Fed and Earnings Contribute to More Sharp Selling

In?last week’s letter, we asked the pointed question “Are we in a Bear Market?” and we answered in the affirmative. This week, nothing that has happened in the markets has changed our view. With that being said, there is always reason for optimism, if one looks hard enough.

A few issues inform our current view of the market. First, not only are we seeing catastrophic market reactions to bad news (think NFLX earnings), but also we are seeing negative reactions to positive news (TSLA earnings,?GDP growth rate). This is a phenomenon that we can classically associated with a bear market. Another trend that we are observing is cascading bouts of selling across sectors, no matter whether they are “speculative” or “defensive”. We saw that continue in earnest this week: there is no obvious sector in which for investors to hide.

This week was full of market moving news. In this week’s letter (and this week’s?Jarvis YouTube Update) we cover the market impact of two major events over the last five days: (1) this week’s Federal Reserve Board meeting and (2) the ongoing earnings season. For the most part, we saw negative responses to these events, particularly in the most downtrodden sectors of 2022, technology and consumer discretionary. What was different this week was that traditional “safe haven” sectors like consumer staples and utilities also fared poorly. This is more evidence of our view that we are, in fact, in a bear market.

In this week’s letter, we will briefly cover the earnings reports of?Microsoft (MSFT)?and?Tesla (TSLA). Both of these remarkable businesses delivered positive business results. But in the context of our current market view, what we find more interesting has been the market’s muted (or negative) reaction to positive news, which we think is a clear indicator of the present sentiment. Though there have been some bad earnings reactions, the news is not all negative in this space after the positive?Microsoft (MSFT)?and?Apple (AAPL)?reports.

We do not want to be completely pessimistic in this time, as we think that opportunities may be developing as investors sell stocks seemingly indiscriminately. In times like these, putting a plan together of how to proceed once the selling stops is important. Additionally, we will share with you some of the indicators we will be watching for evidence that the current trend is coming to an end.

There is one sector that continues to do well in spite of the Fed and likely because of the inflationary environment: energy. Over the past few months, we have showed readers that energy continues to comprise a historically low percentage of the S&P 500 index. That underweighting, coupled with fundamental improvement in the oil business itself, have created strong tailwinds for stocks all through the energy value chain, from integrated providers all the way to oil services. This strength is remarkable in the context of the carnage elsewhere.

As we look at the charts of the S&P 500 and the NASDAQ for the last week, the selling is broad-based, as the two indexes appear to be moving in concert. Read further to see how this plays into specific market sectors, from technology all the way down to “safer sectors” like consumer staples and utilities.

As always, we include the performance over the last week of the key indices and other selected data for the five trading days between 1/20/22 and 1/27/22:

Volatility, as measured by the?VIX?(the so-called “fear index”) increased significantly over the past week, as selling accelerated across a number of market sectors. Technology and bitcoin, both of which have experienced some speculative excess over the past few years, led the market to the downside again this week. What was surprising was that emerging markets and financials, which had been holding up fairly well in the early days of 2022, also moved lower this week. The small cap?Russell 2000?has now moved into textbook bear territory, now down more than 20% from the recent highs in November:

In 2022, we are trying out a new feature for Left Brain followers. We will be releasing a weekly YouTube video to accompany the newsletter, as we hope to bring a bit of context to the points in the letter that we think are the most important for investors to understand. Head over to?our channel?to subscribe today! You can find this week’s video?here.

If you like what you see in the weekly Jarvis update,?please share this newsletter with other investors, friends, and colleagues. The success of the Jarvis newsletter depends on your word-of-mouth recommendation to other like-minded investors. Just in case you are not receiving the newsletter into your inbox on Saturday mornings, make sure to?visit our website?to get yourself on the mailing list. The Jarvis Newsletter is a great way to get your weekend started, as you use your time with the markets closed to do deeper research and prepare for the next week of investing.

With that all being said, let’s get into it!

The Federal Reserve, the Straw That Stirs the Drink?

Old school baseball fans will remember legend Reggie Jackson’s controversial quote that he was the “straw that stirs the drink” for the New York Yankees. In the current context, it is clear that the Federal Reserve is the straw that stirs the stock market drink, meaning that the Fed’s actions have an outsized influence on almost everything in markets worldwide. Since asset prices are evaluated using interest rates as an input, the?Federal Reserve Board’s signal?that it is raising interest rates and ending its bond buying program in March sent stocks reeling, as we can see in the S&P 500 chart from the week.

To some degree, it is surprising to see such violent selling after the Fed meeting. Fed officials have telegraphed for months that this is the direction of monetary policy: tightening. There may be a few things in play here:

(1) Investors have become accustomed to the “buy the dip” mentality, particularly in high growth stocks. Fueled by low interest rates, the BTD concept has led to high valuations across the stock market. That feedback loop may be breaking.

(2) Interest rates have been very low for the last 13 years since the global financial crisis. The market may lack the “muscle memory” of responding to higher rates. We think that investors are finally coming around to the idea that the Fed is moving away from the zero lower bound in the Federal Funds rate.

Our key takeaway from the latest Fed meeting is that Chair Powell and his colleagues are serious about tightening monetary policy. A caveat: in late 2018, Powell signaled an increase in interest rates that temporarily roiled markets, only to reverse course in 2019 as the stock market dropped in Q4 2018. We think this time is different, however, with consumer price inflation running hot at 7% and the Fed governors seemingly now committed to beating back inflation.

The Fed has signaled its course for the next year and investors are responding accordingly.

Earnings?Season Continues

As we state ad nauseum in this space, earnings season is the most crucial time in the investing calendar, giving investors a chance to learn about business fundamentals and hear directly from CEOs and other key executives.

Beyond just the fundamentals this quarter, we are paying close attention to the market’s reaction to those earnings reports and calls. We began to notice last quarter that investors were meeting positive earnings reports with either indifference or even selling, particularly in the technology space. One of the hallmarks of a bear market is an environment in which positive news has a negative reaction. It appears, in the early days of earnings season, that this pattern is continuing. Let’s take a quick look at two of this week’s earnings reports for evidence of whether investors are still responding to positive news with selling.

Microsoft (MSFT)

Tuesday, after the bell, Microsoft?reported its earnings. Overall, the results were strong, powered by pronounced success in the company’s cloud software division. The company reported quarterly revenue of $51.7 billion (up 20% year-over-year) and profits came in at $18.8 billion (up 21%). Said CEO Satya Nadella: “Digital technology is the most malleable resource at the world’s disposal to overcome constraints and reimagine everyday work and life. As tech as a percentage of global GDP continues to increase, we are innovating and investing across diverse and growing markets, with a common underlying technology stack and an operating model that reinforces a common strategy, culture, and sense of purpose.”

Overall, the business results were strong for Microsoft, which has been the norm during Nadella’s tenure. The biggest bright spot was the company’s Intelligent Cloud computing segment, which delivered $18.3 billion in revenue (up 26% year-over-year). Server products and cloud services revenue came in with a 29% growth rate. All of the growth figures are impressive for a company of Microsoft’s size.

We saw Microsoft break the pattern that we described above: the stock actually performed quite well coming out of the earnings report (despite a snap move lower in the after hours trading post-report). Take a look at the chart below. The small “letter E” icon denotes when the earnings report was released.

We saw a similar reaction after?Apple (AAPL)?earnings on Thursday evening after market close:

While the reactions from?MSFT?and?AAPL?earnings are encouraging, but follow through to other software and technology stocks has been slow. We aim to illustrate that my overlaying the?iShares Expanded Tech-Software Sector ETF (IGV)?with the Microsoft chart over the past week to show the relative performance:

So perhaps the mega cap tech stocks like?MSFT?and?AAPL?are trading differently than their smaller counterparts. We saw an altogether different reaction from another mega cap stock in?Tesla (TSLA).

Tesla (TSLA)

Wednesday after the bell,?we heard from?Tesla (TSLA), one of the strongest performing stocks of 2021. Results were strong. Net income came in at $2.54 per share, which beat the consensus estimates and revenue growth came in at an impressive 65% to $17.7 billion. Free cash flow was $2.78 billion, up 49% versus the prior year quarter. In short, Tesla is fulfilling its production goals, growing revenue rapidly, and becoming more profitable all the while. From our point of view, we saw this as a strong report from a fundamental point of view.

Tesla’s earnings reaction was more indicative of what we are seeing across markets. In other words, the reactions of?MSFT?and?AAPL?stocks to earnings were more of the exception than the rule. Take a look at the 5-day chart below of?TSLA. Sentiment is quite negative in the darling stocks from the pandemic like Tesla, even in the face of good news:

As earnings season continues to unfold, we will be watching this pattern of bad reactions to good news continues. A change in this phenomenon would signal a potential end to this period of stock selling.

Next Week’s Earnings

We will see quite a few earnings reports next week, from a broad cross section of companies. We will of course be looking for the fundamental developments in the businesses. But more so, we will be monitoring for the market reactions to earnings. Further negative responses to positive/neutral earnings reports will be yet another piece of evidence for us that the bear market has taken hold. Next week’s key reports:

·????????Tuesday before the open:?ExxonMobil (XOM), UPS (UPS)

·????????Tuesday after the close:?Advanced Micro Devices (AMD), Alphabet (GOOGL), Chubb (CB), General Motors (GM), Starbucks (SBUX)

·????????Wednesday after the close:?Qualcomm (QCOM)

·????????Thursday before the open:?ConocoPhillips (COP), Honeywell (HON),

·????????Thursday after the close:?Ford Motor (F)

What’s Working?

The simple answer to this question is energy, and not much else. Oil prices continue to rise despite weakness throughout markets worldwide, with the inflation theme seeming to play out most directly in the energy sector:

As a result, we have seen continued strength in throughout the energy sector. Seven of the ten best performing ETFs in our Jarvis system this week were from the energy sector, including?United States Natural Gas Fund, LP (UNG),?United States Oil Fund, LP (USO), and?VanEck Vectors Oil Services ETF (OIH).?Nine of the top 11 stocks in our Jarvis Tickers list came from energy. Look below for the 5-day performance of the?Energy Select Sector SPDR Fund (XLE), which was the only sector ETF in the US stock market that was positive for the five days covered by this report:

As we put together this newsletter on Friday morning, we are seeing some positive reaction in the technology/software space developing in response to the positive AAPL earnings. We have seen over the past few weeks that positive moves like that have been met with fierce selling. Next week will be telling whether that pattern will continue.

What is Not Working?

Since energy was the only sector ETF that gained in value over the past week of trading, all the rest were in negative territory. This feeds into the concept we identified in?last week’s letter, which is that selling has begun to cascade into sectors that we generally consider defensive, which are consumer staples (XLP – blue area), utilities (XLU – red line):

Financials (XLF) and health care (XLV) had been other areas where investors had been looking to park capital, waiting for markets to regain their footing. This week, that strategy has not worked particularly well, as you can see from the charts below:

The “nowhere to hide” theme has been strong over the last 2-3 weeks. This cascading selling effect is what led us to start using the dreaded “bear market” term last week. In the next section, we aim to be a bit more optimistic, as we lay out the indicators we will be looking for to determine that things are shaking out in a way that makes us more comfortable with the direction of the broader market.

When will this be Over?

We are spending a lot of our time over the last few weeks plotting and planning for when the indiscriminate selling stops across the markets. We have sounded a conservative tone over the last month or so, which may feel very different to the optimism we usually produce in our research. Difficult times call for a different strategy and we shouldn’t shy away from that.

At the same time, we are optimistic about the direction of the economy generally and we still admire many of the businesses we have studied for a long time. The lesson that we all have learned over the past few weeks is that fundamentals aren’t everything; the technical sometimes take hold of the market, expressing the thesis that fund flows and positioning have their say on market direction in times of trouble.

Here are just a few of the indicators we will be looking for us to become more confident in the direction of markets generally:

1.???????Stocks need to stop selling off on good news.?There has been some progress in this regard this week after the positive earnings reports from?MSFT?and?AAPL.

2.???????VIX index has to move much lower: the VIX index measures fear in the markets by comparing the prices of put and call options. A higher VIX indicates that put options are more expensive relative to call options, indicating that investors are paying up for insurance on their portfolios. As long as the VIX is above 20, it will be difficult for markets to show a bid.

3.???????Risk indicators need to begin improving:?we follow a number of markets and indicators to determine the sentiment of market participants. Included in these are?SPDR S&P Biotech ETF (XBI), iShares Russell 2000 Growth ETF (IWO),?and?iShares Expanded Tech-Software Sector ETF (IGV). We also watch the number of advancing stocks versus declining stocks. For a bull run to get started, that ratio needs to be significantly positive.

4.???????Stocks regaining their 200-day moving averages: this is a crucial indicator that many “market technicians” favor as a gauge of investor/trader sentiment and trend change.

By no means do these indicators tell the full story, from the technical point of view, but this is a sampling of what we want to see in order to become more constructive on the market’s direction. Until then, we will keep looking for securities that work in the current environment, as well as developing our watchlist for when things do turn positive.

Takeaways from this Week

We still saw quite a bit of pessimism in markets this week, with all sectors other than energy delivering negative returns over the past week. “Caution” is still the watch word on Wall Street, with many stock charts looking very scary as many fall below their 200-day moving averages. The Federal Reserve Board’s rate decision and Chair Jerome Powell’s press conference were not well received. The reality of higher interest rates seems to be sinking in more broadly with investors.

We saw some positive signs in the mega cap tech stocks this week, with positive earnings results from?Microsoft (MSFT)?and?Apple (AAPL)?met with buying. This is much different from the pattern we have seen over the past few months of positive news being met with selling. All was not well in this regard, however, as we saw pronounced selling after the?Tesla (TSLA)?earnings report.

While negativity continues to permeate financial markets, we continue to develop a plan to deal with the current market environment, as well as building a watchlist of companies we want to buy when things improve. We shared with you this week some of the indicators that we will be watching to determine when the time is right to move from a defensive posture to being more aggressive.

Announcements:

(1)???In 2022 we are raising our content game. Each week, you can expect to see a YouTube video with our investment team, teasing out the most important points in that week’s Jarvis Newsletter and giving important context on the investing week. Make sure you head over to?our channel, hit subscribe, and turn on notifications, so you will be alerted when each new episode is released!

(2)???We know it has been a long time since there has been a bear market and that investors may not know how best to proceed. With the markets showing increased volatility over the past few months, we know that many investors are wondering if they need a “second opinion” on their investment positioning, whether they manage their own money or use an advisor. We stand ready and willing to help and we are thus offering a?complimentary portfolio review?to interested investors. Just reach out to us on the link provided and we will contact you within a few days to help you assess whether your portfolio is well-positioned to take advantage of business and market trends!

(3)???Don’t forget to?sign up?to receive the Jarvis newsletter in your email inbox every week. Make sure to check your spam/promotions folders if you don’t receive it after signup.

(4)???We hope the insights of the Jarvis newsletter are helpful to you as you get ready for the next week of stock market action. Please share this newsletter with your network if you found it of use. That’s the best way for our work to be found! For more details on Left Brain, Jarvis?, or anything else investing related, please reach out to us at?www.LeftBrainIR.com. Feel free to contact me directly at?[email protected]?or at?(630) 547-3316?with any questions. We would love to receive your reader advice on how we can make this weekly letter more useful to you, as you manage your portfolio and/or choose an advisor to help you accomplish the task.

Rotation from growth to value appears to be a theme that will dominate the investing conversation in 2022. We are shifting our research focus to find stocks that will be beneficiaries of the changing environment. We hope the Jarvis Newsletter (and our research service) can help you in investing process as you seek to optimize your portfolio. At Left Brain, we are sharpening our pencils to help determine the best stocks to purchase once the selling begins to abate. Have a restful weekend (you deserve it after this week) and we will be right back at it Monday!

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