RoboStreet – February 8, 2018
Historic Week for Volatility Defines Textbook Bull Market Correction
This week will go down as one of the most turbulent for investors since records of such activity began being archived. The S&P 500 endured a textbook bull market correction of 10% in the span of six days. There are a few culprits responsible for the trap door sell off that will define what occurred and why. It seems inverse trading instruments that track volatility and designed to protect portfolios malfunctioned badly. Case in point the Velocity Shares Daily Inverse VIX Short Term ETN (XIV) lost 92% of their value, closing Monday at $97.31 and ending Tuesday at $7.35.
In the case of the XIV, this is an Exchange Traded Note (ETN), which is a leveraged debt instrument underwritten by Credit Suisse. One can only imagine the non-recurring charge they will take against earnings for the first quarter, and it is highly probably the company will have to liquidate the instrument altogether as regulators move in to assess the damage and seek measures to avert another computer-generated flash crash.
Apparently, there is over $4 billion being traded in these kinds of instruments, which is not small change. It demonstrates that the creation of such instruments that depend on computers maintaining discipline and order during chaotic times vary greatly. There are certainly select well-capitalized hedging tools that have the liquidity and institutional sponsorship that trade in an orderly manner during extreme bouts of volatility. And then there are the also-ran products that have not been stress-tested, rushed to market with a lot of fanfare, only to crash under the weight of high-volume sudden moves like that witnessed this past week. Separately, there are 5,024 Exchange Traded Funds (ETFs) trading globally and 9,511 publicly traded mutual funds that are all tied to forced selling systems with redemptions and liquidations of stock holdings during a market free fall.
To put this in perspective, there are less than 4,000 companies that are actively traded in the NYSE or Nasdaq. The U.S. stock market, for all practical purposes, is disappearing and when ETFs and mutual funds outnumber available domestic stocks to own by a factor of almost 4-to-1, it is no wonder the rallies and corresponding sell offs are more pronounced that in years past.
But even with that headline, the main catalyst of the selloff was the fear of wage inflation. As per the payroll report Friday, job growth was solid again in January, but the focal point was the 0.3% jump in average hourly earnings. That was in-line with the consensus estimate, but after taking revisions into account, it left average hourly earnings up 2.9% year-over-year and the highest growth rate since May 2009. Plus, there were separate preliminary U.S. regional bank reports that showed GDP growth of more than 5.0% for the month of January that quickly translated to the bond market that the Fed might be well behind the curve in normalizing interest rates.
The vicious bout of selling pressure took a short-term toll on investor portfolios, but also relieved the market of its overly elastic move to the upside fueled by institutional and retail fund flows of over $100 billion into equities during late December and all of January after tax reform was passed into law. However, I expect a full bounce-back recovery because of the strong fundamental and technical aspects of the primary bull trend that was simply stretched like a rubber band and triggered a sudden snap back blow off that eviscerated sellers of volatility.
Within the downdraft, our proprietary AI system is ferreting out some excellent long-term investments that are presently highly attractive entry points. Case in point is Abbvie Inc. (ABBV), the specialty pharmaceutical company posted robust fourth quarter earnings and revenues that beat Wall Street forecast, led by rising sales from blockbuster drug Humira that treats primarily rheumatoid arthritis. In addition, the company raised guidance that was nothing short of impressive. AbbVie expects 2018 EPS of $6.45 to $6.55, compared with the FactSet consensus of $5.83, and raised adjusted EPS from between $6.37 and $6.57 to between $7.33 and $7.43, compared with the FactSet consensus of $6.66.
Shares of ABBV soared from $108 to a new all-time high of $125.86 on the news and summarily were sold off with the market, now trading at around $114. The Tradespoon Stock Forecast Tool is extremely bullish on the next six months for ABBV, predicting the stock will challenge $150, a 30% move higher by the end of July!Below is yesterday’s six-month forecast readout for ABBV.
Bear in mind that the investing landscape has to stabilize and we need to see a strong follow through move up and through 2,720 (50-day moving average) for the S&P 500 for the rally to put momentum back in the hands of the bullish camp. The big picture going forward is seeing the market complete the back and filling process and then resume the upside bias on the back of further strong quarterly earnings reports coupled with tempered inflation data. In doing so, stocks like Abbvie Inc. (ABBV) will far outpace the major averages and its my mission to uncover these special situation stocks that we can buy and hold that are characterized by outsized returns with low levels of volatility.
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