Boom or Bust: Where to Next with Tech Stocks?
Boom or Bust: Where to Next with Tech Stocks? for The Daily Coin
Markets have endured tremendous volatility heading into 2019. By late afternoon on 4 February, the NASDAQ composite index hit 7,336.31, the Dow Jones Industrial Average was trading at 25,166.65, and the S&P 500 index was trading at 2,719.00. Bullish sentiment pervaded US financial markets, and spilled over into European bourses during trading overlaps. The FTSE 100 index was measured at 7,034.13, the CAC 40 slipped slightly to 5,000.19, and the DAX 30 was down marginally at 11,176.58. This begs the question: why the surge in US financial markets?
Multiple factors coalesce to create an overall trend in trading activity, be it bullish or bearish sentiment. In the US, political tensions are balanced with a Democrat-controlled house and a Republican-controlled Senate. We are entering a lame duck presidency period where it is unlikely that unfavorable legislation will pass both chambers of the house and qualify for the presidential seal of approval. This alone sets the stage for greater checks and balances which translates into less volatility in US financial markets.
From a different perspective, the US dollar index (DXY) which measures the strength of the dollar relative to a basket of currencies (EUR, JPY, CAD, GBP, CHF, SEK) is slightly stronger, indicating that US goods cost more per unit foreign currency. This is good for imports, but hinders exports for obvious reasons. Over the past 1 month, the DXY has remained relatively stable, with marginal gains of 0.19%. However, for the year-to-date the US dollar index is down 0.34%. This means that the US dollar is weaker relative to foreign currencies which is good for US exports. Provided the cheaper dollar (and concomitant cheaper price for goods and services) is not hindered by tariffs, duties and sanctions, US markets can benefit.
During 2018, the Federal reserve bank (FOMC) voted to hike interest rates with monetary policy tightening measures. This makes US dollars relatively more desirable, and increases demand for USD. As a result, the US dollar index strengthened 4.4% last year. In 2019, the Fed has been reluctant to hike interest rates (4 interest-rate hikes in 2018) and none so far this year. Dovish sentiment by Jerome Powell and other FOMC members is unlikely to support monetary tightening vis-a-vis interest-rate hikes. US/China trade sanctions are another source of contention and a disincentive to investing in equities markets in the US. Then, why are tech stocks like Google, Apple, Amazon and Facebook on the rise if so much uncertainty prevails in US financial markets?
Do Tech Stocks Perform Well When the Federal Reserve Bank Goes Dovish?
Consider the case of Google (NASDAQ: GOOG) which is currently trading at $1130.43 per share, up $19.68, or 1.77%. This juggernaut has risen sharply from $1033 on January 2, to its current price level. It has a 1-year target estimate price of $1328, and a recommendation rating of 1.7, where 1 represents a strong buy and 5 represents a sell. Clearly, financial analysts are of the opinion that if you trade Google, you’re getting a bullish stock with tremendous upward potential. As a market maker, Alphabet Incorporated lifted tech stocks on a day of heightened trading activity on US financial markets. Google has a colorful earnings history, with some interesting earnings surprise activity over the past year:
- February 1 2018 EPS of $9.70 and consensus EPS forecast of $10.12 à -4.15% surprise
- April 23, 2018 EPS of $9.93 and consensus EPS forecast of $9.21 à+7.82% surprise
- July 23, 2018 EPS of $11.75 and consensus EPS forecast of $9.45 à +24.34% surprise
- October 25, 2018 EPS of $13.06 and consensus EPS of $10.54 à +23.91% surprise
Google’s quarterly earnings release figures have served the NASDAQ well, and evidence of this abounds in stock prices. At the close of trading on Monday 4 February, Alphabet posted positive earnings results, and this wrenched tech stocks out of the doldrums. That the Fed has opted not to raise interest rates is particularly important when it comes to stocks. The correlation between interest-rate hikes and stock market performance is often opaque.
Fortunately, we can explain this correlation in a rather rudimentary way: If the cost of borrowed capital increases, companies with outstanding debts need to pay more in interest to service those debts. Alternatively, companies which require capital and financing will be hard-hit by bank loans at unfavorable interest rates. This ultimately decreases ROI, or results in higher prices of products and services which are then passed onto the consumer. Either way, markets do not react well to interest-rate hikes.
Creaming Profits from Bullish Stocks
The problem with a bullish market, be it the NASDAQ, Dow Jones, S&P 500 or others is that traders will seek to run up the rally and cream it off the top. This is true with day traders and swing traders, not with investors. What typically happens in this scenario is a spike in the price of the underlying equity, driven by all the sheeple (people who follow like sheep). Once profit gains have been locked in, selloffs take place allowing savvy traders to buy Google, buy Facebook, buy Amazon, or buy Apple on the dip.
This process repeats in waves. It is clear that stock prices are heavily overpriced at this juncture. Analysts are urging caution, especially as regards to US/China trade relations. If reciprocal sanctions continue, there is no way for stock markets to shoulder the shocks and stabilize. The tech stock movements we are seeing are perhaps best described as ‘pyrrhic gains’ and unlikely to be sustained over the long term. But for traders, this is music to their ears.
Investors typically await minutes of the Fed FOMC meeting to understand which direction the Federal Open Market Committee is going to move in respect of interest rates. There are many barometers which traders and analysts use to gauge likely sentiment, including US jobs numbers, housing data, the US dollar index, and other resources like the CME Group FedWatch tool. The next meeting of the Fed is slated for March 20, 2019. There is a 96.1% probability that interest rates will remain in the range of 225 – 250 basis points, and a 3.9% probability that rates will rise by 25 basis points, to settle in the region of 250 – 275 basis points.
The FOMC is instrumental when it comes to determining the ‘cost’ of money. When interest rates rise, the USD becomes more desirable to foreign investors, and a hedge their currency by purchasing USD, locking in USD contracts ahead of time if they anticipate a rate rise. A strong USD is a disincentive to investors in stock markets since US organizations earning funds abroad experience lower income in US terms. This drops the prices of equities on US markets. The nonlinear correlations between interest rates, USD strength or weakness, oil prices, inflationary pressures, and investor sentiment makes it incredibly difficult to assess markets with any degree of clarity. However, short-term price fluctuations typically follow predictable patterns, notably with positive earnings generating increased demand for equities. Market leaders like Google and Facebook have the power to lift or sink markets accordingly.