Wednesday was marked by cross-currents. There were various forces exerting themselves upon the market, pushing it around in a volatile session.
Stocks, particularly in the tech space (NASDAQ:QQQ), were sharply lower to open the day. This was driven by the continuing spate of earnings misses in the sector, headlined by a truly lousy quarter from market Goliath Apple (NASDAQ:AAPL) along with a 16% shellacking at the perpetually underwhelming Twitter (NYSE:TWTR).
The morning nervousness increased following a disappointing crude oil (NYSEARCA:USO) report that wiped out a sizable increase and sent the fuel briefly into the red. But stocks quickly recovered following tame Fed comments that gave speculators the green light to buy the dip and send stocks higher.
But that wouldn't be all. Late Wednesday evening, the futures market abruptly plunged. The S&P 500 lost 1% of its value in mere minutes. At fault was a less-than-expected decision from the Bank of Japan, which we'll discuss in a second.
For the S&P 500, the apparent victory the Fed provided was short-lived. On the longer-term chart, we still appear to be near what could be a major top. If the market can't go higher - and soon - momentum will be lost and a correction should kick off:
It's getting near what should be a do or die moment for the market. With earnings continuing to be a complete mess, it's hard to imagine buyers will stay interested in the market at these levels without some major positive catalyst. Otherwise, a revisit to 2,000 or lower is quite probably in the offing.
Apple: The Slow Decline Continues
Apple stock, as you certainly know if you follow any media, was punished on Wednesday following a dreary earnings report. The stock was down 6% and would have been worse without the late-day Fed rally.
Market participants were expecting a bad report from Apple coming into the release. The company, which traditionally posts higher profits and revenues year over year each and every quarter, was expected to post declines.
However, both figures came in way low, with EPS missing by a whole dime and revenue a billion dollars light. Equally disappointing, the company slashed forward revenue guidance, coming in more than 10% below consensus.
The company had issues on many fronts; Chinese sales were down by more than a quarter. Average unit selling price plunged (phones are becoming commodities now, don't forget!) Currency issues caused further drag.
Most importantly, the company has failed to launch new products that would generate excitement. In the past, the perpetual earnings beats were driven by explosive new products or updated models that practically forced consumers to upgrade. Nowadays, that's simply not the case.
I explained this in Apple's Long Slow Decline, and my analysis remains up-to-date today:
What happens to Apple when Samsung (OTC:SSNLF) and Xiaomi offer sub-$200 smartphones that do everything today's phones can do? Since Jobs' passing, Apple has stopped making products that are cultural touchstones. Commoditization and Moore's Law will do the rest of the work in returning Apple from its pedestal to becoming just another tech company.
Sure, Apple still generates plenty of cash. They hiked the dividend again and continue to return large amounts of capital to shareholders.
However, the stock will remain perpetually "cheap" as long as earnings keep declining. If your P/E is 11, such as Apple's, and earnings decline by 10%, you have to drop the stock by 10% to maintain the same PE ratio. This is the process you're seeing occur in the stock now. And your sub-3% yield does little to cushion you. If a company has steadily falling earnings, there's hardly a P/E ratio low enough to protect you from further downside.
If you have a catalyst for Apple growing earnings again, maybe the stock is cheap. But if, as I contend, the smartphone market has peaked and Apple doesn't have an ace up its sleeve, you've seen peak earnings and thus - probably - peak stock price for the next few years if not longer.
There's nothing wrong with owning Apple stock if you're more optimistic on it than I am. However, the stock is not cheap - it's appropriately priced for the risk that earnings continue to slide gradually for years to come. Run a model where Apple earnings fall by a modest 3% a year for the next 10 years, and even with the share buyback and modest dividend increases, your total return isn't going to be very good.
It's very hard to get an edge on the single biggest company in the world. Yes, it might look cheap if you merely look at the P/E ratio, but there's more to the story than that.
Japan: As We Were Saying...
Earlier this week, one of my Daily Briefings highlighted the odd effects that Japan's policy of buying up its stocks might cause. The Japanese Central Bank has, in its infinite wisdom, decided to start buying its nation's stocks at a rate of roughly $27 billion per year.
It makes these purchases through ETFs, and is estimated to own more than half the nation's outstanding ETF assets.
Through this policy, it has become a top 10 holder of the vast majority of the 225 stock Japanese large-cap index. Regarding the risks this poses, I wrote that:
If the pace of JCB stock buying is expanded, as Goldman Sachs and other analysts anticipate, the JCB would be the #1 holder of about 40 stocks out of the Japanese 225-stock benchmark by the end of 2017.
There're a few obvious problems with this. For one, if and when the JCB tries to sell its shares, who will buy? They've taken a position much too large to unwind gradually. Any hint of them even stopping the buying of additional shares would cause a plunge in the Japanese market. I, for one, am avoiding Japanese stocks (NYSEARCA:EWJ) for precisely this reason.
The JCB met this week and decided not to increase the rate of stock purchases along with eschewing other more stimulatory approaches. They highlighted the large downside risks to the economy, the likelihood of a 0% CPI rate going forward, and said they'll add to the easing if necessary.
But the market wanted easing now; the Nikkei plunged 1,000 points - more than 5% - immediately on the news. Global markets swooned as well. Japan is a busted equity market.
You can be long trying to profit from the bank's nearly unlimited willingness to provide a bid. However, even that may not be enough to keep their shares up. Without increasing rates of stimulus, it seems their market may sell off anyways. And if the JCB actually tried to unwind the stimulus and start returning to a more normal state, the short-term shock would be catastrophic.
As for our markets, it's unlikely that Japan by itself would trigger a major correction. It's no China, as far as its modern-day impact goes. However, with the weight of nasty earnings, the slowing GDP outlook, and rebounding interest rates, there's enough on the table that the Japanese selloff might be the thing that tips the delicate global balance toward the downside.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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