What in the world is going on here? With the major indices off sharply here on Thursday after Wednesday's 5% rally in the U.S. stock market, that is the most relevant question.
The one thing that veteran traders -- those who deal in equities, commodities, fixed income and so forth -- seek more than any other can be summed up in one word: direction. The global stock markets have lacked direction this week, but please don't be confused: The direction has been down for a while now.
I cannot count how many times I have written this in my Real Money commentaries, but the most valuable investing concept is the second derivative -- that is, the point at which a trend reverses. The process of finding a bottom or reaching a top for stocks is never a quick one, but if your instincts are honed that is the way to beat the markets. Or, more technically, that is how fund managers generate alpha, thereby producing an adequate amount of reward for the risk inherent in investing in equities.
To find that second derivative, though, you need to know the general direction of the market. The direction of this market turned in October. That isn't 20/20 hindsight; that's just a cold, hard fact. Stocks have plummeted in the fourth quarter of 2018 because short-term interest rates are rising, mainly at the behest of the Federal Reserve, while long-term bond rates are falling due to bond market concerns over the rate of growth of the global economy.
So, to initiate a new position in any stock now, you first must do a top-down, broad strategic analysis of the global securities markets. That is a very difficult task, and the folks paid handsomely to do it are wrong as often as they are correct.
But value is always a shining beacon, especially for individual investors, and beaten-down names will always have a certain appeal. In a falling market that makes sense, but what was incomprehensible to me was the prevalence of advice from so-called experts to do that in a rising market.
Buying stocks that constantly are falling in a market that is rising quickly -- in the midst of "the longest bull market in history," for example -- in an effort to find bargains is just not a sound strategy. The stock market is a forward-looking discounting mechanism, and future fundamentals are fully, if sometimes imperfectly, reflected in today's stock price. So, when shares of General Electric Co. (GE) , Ford Motor Co. (F) and IBM Corp. (IBM) were being sold off steadily for quarters (not just days or months), it was a sign that the market had deduced -- correctly, in all three cases -- that the earnings power of those three companies had been permanently diminished.
But now Amazon.com Inc. (AMZN) , Apple Inc. (AAPL) , Facebook Inc. (FB) , Netflix Inc. NFLX and Alphabet Inc. (GOOGL) are being sold off consistently (with exceptions, such as on Wednsday) and I am still reading many articles advising investors to buy them on weakness. Are those pundits making the same mistake they did when they advocated buying fallen angels such as GE, F and IBM?
Hasn't the weakness in the FAANG stocks been a sign that those companies are entering a period of slower growth and therefore should obtain lower valuations?
Growth is the final frontier for U.S equities; that's what makes the idea of investing in tech stocks so attractive. The rate of growth is easily imputed from a stock's valuation multiple, and that is where the high multiples generally accorded to tech stocks become so dangerous.
CEOs always will blame slower revenue growth on a slowing economy, but our job as security analysts -- and the moment you own an individual stock instead of an ETF or mutual fund, you become one -- is to differentiate cyclical slip-ups from secular downturns. The massive campuses of Silicon Valley, now expanding to places such as Queens and Austin, were built on equity valuations based on never-ending growth. Basic math will tell you that can't happen, and the signs were obvious this summer.
Unit-based analysis is key and quarterly earnings reports are rife with these numbers. You just have to look.
The individual metrics are different, but Facebook (users,) Apple (iPhone shipments,) Twitter (users) and Netflix (subscribers in the crucial U.S. market) all have shown slowing trends in unit growth in quarterly earnings reports throughout 2018. It is harder to measure unit growth at Alphabet (Google) and Amazon, but the market is telling you that those giant companies' growth rates are slowing, too.
So, the plunge in the prices of the tech titans was presaged by clear signs of slower unit volume growth. That is why I have advocated buying tech bonds instead of tech stocks in my recent columns and will continue to do so in 2019.