Whew - well that was an interesting last few days in the market. Today I’ll offer up some potential stock buying opportunities after the big selloff - and provide some thoughts on what just happened.
A currency trader rubs his eyes at the foreign exchange dealing room of the KEB Hana Bank headquarters in Seoul, South Korea, Friday, April 5, 2019.Ahn Young-joon/The Associated Press
Buying the dip
Citi’s stocks for the rest of 2024
Citi U.S. strategist Scott Chronert took a bit of a victory lap in a Wednesday research report, reminding clients that he predicted a “summer squall” correction in equities because the high profit growth implied in valuations set the stage for disappointment. His post-sell-off outlook is more optimistic, and he offered a group of investment opportunities he believes are ideally suited for the second half of the year.
The key concept to Mr. Chronert’s approach is market-implied growth. The methodology involves reverse engineering a discounted cash flow framework to understand where fundamentals have to go in the next five years to justify current stock prices.
Instead of forecasting future profit growth and using that to calculate net present value (a fair value for the stock price, essentially), he starts with net present value and estimates the stream of cash flow or earnings that would justify it.
When the summer began, the strategist found that unreasonable profit assumptions were widespread. Now, he believes expectations are broadly more reasonable. Risks of slower growth are rising, but so is the likelihood of Federal Reserve rate cuts. Easing inflation pressure and a less inverted yield curve also boost his fair value assumptions.
To provide clients with investment ideas, Mr. Chronert looked at the biggest 50 per cent of stocks by market cap in the Russell 1000, and then screened it for names Citi ranks as buys. He then searched for consistent profit growth, whereby Citi estimates 2025 earnings growth will be no less than 5 per cent.
Stocks where market-implied growth had improved from negative (wildly optimistic) to neutral, and from neutral to positive (undervalued) were then identified. Thirty-three names made it through the screen.
Popular investments on the list include Apple Inc., Analog Devices Inc., Applied Materials Inc., Amazon.com, Carrier Global Inc., Dell Technologies Inc., Docusign Inc., Corning Inc., Alphabet Inc., Home Depot Inc., Snowflake Inc., Teradyne Inc. and Target Corp.
Companies where market-implied growth is most below five-year consensus profit growth include Applied Materials, Advanced Micro Devices, Docusign, ROBLOX Corp. and Alphabet.
Trader Gregory Rowe works on the floor of the New York Stock Exchange, Monday, Aug. 5, 2024. (AP Photo/Richard Drew)Richard Drew/The Associated Press
Volatile times
Random Thoughts on Monday’s Sell-off
There was volatility everywhere on Monday but in terms of real panic it seemed to be limited to the CBOE Volatility (VIX) Index. The VIX went from just over 23 in overnight trading and spiked to 66 before the S&P 500 open, one of the three biggest moves in index history. In a podcast earlier this year, derivatives expert (and former BMO Capital Markets trader) Kris Sidial explained how speculative traders are shorting volatility in much bigger size than before Volmageddon in 2018 - and I think this had a lot to do with Monday’s action. In 2018, a sharp jump in the VIX resulted in some exchange-traded products designed to short volatility to lose 90 per cent in a single trading session.
There was a lot of discussion about the yen carry trade on Monday. Anyone can say whatever they want here because the yen carry trade – borrowing funds at low interest rates in Japan (sometimes by shorting Japanese assets) and buying higher yielding assets in the west – is unquantifiable. It can’t entirely be coincidence that the Bank of Japan raised rates just last week and that the U.S. dollar has fallen almost ten per cent relative to the yen since July 10 this year. But, I also note that the yen didn’t spike on Monday (as loans or shorts were repaid and positions flattened) specifically, suggesting a lack of panicked unwinding. Former Federal Reserve economist and now hedge fund manager Mark Dow wrote a piece a while back arguing that the yen carry trade is over-estimated because currency volatility makes it dangerous to put on.
Credit spreads widened on Monday but not dramatically. Former Credit Suisse, now UBS, strategist Andrew Garthwaite has historically argued that credit markets provide better market signals in periods of extreme volatility. Mr. Garthwaite successfully predicted the post financial crisis stock rally in March 2009 using high yield credit spreads.
Let me conclude this section by pointing out that J.P Morgan fired their chief strategist last month for being too bearish. Maybe we should have seen this selloff coming.
Diversions
The best trading floor TV show returns
One of my favourite TV shows, Industry, is set to return for a third season. It’s about a small group of interns vying for a much smaller number of trading floor jobs at a U.K. broker dealer. The interns are all highly intelligent, deeply Machiavellian and have serious psychological issues and many secrets.
The show does not hold viewers hands as far as finance jargon goes and how deals work – it’s as accurate to what I remember of trading floors as I’ve ever seen. There’s an executive who cut his toenails at his desk in a disgusting I-can-do-whatever-I-want flex.
The Roger Ebert site called it “One of the Best Shows of the Decade”. It’s not for kids - nudity and drug use feature heavily.
For those unfamiliar, the trailer for season one is here (let’s call it not safe for work just to avoid problems) and for those already on the bandwagon like me, the season three trailer is here.
The essentials
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Globe Investor highlights
David Berman suggests the volatility that has rocked global stock markets this week may be offering a pleasant takeaway: Canada looks like an attractive market for anyone in need of shelter from the turbulence.
The sell-off in equity markets is raising fears of economic troubles in the United States and the potential for a recession, but those concerns look overblown when compared to a bevy of indicators pointing to a firm expansion, report Matt Lundy and Mark Rendell.
Starting last Thursday, the Japanese stock market experienced its most severe two- and three-day trading drops since the 1950s. The New York Times points to one key trigger for why it became the center of the global selloff.
What’s up next
I’ll be looking for any signs of a popular trade unwinding. The biggest question when assessing how bad a market will get is Where is the leverage?
More specifically: Which funds have borrowed too much money, or bought too many derivatives, to put on a trade that is now way offside? One of the worst things that can happen is for a bunch of hedge funds to start limiting redemptions.
Clearly there was some leverage related to the VIX before Monday so that bears watching. The yen too, for similar reasons.
U.S. earnings season is in full swing. Profit reports from economically sensitive companies will be of particular note, both those with global revenue and U.S. specific sales, to gauge economic growth. Nvidia Corp reports on August 28 – everyone will be holding their breath ahead of that one. The Russell 2000 should move in accordance with the market’s optimism on U.S. growth.
See our full economic and earnings calendar here (You can bookmark the page - it gets updated weekly)