@theMarket: Rotation Is the Name of the Game

Misery loves company, or so they say. There was plenty of that this week as declining technology stocks dragged down the indexes.

 

While the stock market had been stuck in a rut most of the month, the tone changed this week. Markets felt the pain as the leading AI -fueled semiconductor index was walloped. However, appearances can be deceiving. There were some pockets of safety that did well as rotation strategies replaced momentum plays among traders.

 

Quarterly earnings have begun. The estimates call for a 23-24 percent gain in earnings this season. That follows a 26 percent+ record last quarter. Bank stocks were the first to report, and most did not disappoint. Goldman Sachs' profit, for example, was up 78 percent from the prior year while JP Morgan soared 41 percent. It may come as no surprise that investment banking fees had a lot to do with those results.

 

The large-cap banking index made new highs for the year even as AI technology and the semiconductors index suffered additional selling. Boring old utilities, consumer staples, and health care outperformed as most of the AI darlings languished.

 

SpaceX, the Musk deal-of-the-century IPO that I warned readers not to chase, is now down to $124/share, well below the $135/share IPO price. Last week's broker-hyped offering, the "must have" Korean-based ADR, SK Hynix, has also been a dud (minus-37 percent).

 

Not all technology has done poorly. After being ignored or sold down for weeks, the Magnificent Seven stocks have added $1.5 trillion in market value in July, while semiconductor stocks, excluding Nvidia, have erased nearly $1.7 trillion in market value. Software companies, another casualty of AI predominance, have come back from the dead. Forty-four out of 51 software stocks in the Yahoo Finance industry basket are up for July with a median gain of 6 percent.

 

Given the high valuations of most stocks, it seems investors are quick to punish and just as quick to reward. Those companies that disappoint, failing to live up to investors' expectations, are quickly taken to the woodshed. IBM announced weak preliminary results, and the stock fell 25 percent, the largest decline since at least 1968. Netflix also disappointed and opened down 10 percent on Friday.

 

The next two weeks should be interesting as more companies report. I warned readers in weeks past that, this time around, quarterly earnings will see investors take a much more selective approach to companies based on their results and guidance. Evidence so far indicates I am not far off the mark.

 

This week, we also had the results for both the Consumer Price and Producer Price Indexes for last month. As I predicted, both numbers fell well below street expectations. I also expect next month's numbers to be weak as well (unless Trump's Forever War pushes oil prices higher still). Markets pushed higher for a day in celebration, but it didn't last long.

 

Kevin Warsh, in his first appearance as Federal Reserve Chairman before the House Financial Services Committee, threw cold water on the monthly inflation numbers. He pointed out that one or two data points do not make a trend.

 

Warsh said, "The longer prices have been above the inflation target, it's usually a bit harder to dislodge them and get them lower. Our job, my commitment to you, is to take sticky prices and to unstick them." That may be music to the ears of Main Street (and me) but do nothing for the financial market's hopes of easier monetary policy this year.

 

The bullish tone of the markets preceding and just after the Fourth of July has come and gone. As readers know, I have approached July and August with caution. Since the holiday, investor sentiment and fund flows have waned, while the technology sector has come under more pressure.

 

This week, we saw further evidence of that as the Nasdaq declined more than 3 percent, the S&P 500 dropped 1.43 percent, and the Russell small-cap index, the best of the bunch, maintained its bullish posture. It declined by less than half a percent.

 

It is no surprise to see the areas that went up the most experience the most severe declines. It is how markets work. Profit-taking in semiconductors was in full force this week. While I do expect bounces along the way, I think over the next few weeks we will see further downside.