An accommodative Fed and strong earnings… versus a China crackdown, the Delta variant, inflation, and disappointing GDP… which way will stocks go?
This week, investors found themselves trying to navigate headlines that support both bullish and bearish arguments.
On one hand, the Fed remained incredibly accommodative at its Wednesday meeting.
According to Fed Chairman Powell, we’re still “some way away” from the Fed ending its quantitative easing program.
We can add to this a second quarter earnings season that has been incredibly strong to date.
And, of course, the market is hovering around all-time-highs, so we have bullish momentum.
On the other hand, there’s the Chinese government doing major damage to Chinese tech stocks…which sets up the risk of a similar regulatory crackdown on U.S. tech companies operating in China (think Apple).
Plus, we also have the Covid-19 Delta variant that’s putting some investors on edge about the potential for a return to lockdowns.
And then there are growth worries – the latest of which was yesterday’s second quarter GDP number. It rose 6.5%, which was miles short of the 8.4% forecast.
Given this push-pull on the market, where do investors net-out?
That’s what we’ll answer today with the help of our technical experts, John Jagerson and Wade Hansen.
In their Wednesday Strategic Trader update, John and Wade tackled these issues, distilling them to a bottom-line takeaway for investors.
Let’s find out what it is.
***How much of a threat are Beijing’s actions to U.S. investors?
For newer readers, John and Wade are the analysts behind Strategic Trader. This is InvestorPlace’s premier trading service, combining options, insightful technical and fundamental analysis, and market history to trade the markets in all sorts of conditions.
Given the short-to-intermediate term focus of their trades, John and Wade’s broad analysis of market conditions serves as a wonderful crystal ball for investors looking to get a handle on what’s around the corner.
As to their latest analysis, let’s begin with the first headwind they’re eying – China.
From John and Wade:
In our view, one of the most significant new negatives for stocks is the recent moves China has made towards companies in its technology sector.
Starting months ago, Chinese regulators slammed the door on an IPO for Alibaba’s sister payment company Ant Group, and the government has gotten a lot more “hands-on” with its tech giants since then.
Rumors last Friday were confirmed on Monday that China’s government had slammed the brakes on for-profit education companies being able to raise capital or make a profit.
Stocks like New Oriental Education & Technology Group Inc. (EDU) and Tal Education Group (TAL) have dropped like rocks becoming almost un-investable.
To see what this looks like, below we show EDU and TAL’s respective stock prices on the year. Though they’ve been withering for months, you can see the knife-edge drop over recent days.
As I write, investors are sitting on losses of 87% in EDU and 91% in TAL since the start of the year.
For context, if an investor who has suffered these losses wants to hold in hopes of an eventual break-even, that will require a 669% gain from EDU, and a 1,011% gain from TAL.
Now, this is awful for anyone invested in these stocks, but how worrying is this from a broader, U.S.-investor perspective?
Back to John and Wade:
The question this change raises is what sector will China’s regulators turn to next?…
If the Chinese government is going to clamp down like this on its own tech companies, what are they willing to do to other domestic sectors and foreign companies like Apple (AAPL) that need access to Chinese markets for growth?
We don’t see this as a harbinger for the end of the rally, but we plan to avoid companies with direct exposure to this uncertainty in the short term.
On a positive note, John and Wade believe that a reversal of the policy could create some very profitable bullish opportunities later this year. If you’re looking to take advantage, keep your eyes on Alibaba, Pinduoduo, and JD.com.
***What about the market risks of the Delta variant and inflation?
John and Wade lump these challenges together since they’re likely to have the same effect on stocks. In both cases, rising trends will constrain growth.
The CDC is now recommending masking requirements in Covid-19 hot spots, even for fully-vaccinated individuals. And if you look at the CDC’s map of “hot spots,” (below in red and orange), it’s basically 2/3rds of the entire U.S. by land-mass.
This recommendation is turning into a mandate in many areas, such as Los Angeles, where I live.
It’s not a huge leap to go from mandated masks to mandated shut-downs if government officials believe Covid-19 numbers are surging.
Back to John and Wade for this risk, as well as inflation concerns:
While we don’t want to get ahead of ourselves, if new lockdowns start to look more likely, growth will fall.
As we have pointed out already this month, consumer and producer inflation is high, but the longer-term trend is not quite as alarming as the month-over-month numbers would suggest.
Right now, we see this as a reaction to rising spending and stimulus, which is a positive for the market, but it’s a trend that we need to watch closely.
In the short run, we see this as an issue that will remain localized.
Regional banks, builders, and other firms in the Southeast and Midwest should probably be avoided, but we don’t usually have those in our watchlist so it shouldn’t affect our trading strategy unless conditions worsen considerably.
Finally, what about yesterday’s disappointing GDP number?
While it did fall well-short of expectations, John and Wade write “6.5% economic growth is still very good because consumer spending (most of the U.S. economy) was driving the increase.”
Plus, John and Wade expect the two revisions in August and September to show an increase closer to what analysts had originally forecast.
***Turning to bullish influences, how much support will stocks get from the Fed and Q2 earnings?
On Wednesday, Fed Chairman Powell gave the market what it wanted – more quantitative easing without a clear end in sight.
From the Strategic Trader update:
…the statement is exactly what investors anticipated and the timeframe for a taper is still far out in the future.
As a source of “noise” in the market, the Fed is one that we see as mostly positive for prices. If there are no plans to remove monetary stimulus this year, support in the major indexes should remain solid.
Finally, turning to Q2 earnings, they’ve been incredibly strong so far.
In fact, according to data analytics company, FactSet, the S&P 500 index is currently reporting the highest year-over-year growth in earnings since Q4 2009. Plus, analysts expect double-digit earnings growth for the second half of 2021.
Here’s John and Wade for how this impacts the market:
Major stock market reversals are extremely rare while growth rates are this strong, so this is a big positive.
***How do all these bullish and bearish influences net out against one another?
For the most part, John and Wade think the negatives are temporary and the positives are more significant. That said, the headwinds they identified require close monitoring because they can change quickly.
Here’s their bottom-line to take us out today:
Investors tend to be nervous when the major indexes are first breaking to new highs and that is what we think the back-and-forth reaction to the news currently shows.
China’s regulatory changes, U.S. inflation, and rising COVID-19 infection rates are serious issues, but with earnings growth, high consumer confidence, and an accommodative Fed we feel that the intermediate-term trend should remain very positive this quarter.
Have a good evening,