US stocks are having yet another calamitous start to the week, both the Nasdaq and the S&P 500 are down more than 3% at the time of writing. The question now is, will this sell off last, or have we been wrong-footed by another strange Monday in the land of investing? When the mood is so biased to the downside in January and on the week that the Fed has its first meeting of the year, it is unlikely that risk aversion will change in a meaningful way before we hear what the Fed have to say. Without saying anything the Fed have managed to cause four things to happen in the markets: the steep rise in Treasury yields across the curve, the selloff in stocks – particularly richly valued tech stocks, the sharp drop in crypto currencies and a halt in the IPO market. If the Fed wanted to reduce the level of speculation in the market then they have done it, but will they backtrack at this week’s meeting?
What to expect from the Fed meeting
A scenario where the Fed continues to see inflation as transitory, although without using the word “transitory” could be on the cards for Thursday, especially now that the market is pricing in four rate hikes this year and the US 2-year Treasury yield is around 1%, although it has backed off from recent highs. However, we need to balance this with the risk that the Fed will taper more aggressively, it is currently still buying $40bn of mortgage-backed securities every month. In an environment where there are vaccines, the economy and labour market is strong, and house price growth is through the roof, this seems unjustified. Thus, the Fed needs to tread a tightrope, so as not to trigger a deeper market sell off. While the Fed is unlikely to want to continue to act as a backstop for financial markets, particularly for those profit-negative companies, plenty of solid companies are being thrown out with the bathwater in this market rout. For example, Microsoft is down more than 5% on Monday, even though it is reporting results later this week. More on what to expect from Microsoft later, what we want to see from the Fed is a move that suggests it is serious about “normalising” monetary policy and targeting inflation that is running out of control, at the same time as saying that it won’t slam on the brakes to such an extent that its actions will trigger an economic recession. If it manages this feat, and it’s a big if, then we could see some differentiation in the tech sector come into play, with the likes of Microsoft, Apple and Google staging a recovery while the richly valued end of the tech sector continues to sell off. If that happens then it could make it far more interesting for us fundamental analysts as balance sheet strength becomes a driver of stock market performance once more.
Signs that the selloff has gone too far
The performance of stocks and other asset classes on Monday are a sign that risk aversion is in full swing. Although all sectors of the S&P 500 were hammered, the consumer staples and utilities sectors performed the best, “only” down 1.8% and 2.8% respectively, at the time of writing. In contrast IT and consumer discretionary were hit hard. Considering consumer discretionary was a key pillar of the value trade, this sector’s recent sell off suggests that the strategy of buying value stocks is also under pressure as stocks retreat. Other sectors also suggest risk aversion. In the commodity space, Brent crude was down more than 1.7% on Monday, and copper prices were down 2.19%. The fact that these commodities that are highly corelated with economic growth did not fall as much as global stock indices is a sign that the global economy will avoid a recession, even with Fed rate hikes coming up. Added to this, there is a sign that the sell off has gone too far in the crypto space. Crypto made a tentative come back on Monday, with Bitcoin rising from a low of just above $33,000 back to $35,900, which could be a sign that risk sentiment will improve as we progress through to Tuesday.
FX market and what the SNB will do next
In the FX market, risk aversion was the theme of day on Monday, EUR/CHF made a fresh low at 1.0300, which must be causing the Swiss National Bank heart palpitations. We know from experience back in January 2015 that the SNB is not afraid of enacting policy and intervening directly in the market to weaken the CHF. Thus, beware EUR/CHF at these levels. We would note that the euro bounced back to 1.0350 vs the CHF, earlier on Monday, however, we don’t think that this was official SNB intervention because it started to decline by the European close. If we see another dive to 1.0300 then the SNB might step into the market. As we lead up to the Fed meeting, the dollar is also rising, hence why USD/JPY is stable around 113.70 and remains within its most recent range. Laster this week, the dollar’s uptrend could be at risk if the Fed is perceived as stepping back, even a small amount, from its aggressive hiking cycle that is currently priced in.
Earnings season: tech comes to the fore
As mentioned, another factor weighing on the market is earnings season and the prospect of a big disappointment. This is why we are especially focused on Microsoft and Apple’s results that are due for release later this week. The first of the tech giants to report earnings this week is Microsoft, who reports results after the market closes on Tuesday. The market expects 13% earnings growth for 2021. It is also worth remembering that Microsoft reported stellar earnings growth for Q3 2021, with earnings rising a whopping 22%. Thus, anything weaker than 13% could lead to fears over a slowdown. We also think that the market will be looking out for any updates on Microsoft’s $69bn acquisition of video game publisher, Activision Blizzard. This is a fast-growing segment of the tech world, and analysts will want to know the percentage of revenues that Microsoft executives think will come from Activision Blizzard in the years to come. It will be also be worth watching out for any demand impact from Microsoft Office’s price hike that comes into effect from March 1st. A company with pricing power in this environment could be cheered by the market. Lastly, revenue growth for its cloud business, Azure, is crucial to its service revenues. Overall, Microsoft is one of the tech giants that we think could outperform in a relative value tech trade due to its pricing power, size and scale and diversified business units. It is worth noting, that Microsoft’s shares rise the day after an earnings report 60% of the time, according to analysis from Bespoke. However, technical signals point to further downside for this stock, so it could take an epic earnings beat to change that momentum.
All eyes on Apple
The retail tech giant Apple is reporting earnings at 1630 ET on Thursday, and the market is expecting 12% earnings growth with some revenue growth also expected. This could be what a “bad” quarter looks like for Apple after some tremendous earnings figures in recent years. Christmas trading is expected to be robust, and it could report revenues that are likely to beat Q4 2020, when revenues were $114bn, a quarterly record. However, in Q3, Apple said that it expected to lose out on $6bn in sales in Q4, due to parts shortages such as microchips, along with the global supply chain crisis causing delivery problems. Will this impact 2022 sales, and the pipeline of new or updated products available? If the answer is yes, then we could see a further sell off in Apple’s share price in the short term. Its share price is down by 11% so far this year, a disappointing outlook from Apple could spook the market and lead to further losses for the broader tech sector in the short term. Added to this, Apple’s stock price does not have a good track record for rallying after an earnings report and has fallen after earnings calls for 5-straight quarters, according to Bespoke. Overall, we think Apple will weather the tech sell off better than others in the long term, even if storm clouds are gathering over this week’s earnings report.
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