In 2013 a consistent trend of bad macroeconomic news causing stocks to rise and good news causing them to fall could be seen marketwide throughout most of the year. The reason for this was simple: bad news led short-term traders to assume the Federal Reserve would continue its QE policy of expanding the monetary base through bond buybacks, which would indirectly cause stock prices to rise and rise. Whether this caused the S&P 500 to rise by 30% in 2013 or it was merely a self-fulfilling prophecy, the strategy of buying bad news and selling good news worked very well last year.
In 2014, the trend abruptly ended in January, when bad news from China caused stocks to sour. Slowly, good news has become good again as investors focus more on recovering macroeconomic conditions than on Fed changes to the monetary base.
Yesterday, however, the stock market became temporarily dependent on the Federal Reserve again when the Reserve announced that investors were wrong to assume the central bank would raise its rate target in the near term. The full minutes, while admittedly boring, are worth a quick skim.
The news was a boon for many momentum stocks that had slumped in recent days. Pandora (P), Tesla (TSLA), FireEye (FEYE), and Netflix (NFLX) are all names that have low or negative earnings but have seen multiple price expansion in the past couple of years on the premise that they are fast-growing companies that will disrupt pre-existing and inefficient industries.
In other words, fundamental analysis of the present is far less important for investors in these names than in an understanding of their broader market and the potential for the companies to grow into massive future revenues and earnings. This makes them high risk, high reward names—and that means they are a favorite with hedge funds and institutional investors looking to obtain “alpha”, that overperformance of an index that makes or breaks careers and fortunes.
The problem with these companies is that, because they are high-risk names, investing in them depends not only on their ability to grow at a high rate, but also on the market to tolerate risk. When macroeconomic turbulence like a decline in the Fed’s expansion of the monetary base hits the market, it hits these names even harder. They will lose tremendous value in a very short period of time—and that’s what we have seen in 2014 for most of these names.
At the same time, news from the companies themselves has caused their values to rise. For instance, Pandora is still up over 10% for 2014 because the company announced new developments for its in-car service in January that has the potential to translate into major revenue growth in the future. This caused the stock to flirt with $40, only to crater to sub-30 in March and early April as the Fed’s accommodating monetary policy faded.
For long-term holders of Pandora, this is not good. But for swing traders that have variable price targets based on changing market conditions and an understanding of sell-side models and assumptions in the marketplace, this is a tremendous opportunity. Any trader who has a sell price target of $39 for the stock and a buy target of $30 has already made about 47% return in the first quarter of the year, with the ability to hold more shares of P now than at the beginning of the year. The same, to different degrees, applies for the other momentum stocks named above.
Again, this is why having the flexibility to trade or invest, combined with an understanding of fundamental and macroeconomic drivers, is so important for professional investors. It is also difficult for retail investors to replicate, because the market is always changing and requires close scrutiny, research, and contemplation. But for those few traders who can make sense of these trends and translate that sense into profits, tremendous rewards await.