The psychology of the market may be changing, and investors would be wise to take notice.
As I wrote a few weeks back, if you are going to follow one company this earnings season, Amazon (AMZN) is the one to follow. No company is more important than Amazon in bolstering the psychology of the market. Over the past two years, Amazon has consistently reported year-over-year earnings declines only to see its shares trade higher after the release.
The implication from this price action was that current earnings don’t matter for Amazon, as evidenced by its trailing P/E ratio of over 600x. Naturally, investors applied the same concept to the S&P 500 (SPY) as a whole in bidding up shares well beyond their earnings gains last year.
Fast forward to Thursday’s earnings release and the behavior was markedly different. Amazon actually reported a profit and a year-over-year increase in its earnings, something it had failed to do in the past two quarters. But this time, instead of sending shares to new all-time highs, investors sold off shares on the news. Amazon gapped down over 7% Thursday and close to 10% on Friday.
Investor behavior has changed.
This change in market behavior is critical because it reflects a change in psychology. Psychology, of course, is one of the most important drivers of short-term market movements. In prior quarters, earnings disappointments and even negative earnings did not matter. The collective psychology was so optimistic that nobody cared about negative news. Therefore, there was no trade. As Colm O’Shea said in Hedge Fund Market Wizards, “you can’t be short just because you think fundamentally something is overpriced”; you have to “wait until people start to care.”
If people are starting to care about Amazon, then perhaps they will soon begin to care about the wide disconnect between the historic gains in U.S. equities last year and the reality of lower inflation expectations. If so, the weakness observed in the first month of this year could be a harbinger of things to come. At the very least, it is suggestive of increased volatility going forward.
To be sure, as we are only a few weeks from all-time highs, it will take time for investors more broadly to start “caring.” But as I wrote a few weeks back, investors should be paying much more attention to risk management this year.
We’re not in 2013 anymore.
This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.