Why the stock market is as vulnerable as someone after a bad breakup

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Monday, January 31, 2022

Remember your first bad breakup?

I bet it was painfully brutal. The weeks full of tears. The instant anger at the sight of life itself. The endless worrying if your ex was already seeing someone else. The parking outside of their house from 9 p.m. to 4 a.m. with the lights off to watch if they went anywhere (or was that just ... ahh never mind there, let's keep it moving).

The point here being is that you were emotionally vulnerable. So vulnerable and raw in fact you probably took your ex back after their barrage of sweet-talk (or back in my day, after sending "143" 50 times to their translucent blue Motorola beeper).

I think this is where a legion of investors enter February following a painful start to the year for markets: vulnerable.

Many investors I talk with only know low interest rates (think here the sub 40-year-old crowd who has powered the market in recent years). They only know to buy dips in stocks because the strategy has worked wonders this past decade. They only know tech stocks good (insert caveman voice), dividend-paying slower growing companies generally bad. Hence, they are vulnerable to late-in-the day rallying markets (as seen last week) blowing sweet nothings in their ear as if they were saying: "I still love you, take me back baby please."

But the reality is that just like that ex, the market right now is dangerous as it works to price in anywhere from five (new Goldman Sachs call) interest hikes this year to seven (new Bank of America call). There will be a price to pay for higher interest rates as it pertains to the economy and markets, which is why stocks at present are experiencing wild volatility. Stocks are trying to figure out that price.

"How will the economy and markets handle hikes? Clearly risk assets are vulnerable. One way to view the recent stock market correction is that with the Fed no longer in deep denial, markets have caught on to the idea that inflation is a problem and the Fed is going to do something about it. As the Fed pivot continues-and the bond market prices in more hikes, we could see more volatility," said Bank of America's head of global economics Ethan Harris.

Harris — who is now calling for seven rate increases and only 3.6% GDP growth in 2022 — will be on Yahoo Finance Live this morning. If you own stock, this is a must watch interview.

"Rates — seven or eight increases — may also shock the economy. And that could possibly even cause a recession," Stifel's long-time CEO Ron Kruszewski told Yahoo Finance Live.

So in my humble view, ignore the market's thirst traps it's posting into closes at the current moment. Stay disciplined during your vulnerable period. Just like your former heartbroken self, something better will come along ... in this case a better opportunity to get into stocks.

Happy trading!

Odds and ends

What first quarter warning: The next decade will be amazing for Netflix, so ignore the recent stock price plunge on the back of disappointing first quarter subscriber guidance. Or so say the whales. Netflix co-CEO (and co-founder) Reed Hastings paid $20 million to buy shares on Jan. 27 and Jan. 28, according to an SEC filing late on Friday. Shares of the streaming giant had plunged 21% on Jan. 21 in the wake of the company's "disappointing" outlook. The average price paid by Hastings was $388.83. Netflix shares closed Friday at $387.65. Hastings joins Pershing Square's Bill Ackman in buying Netflix on the dip — Ackman disclosed on Twitter he bought 3.1 million shares. I would remind you that these buys from the billionaires are likely very long-term oriented. Netflix shares could stay volatile in the near-term on 1) rate hike concerns weighing on high multiple tech stocks; and 2) worries on where the next leg of growth for Netflix will be derived. In fact, one Wall Street analyst told me the stock could be "dead money" [In English, the stock doesn't move higher a lot until there is a new positive catalyst].

Tech stocks: There is no hiding that one of the worst trades of the past three months has been 1) buying the dip on richly valued software stocks; 2) holding onto shares of richly valued software stocks. The iShares Expanded Tech-Software Sector ETF — which tracks shares of leading software names such as Adobe, Microsoft, Salesforce and Oracle — has tanked 22% in the past three months, compared to a 3.7% drop for the S&P 500. The basic mechanics behind this risk-off trade are as such. First, Wall Street pros plug in higher interest rates into their algo trading formulas and get lower future expected returns for software names (and stocks in other sectors, obviously). They then compare those potential returns to the valuations the stock is fetching in the market today. They then sell software stocks after realizing they trade on wild, WILD valuations based on future profit and cash flow growth. When interest rates are low these stocks do well because the broader market is probably rising (as we saw last year) as those algos only see fatter returns in the future. If none of this makes sense, shoot me a line on Twitter — I got you covered.

The sharp sell-off in software stocks has led me to chat up several bigwigs in the space to get their views — you know the grizzled veterans who have seen numerous interest rate cycles and software stock cycles. In gathering some threads, we could be nearing a point where these software stocks are simply too cheap (relatively speaking) given the demand trends the underlying companies are seeing. Take software player ServiceNow. CEO Bill McDermott (former long-time CEO of SAP) told me his business is gaining momentum into the first quarter as companies transform workplace functions amid the pandemic (I happen to believe this is an underappreciated, structural investment theme). Over at cloud service company Snowflake, CEO Frank Slootman (who has been everywhere in software, as his new leadership book details), told Yahoo Finance Live the software rout borderline makes no sense based on his company's business trends. Sure these folks are talking their books, but they have the financial data to back it up.

Charts to watch: Two charts worth sharing with you today. While the broader stock market has endured wild swings in the past two weeks — and those aforementioned software stocks have been crappy trades — the rotation into "defensive" consumer staples has stayed rather consistent. Jefferies highlights the flows into consumer staples ETFs have led the pack thus far in 2022. I think this trade will be tested soon as the market gets comfy with where interest rates are headed this year and values appear in the tech sector (see Netflix buying above). Moreover, fourth quarter earnings reports from consumer staples haven't been great — just take a quarterly whiff at inflation-battered toilet paper maker Kimberly-Clark.

Who doesn't love a good consumer staples stock when the broader stock market is being blown up...
Who doesn't love a good consumer staples stock when the broader stock market is being blown up? (Jefferies)

Then there is gem of a meme stock chart from the team of Eric Platt, Nicholas Megaw and Joshua Oliver at the Financial Times. As you can see, the frenzied interest (as seen here in the daily value of shares traded) in fundamentally beat-up companies such as GameStop, AMC, Express and Nokia has completely fallen off a cliff (and so have their respective stock prices). Where'd you go GameStop faithful? I thought the company was the next Apple. Nevertheless, Yahoo Finance market wizard Jared Blikre does a nice look back here at the meme stock frenzy. It's worth a watch and a share on social media.

Not spotted: meme stock traders. Where you at?
Not spotted: meme stock traders. Where you at? (Financial Times)

Stats around Tom Brady: I can't help myself with this one seeing as NFL great Tom Brady appears poised to head off into the sunset, as our friends at Yahoo Sports discuss. Since Brady played his first game in the NFL as a member of the New England Patriots on Nov. 23, 2000 (his first start at QB came on Sept. 30, 2001), here is how a few assets have performed: 1) S&P 500 and Dow Jones Industrial Average up about 237% each; 2) Apple +57,708%; 3) Microsoft +974%; 4) General Electric -75% (the legendary Jack Welch was still the CEO of GE at the time of Brady's first game ... he retired in 2001); Class A shares of Warren Buffett's Berkshire Hathaway +613%. Tesla wasn't founded until 2003 and bitcoin 2008, so can't help you with price performances on those. Robinhood founder Vlad Tenev was 14 years old when Brady first took the field, so no price performance there either.

Other business news: Exquisite profile of Texas Roundhouse founder Kent Taylor by Fortune. Taylor committed suicide in March 2021 after battling complications from COVID-19. Good roundup by The Wall Street Journal on what executives are saying about inflation. I will add this: here's what the CEOs of 3M and P&G told me about inflation recently. Minneapolis Federal Reserve President Neel Kashkari also weighed in on inflation in a new interview with Yahoo Finance's Brian Cheung. Bed Bath & Beyond's turnaround has hit a few major speed-bumps — shares are down a startling 65% from their June 2, 2021 high. Shares hit a closing low of $12.92 on Jan. 21. The Wall Street Journal dives into missteps the retailer has made that may be alienating customers. If inflation stays hot, it may make value menus at fast-food chains like McDonald's, Domino's Pizza and Burger King extinct. Here's a nice dive into the topic by WSJ.

Brian Sozzi is an editor-at-large and anchor at Yahoo Finance. Follow Sozzi on Twitter @BrianSozzi and on LinkedIn.

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