What the heck? What is going on here? Can we possibly have had a huge sell-off and then a rally to be in the black? How does stuff like this happen?
I am going to give you a bunch of reasons, some of which you might find unsatisfying and some of which are just plain as the nose on a person's face.
Let's start with the right-in-the-kisser ideas.
At any given time there are a lot of camps on Wall Street, meaning there are views that determine the direction of stocks, different stocks, that are, for the most part, caused by ETFs.
Here are the camps:
First, there is the camp that says the Fed is going to overshoot and slow the economy down to the point where you have to bet that we will end up close to a recession. Not in a recession. There is too much employment momentum for that to happen as we saw from the non-farm payroll report this past Friday.
Still, if that's the case you need to rotate out of the industrials and move into the slowdown stocks.
It's pretty amazing how stark this rotation into these kinds of stocks really is. I will pick on a couple to prove my point. The first is PepsiCo (PEP) . Less than a week ago this company reported a very good quarter with a nice bump in carbonated beverages and good snack growth.
At the time it reported, however, buyers were tilted toward the cyclicals because we had just gotten the trade deal with Canada and Mexico, and the thought was that China would be next. It was a natural though and it caused people to sell PepsiCo aggressively even as the quarter was better than expected and the guidance, ex-currency-the very strong dollar - was in-line.
But that was then. Later in the week Fed Chairman Jay Powell decided that the economy was so strong that he would have to raise rates lockstep through 2019. The whole data dependency that the stock market loved, the one that Janet Yellen really emphasized, was out the window and, instead, we got news that the Fed wasn't going to let inflation get out of control.
Then we got the strong employment report, although I could argue - and will argue - that it wasn't as strong as it looked.
No matter, the Fed had spoken and when you meld Powell's view with the higher interest rates that we have been getting because of a stronger economy, we get a decided new narrative: the Fed is going to throw us into a slowdown. What do you buy in that case? The soft goods stocks that do well in a recession. Which might that be? How about PepsiCo? Next thing you know, the stock's on fire.
Maybe I am just picking on an oversold PepsiCo? I don't think so: take a look at the stock of Kimberly-Clark (KMB) . It got a savage downgrade from Goldman Sachs today, saying that the good news the firm was counting on didn't count and the stock was no longer worth buying. If there weren't a big rotation this stock would have been crushed. Nope, it went higher.
Now what else do PepsiCo and Kimberly have in common? Yield: they both give you about a 3.5% return. If there is a slowdown then we have seen the peak in rates. If we have a peak in rates than you want to own stock with a 3.5% or more yield - more than Treasurys - and these two are emblematic of that opportunity.
Second camp? Those who think we have genuine runaway inflation. This is a camp that has its view stoked everyday. For example today, a spokesperson for PPG Industries (PPG) , the giant paint conglomerate, announced that it was putting through a 10% price hike. "While PPG remains aggressive in its efforts to control expenses," Rebessa Liebert, a senior vice president for automotive coatings said, "we have experiences continued and unprecedented cost pressures in raw materials, freight, distribution and labor across every region. "
That's mighty negative. That says inflation is raging and the Fed is actually behind the curve in slowing it down. What do you do if you think that inflation is already out of control and therefore rates have to go higher? You sell the high growth stocks betting that their future earnings aren't worth as much when you have high inflation in the outyears. Now, until last week we had a belief that even if the Fed tightened too much these stocks would roar. These stocks are now collapsing and didn't even rally much during the intraday turn. It is amazing to see how much the super growth stocks, the cloud kings, the medical devices and the like just plain old collapsed.
Amazon's (AMZN) stock gets clocked. Why not? It just said it had to raise its wages to $15 an hour. Alphabet's (GOOGL) stock gets decked, of course, by what we now call a privacy security flaw. Those seem to have become an inevitability, haven't they? The only FANG stock that held up is the one that's now a value play: Facebook (FB) , because it sells at less than 20 times earnings. Obviously, no one believes those numbers, but the stock has a harder time going down because it does represent some value.
We just interviewed John Donahoe, the CEO of ServiceNow (NOW) , when we were in San Francisco and the company is just doing so well that it is hard to imagine anything that can stop it. We saw gigantic selling in the likes of Adobe (ADBE) , Workday (WDAY) and VMware (VMW) , too.
That's because the big institutional investors simply won't pay as much for those future prospects because these investors know that, historically, the value of the earnings and sales in the outyears aren't worth as much. That's what inflation does.
Do these money managers care if inflation gets under control? No. They just want to sell ahead of others who are going to sell when they find out how bad things really are.
Then we have the stocks that need a stronger economy to buy. Neither camp wants these stocks. So the airlines - hurt by higher oil prices - see their stocks get crushed. A pure commodity maker, Alcoa (AA) , gets annihilated.
So the recession means buy soft goods stocks and the recession means sell industrials, are two sides of the same coin, while inflation means higher interest rates and less purchasing power so sell the super high growers.
Now I said there would be some less obvious reasons for the sell-off and the recovery. Here they go:
- It was a darned holiday for heavens sakes and we had no bond market but we did have the actions of other bourses that don't celebrate Columbus day, bourses like Europe and Asia. They were all crushed, Europe because of Italian worries, Asia because China's stock market got gobsmacked. The people who don't know anything like to trade off of overseas and that worked until the afternoon when other buyers came in, oblivious to Europe or Asia and instead just wanting to get some bargains in an oversold market.
- We are in the grips of insane ETF action that involved all the cloud kings. They are trading together in a basket, one that was probably set up to take advantage of exactly what we have noticed: there are a group of stocks that are super growth oriented and they can be bought and sold together. That's what the ETFs do. That's what happened today.
- A new camp has emerged - the one that says rates have overshot. This is a minority camp because the Fed has told you this camp is wrong. But if rates stabilize here, you could see a humongo rally and they want to be positioned correctly.
- Finally, we are oversold. We've been going down to the point that many people who have been waiting to do some buying because they need to gain some performance on the averages came in and bought. That's money management 101.
Now, let's summarize. Higher inflation and concomitantly higher rates do slow the economy. Those who think the Fed is going to overshoot and slow the economy to the point of crashing, causing rates to go lower, bought PepsiCo and Kimberly and sold the industrials. Those who think the Fed has lost control and that rates and inflation have to go higher, sold the high growth stocks. And everything went off kilter, hopelessly magnified, because everything happened on a bank holiday. All the world's a stage of rates, inflation and the Fed. High growth stocks, cylicals and soft goods? They're merely players.