earnings and value instead of wishful growth and momentum. If this is the case, I would think the rally should continue for a little longer. However if there isn’t a rotation to value, I would question how much steam is left as the market seems to be overinflating and failing to recognize the significant downside risks such as worldwide central bank tightening, trade wars, etc. Also, any move below 2800 here would also represent a lack of conviction and would put us firmly back in the previous trading range with increased downward pressure. As earnings season continues, we should gain more clues about what the market’s future beholds. Stay tuned.
Stay posted as we continue to navigate these markets together.
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Clint Kirby - Chief Financial Strategist
Clint Kirby, DreamWork Financial Group is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.
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