There are decades where nothing happens; and there are weeks where decades happen,” according to Vladimir Ilyich Lenin. The latter sort of weeks seemed to dominate the quarter just ended, even if the discussion is confined solely to financial markets and economics and ignores the din of the political headlines.
As the year began, the stock market was marching higher in a virtual straight line in a seemingly preordained path to ever-increasing peaks. Sort of like the New England Patriots, who appeared to be moving to yet another Super Bowl victory. Even when trailing late in the AFC championship game, a fourth-quarter Pats rebound against the Jacksonville Jaguars appeared inevitable, and it was. But in the Super Bowl, the Philadelphia Eagles held off another late comeback by Tom Brady & Co., rewriting the well-worn script.
Likewise, three months into a year in which stocks started with such overwhelming confidence, the major market averages broke their nine-quarter winning streak. Ironically, that stumble took place as the bull market celebrated the ninth anniversary of its liftoff from the financial-crisis lows of March 2009.
Emblematic of the atmospheric change was the VIX, formally the Cboe Volatility Index, but known universally by its ticker initials. From the somnolent single digits, which reflected a near-hubristic certainty that nothing could go wrong for a bull market that was rising almost in a straight line, the VIX suddenly jumped in early February on the merest hint of inflation.
Indeed, speculators had made bets on persistently low volatility, or “the latest sure thing,” as this column warned last year (“The Trouble with Those Can’t-Miss Trades,” Oct. 14, 2017). Of course, those bets paid off until they didn’t. The VIX surged as bond yields jumped on signs that at long last, wages might be stirring in a labor market that was at full employment by conventional measures. The unwinding of the “short volatility” trade triggered the sale of stocks, knocking the major averages from their peaks.
After this largely technical episode in February, March’s market rockiness has triggered what might be called a disillusionment with technology, or at least with some of the highflying FANG stocks. Most prominent has been Facebook (ticker: FB), which has shed an astonishing $75 billion in stock-market value since the disclosure of data harvesting by Cambridge Analytica erupted a couple of weeks ago.
Both Facebook and Google parent Alphabet (GOOGL) face regulatory challenges, according to Strategas’ Washington team, led by Dan Clifton. Facebook founder and CEO Mark Zuckerberg is slated for a Capitol Hill inquisition over privacy issues, which could have an uncertain impact on his company’s business model. It’s also telling that a chart of the FANG stocks shows Alphabet and Facebook have trailed Netflix (NFLX)—the top performer in the Nasdaq 100, with a 53.9% surge in the first quarter—and Amazon.com (AMZN) since the turn of the year.
Amazon has been the object of President Donald Trump’s particular ire since the 2016 election campaign. Axios last week reported Trump is “obsessed” with Amazon, after which the president tweeted that the e-tailer doesn’t pay its fair share of taxes and uses the U.S. Postal Service as its “delivery boy” while putting “thousands of retailers out of business!”
“We saw very little attention paid to the one area where Trump could actually hurt Amazon—cloud-computing contracts,” Clifton writes. Amazon Web Services could receive the sole contract, worth billions, for cloud computing for the Department of Defense, and that has attracted criticism from other big tech rivals. Amazon’s shares fell after Trump’s tweet last week, losing some 3.3%. AWS, an integral part of Amazon’s business, effectively subsidizes its retailing operations.
Amazon also unveiled plans during the quarter to coordinate with Berkshire Hathaway (BRK.A) and JPMorgan Chase (JPM) to create an alliance to deliver health care to their employees. On the flip side, The Wall Street Journal reported Thursday that Walmart (WMT) is considering acquiring Humana (HUM) in an attempt to deliver health services more efficiently. That follows CVS Health’s (CVS) proposed buy of Aetna (AET). The aim of all these combinations would be to tackle the one sector that’s proven least tractable to controlling costs with technology: health care.
Perhaps the greatest disillusionment in the tech world has been in the realm of transportation. The death of a pedestrian in an accident involving an Uber Technologies self-driven car has shaken the high hopes about artificial intelligence’s ability to take us wherever we want without hassle—and without the expense of a driver or our own car.
That disappointment also extended to Tesla (TSLA), which has staked much of its future on autonomously driven vehicles. The electric-auto maker’s stock slid 17% in the first quarter (when after-hours trading on Thursday is included), one of the worst performances in the large-cap Nasdaq 100.
In what appeared to be a news dump at the end of the holiday-shortened trading week, Tesla late on Thursday disclosed the recall of 123,000 Model S sedans for a possible power-steering failure, reversing a 3.2% gain in normal trading hours. The stock previously had been hit by news of a fatal crash of a Model X SUV, which may have involved its Autopilot feature.
The real crash hasn’t been in Tesla stock, but its bonds. The equity has been basically a perpetual call option on bullish expectations for Tesla’s business of selling supercool, zero-emissions (ignoring electric plants) automobiles that burns prodigious sums of cash. Bonds, however, provide only the homely promise of semiannual interest coupons and the return of principal—provided all goes well.
Moody’s Investors Service last week rendered its judgment that things weren’t.
The ratings service cut Tesla’s overall rating a notch, to B3 from B2, while the company’s $1.8 billion of senior unsecured notes were trimmed to Caa1, reflecting the company’s “liquidity pressures due to its large negative free cash flow and the pending maturities” of other debt.
The bond market’s dyspeptic reaction was to slash the price of those aforementioned 5.3% senior notes due 2025 to $87.50 from par at their issuance last August, according to Cliff Noreen, deputy chief investment officer at MassMutual, the big mutual life insurance company. Back then, he opined in this space, Tesla got an attractive yield, commensurate with a double-B (top-tier junk) credit, and the notes never traded above par. Meanwhile, the shares have fallen from a peak of $385 in September to under $260 after-hours on Thursday.
Equity analysts remain relatively sanguine that Tesla will be able to step up production of its Model 3 sedan (see page 11), which is crucial for the company’s cash generation—so much so, according to a Bloomberg report, that the auto maker sought volunteers to ramp up output of the sedan to prove wrong the “haters” doubting the company. All of which speaks to the more sober expectations among investors.
As for the VIX, it has remained near 20—nearly twice its previous level of nonchalance—albeit down from 37 while the market was being roiled in February. Tech retains its fans, but some of the irrational exuberance, to coin a phrase, has been tempered. And that’s without even mentioning trade and tariff tensions or the prospect of continued interest-rate increases by the Federal Reserve.
More eventful weeks likely lie ahead.
After the rough first quarter, it might be comforting to know that April isn’t the cruelest month. The Dow industrials have averaged a 1.9% gain in it since 1950, the best showing of any month, according to the Stock Trader’s Almanac. During that stretch, there were 46 positive Aprils and 22 negative ones.
The first half of April tends to be positive, perhaps in anticipation of strong first-quarter earnings, the publication speculates, although the Dow is prone to weakness in the second half, following mid-month income-tax payments.
Aprils in midterm-election years tend to be less favorable, however, with an average 0.8% gain in the Dow. More importantly, April ends the strongest six-month span of the year, ahead of the hoary “sell in May” indicator.
Say what you will, the Stock Traders’ Almanac found that the Dow had returned an average 7.6% between Nov. 1 and April 30, going back to 1950, compared with just 0.4% between May 1 and Oct. 31. The tendency for weakness in the middle of midterm election years is even more pronounced. The second and third quarters have been the weakest of the four-year cycle, with an average decline of 1.8% in the Dow industrials.
That historically sets up for the “sweet spot” of the four-year election cycle. From the fourth quarter of the midterms to the second quarter of the “pre-election” year, the Dow has averaged 20.4%.
Whether past will prove to be prologue for this unique political scenario is another question. So many of the fiscal goodies that tend to drive the election cycle have been served up early, which helped the major indexes set records earlier this year.
Then there’s the Fed, which is on track for another two, and maybe three, quarter-point interest-rate increases this year. The Treasury market is reacting anomalously, with longer yields coming down again. The yield curve, expressed in the spread between the two- and 10-year notes, has fallen to less than a half-percentage point. That’s made it the flattest since the financial crisis. The history of the yield curve suggests caution.