Investors on edge with rates as earnings bubble in

Stocks ended the session on a sour note after trading higher earlier in the day. It was a volatile session which left the Nasdaq and its tech-elites bruised.

Baby and bathwater.  I am not sure about the origin of this brutal sounding yet popular saying, but most of us know it and have uttered it. Surely, none of us has actually ever thrown a baby out with the bathwater. Yesterday was one of the most volatile sessions for stocks, year to date. Granted, the year was just freshly minted just a few short weeks ago, but it was nonetheless, quite a rough session, leaving many wondering if it was a specter of what is to come for the remainder of 2022. For some reference, Christmas is just 339 days away… yep, it’s going to be a long one. 

I am going to focus on the Nasdaq as it has been thrown into sharp focus over the past few months.  The reason for that focus is that the index is heavily, heavily weighted in technology and growth stocks. Most technology stocks are growth stocks, but there are also many non-technology growth stocks in the index as well. The technical definition of a growth stock is one which is expected to grow future sales and earnings faster than average.  Historically those great growth prospects came from technology-based innovation. Think of Apple, Microsoft, Intel, Cisco Systems, Oracle… all of them classics. Social Media stocks hit the scene with great growth in prospective subscribers.  Think of Facebook, Twitter… AOL, also classics… one more than the others. Now, we have great growth prospects through innovative business models finding new markets (Uber, Lyft, Peloton), exciting game-changing products (Tesla, Rivian, Crocks, Beyond Meat), biotech/pharma stocks with potential lifesaving discoveries (Moderna, Biorad, Vericel), and even exciting innovative media (Netflix, Disney, Electronic Arts). Now, it isn’t fair to say that Caterpillar or Proctor & Gamble don’t have innovative products with great prospects, but those companies are more focused on maintaining their brands and maximizing their returns on those investments. Those companies are expected to have stable returns and are likely to pay dividends. Though many would incorrectly refer to those companies as value stocks, let’s just put them in the category of not-growth stocks.  Getting back to growth stocks, because they all have such great potential futures, investors are willing to pay sizable premiums to buy them.  Further, because the bulk of their current value is based on prospective growth, with an emphasis on the modifier: prospective, if there is any hint that those growth prospects may not come true, those stocks are likely to be jettisoned rather abruptly. In other words, because of their very nature, growth stocks tend to be more volatile than… not-growth stocks.

When trying to determine what a growth stock is worth, we look at potential sales for the next few years, which is not an easy task for upstarts, but it can be accomplished with some level of accuracy.  Beyond those first few years, the years of rapidly compounding growth is where the real challenge is. How can we tell, for example if an upstart biotech will be successful in developing a life-saving cancer drug when it will take years to develop and get regulatory approval? Well, we know how big the target market is, and if the company is successful, great growth awaits it.  That unknown, but potentially exciting growth, is baked into a terminal value, which mathematically, is highly sensitive to interest rates. Lately, there has been a fascination with potential interest rate hikes over the next 12 months and their impact on growth stocks. Let’s be clear, higher interest rates affect growth companies the same way in which they affect non-growth companies. If Caterpillar finances the purchase of heavy manufacturing machinery, it will cost more. Likewise, if Intel finances the buildout of a new fabrication facility, it will cost more. Consumers who purchase those company’s end-products using credit will be able to afford less and possibly purchase less.  Remember, the mathematical terminal value of a stock is the company’s value beyond the seeable future (>2 years in most cases) for perpetuity.  Perpetuity, in finance means forever… and that’s a mighty long time. The late musician Prince got it right with that lyric, and so should you. The Nasdaq ended yesterday’s session in a technical correction zone. That means the index is greater than 10% below its recent high. The Nasdaq, and its growth stocks, have been under severe pressure since the Fed began hinting of interest rate hikes in 2022. The Fed is going to meet next week and vote on monetary policy, and with inflation on the rage, investors are on edge over the potential for policy makers to surprise us with policy changes, if not hints of them. We are also at the start of earnings season… which is really an investors’ best bet for determining how well a company may do in the future. After today’s close, Netflix will announce its earnings making it the first FANG stock to hit the tape. Netflix will talk about subscriber growth, exciting new media creations in the works, and possibly some new innovations.  They will most likely not talk about bond yields and interest rates. Pay attention to the baby, please. 

WHAT’S SHAKIN’

The Travelers Company (TRV) is trading higher by +3.08% in the pre-market after it announced that it beat EPS and Revenue estimates by +35.31% and +3.64% respectively. The company attributes strong results to strength in underwriting and investment growth. The company’s forward P/E is 12.73, which is cheaper than the 15.57 mean forward PE of its peers. Dividend yield: 2.20%.  Potential average analyst target upside: +4.8%.

Ford Motor Company (F) is trading lower by -2.18% in the pre-market after falling by -7.9% yesterday. Jefferies downgraded the stock from BUY to HOLD, citing limited upside, with all its recent positive developments already baked into the stock’s value. Dividend yield: 1.78%.  Potential average analyst target upside: -3.4%. WHY IS THIS NEGATIVE? Because the stock’s current price is higher than the average 12-month analyst target. Though that can be interpreted as the stock being overvalued, it does not mean that it will not continue to trade higher.

Also this morning:    KeyCorp (KEY), M&T Bank (MTB), and United Airlines (AAL) beat on both EPS and Sales, while Regions Financial (RF) and Baker Hughes (BKR) missed on EPS but beat on Revenues. After today’s close we will hear from SVB Financial (SVB), Netflix (NFLX), Intuitive Surgical (ISRG), PPG Industries (PPG), and CSX Corp (CSX).

YESTERDAY’S MARKETS

Stocks traded lower yesterday as investors faced pre-FOMC meeting jitters. The S&P500 Index fell by -0.97%, the Dow Jones Industrial Average was lower by -0.96%, the Nasdaq Composite Index dropped by -1.15%, the Russell 2000 Index traded lower by -1.60%, and the S&P500 ESG Index gave up -0.99%. Bonds rose and 10-year Treasury Note yields slipped by -1 basis point to 1.85%.  Cryptos slid by -0.67% and Bitcoin was lower by -1.58%.

NXT UP

• Initial Jobless Claims (Jan 15) is expected to come in at 225k, slightly lower than last week’s 230k.
• Philadelphia Fed Business Outlook (Jan) is expected to have risen to 19.0 from 15.4.
• Existing Home Sales (Dec) may have pulled back by -0.6% after gaining 1.9% in November.