Stocks went on a wild ride on Friday after a high profile analyst suggested shorting the market’s hottest stock, Nvidia. Within minutes a whole gaggle of leading tech stocks, including the so-called FANG members, went into sharp decline. By session’s end, they were down 2-5%, while the rest of the market was up. This all happened on a summertime Friday, a time conducive to such moves.
Let’s look at this a little closer. Many leading stocks, like Apple#, Facebook# and Amazon, had risen about 40% just since the first of this year. In a market where all three of the above mentioned names are top ten S&P stocks, institutional traders trying to match the performance of the leading averages, were forced to chase. Being underweight in any one of those stocks left investors seeking to match or beat the S&P 500 in a big hole. In other words, success begets success. But the reverse is true, and we will see today if there is any follow through. There probably will be. Shocks of the magnitude we saw on Friday will also certainly shake a few trees and increase investor fears that the one way street up is going to lead to some sort of correction before the saga ends.
So let’s start with Nvidia, the maker of very high end and speedy graphics chips used in everything from computer games to driverless cars. It was the hottest stock in the S&P 500 last year and, after a brief correction earlier this year, had shot up another 60% by Friday morning when the analyst’s negative call came out. That call didn’t dispute Nvidia’s fundamentals. It didn’t suggest near term growth was going to falter. No, it was all about valuation. Nvidia’s stock was a little over $100 per share in early April. By Friday morning, it was well over $160. Volume in the stock last week was huge, a sure sign of a buyer’s panic.
When Apple languished around $90 per share last year, no one wanted it. Apple was no longer viewed as a growth stock, even knowing that the next phone, the iPhone8 was destined to be a big hit. But then the mood changed and Apple started rising faster than the market. Maybe the iPhone8 would be a bigger deal than originally thought. Maybe Apple could sustain some growth. Whatever. The important point is that Apple, the biggest stock in the S&P 500, started outperforming in a big way. Suddenly, underowning Apple, which worked when the stock was sluggish, was becoming a big mistake. As a result, Apple’s shares have risen 40% this year as everyone reversed course. To win this comparative battle, one didn’t just have to own Apple; it had to be one of the biggest, if not the biggest, portfolio holding given Apple’s weighting in the S&P.
I can go on and on citing names like Amazon and Tesla.
Money flowing out of these stocks moved to the year’s underperformers, at least on Friday including the energy and bank stocks. Strength in bank shares was further stoked by the likelihood that the Fed will increase interest rates 25 basis points at its upcoming meeting.
But now let’s take a step back, get off this emotional roller coaster, and reflect.
Newton tells us that a body in motion tends to stay in motion. Given the size and speed of Friday’s correction in the prices of the big high flyers, more damage should be expected. At one extreme, they could fall this morning, catch a bid later in the session and rally once again. But more likely, a correction of 3-5% after unimpeded upward moves of as much as 40-60% doesn’t appear strong enough to create enough fear. It would seem to me that a correction of at least 10% or even more is likely. Retracing roughly half of the straight line moves just this year alone would be an appropriate response. That could take days or weeks, not just hours. June is a perfect time for such a correction given the dearth of other competing economic or earnings news.
The next question is where are the sellers going to park their proceeds. Friday’s price moves in bank and oil shares shows money isn’t leaving the market; it is just rotating. But does it make sense to rotate out of rapidly growing companies into companies where growth is either limited or non-existent? Maybe in the short run it makes a little sense but not in the long run. Oil prices remain mired in the mid-$40s. While some companies can make good money at that price, they won’t flourish. Bulls on oil suggest today’s swollen inventories will begin to decline as summer demand increases. But that happens every year. It is why inventories are normally highest around Memorial Day. The U.S. oil producers have shown they can crank up production quickly. While some others around the world are trying to keep limits on production growth to sustain high prices, that tactic doesn’t appear to be working. Countries like Libya and Nigeria and also increasing production, and OPEC members consistently cheat when it comes to production quotas. Unless Saudi Arabia wants to curtail production significantly, the outlook for any sharp increase in price is dim. Tech may be overpriced for the moment, but oil doesn’t seem to be the place to go.
Similarly, while higher short term rates are good for the banks, a flattening yield curve is not. Bank stocks have been on their own ride up since the Trump victory and aren’t very cheap either. While the group has better growth prospects than the oil stocks, banking isn’t a growth industry.
Thus, what is most likely, at least in my view, is that this tech correction has a few weeks to run, and money will likely move to the sidelines, waiting for a better reentry point. Don’t lose sight of the fact that names like Facebook# and Amazon are some of the greatest growth companies of our generation. As long as they keep growing, their stocks will follow. That doesn’t mean 20-40% growth deserves a 50-60% move in the stock price. Stocks often get ahead of themselves, and the correction that probably began on Friday is healthy. The leadership stocks that were up 40% or more this year could easily correct 15-20%. Traders can take advantage of that mood. As long term investors, it may be appropriate to take a little money off the table if one’s positions in these names got a bit outsized. But they remain core holdings, and growth will resume once the stocks return to fair valuations.
The big news this morning is that General Electric’s long time CEO, Jeff Immelt is going to step down at the end of 2017 to be replaced by John Flannery, a seasoned GE veteran who heads its health care group. Mr. Immelt did a solid job steering GE through the 2008 recession and its business is in solid shape. But he has constantly sought to reconfigure GE and had a very checkered history of selling off unwanted businesses at low valuations while overpaying to get into new areas at their highs. Undoubtedly, his biggest mistake was to push GE into the energy field at exactly the wrong time. As a result, its shares have lagged behind other leading industrial names since the recession ended. This is a very healthy company in drastic need of a change. Hopefully, Mr. Flannery will be up to the challenge.
Today, former President George H.W. Bush is 93.
James M. Meyer, CFA 610-260-2220
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