| Focus on the Price
By John Jagerson, CFA, CMT Tuesday, January 22, 2019 1. Guidance matters more than earnings 2. SKEW was warning of potential short-term selling 3. Growth rates still positive How can we improve the new Chart Advisor? Tell us at chartadvisor@investopedia.com Major Moves
I mentioned in the Chart Advisor newsletter issue yesterday that investors tend to "punish" stocks more for negative comments in management's guidance statements then they will for a decline in actual performance. The reason for this is that the value of the stock today is the estimated present value of its future cash flows (earnings and/or dividends). This makes sense because a new shareholder does not get any of the value of past cash flows. Today's buyer is making their investment based on how they think the company will perform in the future. Obviously, when management changes their estimates it will affect the expected value of all future cash flows.
Today's report from Stanley Black & Decker, Inc. (SWK) is a great example of the impact management can have on future expectations. When adjusted for extraordinary items and one-time charges, SWK reported earnings-per-share of $2.11 compared to the average analyst expectation of $2.10. Revenue for the fourth quarter was also slightly higher than average analyst expectations.
However, SWK's management has adjusted their long-term growth sales goals to 4% from 6%. The stock dropped over 15% on the news nearly erasing all of the gains over the last few weeks. There are two things I would point out in the following chart of SWK.
1. From a technical perspective, stocks that disappoint (either by missing expectations, or reducing guidance,) while they are bumping up against a prior resistance level tend to experience the largest corrections. This was the case with SWK bumping up against the prior highs near $136 per share last Friday. From a risk control perspective, a stock in this situation just before its report should warrant some extra attention from investors.
2. Investors looking for a likely level for the stock to pivot higher again may want to target trendline support (based on the last two lows in October and December,) which is currently around $14.70 per share. We don't know if the stock will stop at that level yet but if it does pause and begin to rise again then closing the earnings-gap in February becomes more likely.  Source: finviz.com S&P 500 The S&P 500 is hovering near a potential pivot level at $2640. As I have written about previously, this is roughly equal to the bullish pivots in October and November and the consolidation after the correction in the first quarter of 2018.
Today's decline seemed at first to be related to negative news about trade negotiations between the US and China. The Financial Times reported that the US had rejected preparatory trade discussions with Chinese negotiators. Any signs of trouble on this front has been enough to send the major stock indexes lower over the last few months.
However, one of President Trump's economic advisers, Larry Kudlow, denied that report later in the day. I had expected that we would see the major indexes recoup more of their losses after Kudlow's comments. The fact that the semiconductor/technology-heavy NASDAQ closed with nearly -2% losses for the day seems to indicate that investors had more on their minds than just trouble with trade negotiations.
Most rallies after a major decline are interrupted a few times when the market forms a bottom or a series of rising lows. So, although the selling in the S&P 500 today was frustrating, it is far from abnormal after experiencing a nearly 14% rise in price since the bottom on Christmas Eve. Although selling at this price level is disconcerting, I would be reluctant to become very bearish without further selling over the next few sessions.  Source: finviz.com
Risk Indicators
One of the risk indicators that I regularly refer to is the CBOE SKEW index which measures the relative premium investors are pricing into put options that investors use to hedge risk in the S&P 500. What I have found is that when the S&P 500 is rising with the skew, resistance levels (such as $2640 on the S&P 500) are more likely to hold–at least temporarily.
As you can see in the following chart, the SKEW index has been rising with stocks as investors were hedging during the rally over the last few weeks. In absolute terms, this level of the SKEW isn't particularly high, so it doesn't really indicate any panic; but it does signal a fairly high probability for some short-term selling. If we see much more negative guidance like we saw from SWK today, the selling could get worse but I would expect to see an early warning sign from the SKEW approaching its historical highs first.  Bottom line: Growth remains positive Whether today's selling is just a little profit-taking by investors who were spooked by negative earnings reports from stocks like SWK and Arconic (ARNC) will probably take a few days to determine. In my opinion, I believe that the positive earnings growth rates compared to the fourth quarter reports of 2017 still keep the odds in favor of a good first half of 2019. Externalities like the government shutdown and trade negotiations are an important X factor, but the underlying fundamentals still justify an optimistic outlook.
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Tuesday, January 22, 2019
Just a Pause - or Something More?
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