foxex: Fear of the Unknown

The Market Sum | INVESTOPEDIA

Insight after the bell

By Caleb Silver, Editor in Chief

Monday's top stories:

1 - Fear of the unknown leads to another sell-off

2 - How we pay for Netflix to grow

3 - Chart of the day- Mind the bumps: markets & midterms

Final Numbers:

DJIA: - 0.50%

S&P500: - 0.43%

Nasdaq: + 0.26%

#1 Fear of the unknown leads to another sell-off
Sometimes, stocks fall and no one knows why. There are just more sellers than buyers, and every seller has a reason that is unique to them and their situation. This seems to be a persistent theme of late as investors are looking for reasons to get out even though nothing has really changed for the past couple of months.

We knew earnings would be good, and they have been.

We knew interest rates would be rising, and they are. The Fed will raise them at least one more time this year. You've been warned.

We know oil prices have climbed steadily for the past several months and that the price of gasoline in the U.S. is more expensive than it was 6 months or a year ago.

We know we've enjoyed an extended bull market for stocks. Stocks have been the place to be for quite awhile, although the couch is getting more uncomfortable by the minute. Investors are looking to sell more than they are looking to buy these days.

Why? Maybe it's tax loss harvesting of the end of the year?

Maybe it's the upcoming midterm elections? Elections can shake things up for investors as we illustrate below in our chart of the day.

Maybe it's a nagging fear that the tariff standoff with China will escalate into an all out trade war? That's legitimate, but most economists don't see that hurting GDP too much, even in a worst-case scenario.

Maybe we just need a reason to take some money off the table and there are enough to choose from, so we do.

That's what I think is happening right now.

Why it Matters: In volatile times like these you'll read a lot of headlines about why stocks are rising and falling. The financial media - present company included - will speak to traders or investors and ask why the market is moving this way or that. Like belly buttons, everyone has a theory. Those theories fit their particular narratives and help them make sense of a sometimes senseless world. That's OK, but it doesn't mean the individual investor needs to adopt that theory and behave in a similar fashion. Everyone's needs, like our belly buttons, are unique.

But facts are facts, and there are a few worth noting:
1. Stocks have been rising through most of the year because the economy is strong, tax cuts are coming and earnings growth has been robust. It also helps that companies have been buying back their own shares like there is no tomorrow. They were, at least, until earnings season began a couple weeks ago. As we noted then, buybacks take a breather during earnings season because executives don't want to be accused of insider trading, or buying back shares ahead of their SEC filings. Makes sense. That buyback, blackout period is coming to an end for most companies next week, according to Deutsche Bank. See their chart

2. Earnings growth is strong! According to FactSet, earnings growth for the S&P 500 is 19.5 percent for the third quarter, which is tied for the 3rd-highest growth rate since 2011.

What's Next: This is peak earnings week and we'll hear results from Amazon, Microsoft, Ford and hundreds of other companies. The FAANG stocks had been the leaders of the market until about 6 weeks ago when momentum shifted away from growth stocks to value stocks. That's healthy, but stronger than expected results from the world's biggest companies can be contagious. Sometimes, absent real news that should move markets, investors just need a reason to believe.

How To Decode A Company's Earnings Reports

#2 Why are we funding Netflix's growth?
Reed Hastings, the CEO of Netflix, likes to say that the company's only competition is sleep. For those of you who have binge watched Ozark or Orange is the New Black, you know what he means. What's incredible, though, is the fact that Reed and Co., have been able to grow Netflix into a company worth $420 billion with 137 million subscribers worldwide, without deficit spending. It loves to borrow money, and investors love to loan to it.

Why it Matters: Netflix announced that it is issuing $2 billion worth of bonds to fund "general corporate purposes, which may include content acquisitions, production and development…" In other words, Netflix needs to borrow the money to continue being Netflix. It already plans to spend $8 billion this year on content, but will likely spend more than that if it wants to stay ahead of Amazon Prime and Hulu.

What's Next: Netflix is awash in debt and bleeding cash. Normally, that's a sign of a company in the midst of a death spiral. A week ago, Netflix told us it has $859 in negative cash flow. That means losses. It also said it expects those losses to add up to $3 billion for all of 2018. In the meantime, it has borrowed $8.34 billion to date, up from $4.89 billion a year ago. A decade ago, Jeff Bezos ran this same playbook at Amazon. While most tech companies were chasing profits, Bezos was dialed into providing a great consumer experience, profits be damned. He thinks 2 years ahead, not two quarters ahead. Hastings is using the same playbook. He knows users love the service and he is not about to spend precious cash flow to produce great content. Why would he when investors are willing to pay for it by buying debt while bidding up the stock at the same time?

If you have a problem with that, chill.

Read More:
Netflix Unveils $2bln Debt issue to Fund New Content
Netflix: 7 Secrets You Didn't Know (NFLX)

Chart of the Day: Stocks & Midterms
We've addressed the fact that Octobers, prior to midterms, can be very volatile. Ari Wald, the market technician for Oppenheimer & Co., compared this October to October of 2014 and found some interesting similarities. In 2014, the world was bracing for a potential Ebola outbreak as the midterms approached. The S&P 500 pierced through its 200 day moving average, which also happened this October. We are still below that threshold. But, right after the election in 2014, markets popped and rallied hard until the end of the year. Wald is not insinuating that this will happen again, but many of the characteristics are similar.

In a research note to clients, Wald writes, "We show this comparison to refute the idea that current conditions argue for imminent disaster. Still, similar to October 2014, there's longer-term warnings that warrant monitoring."

We will, indeed.