Alibaba filed an amended statement this morning ahead of its IPO, but investors are still waiting to see the terms.» Read More
Bank results are on a roll, and it's picking up speed. On Wednesday, Bank of America's earnings were a bit light, yet they still managed to vault over Wall Street's bar. On a related note, PNC Bank, US Bancorp, and even Northern Trust were all better than expected.
With PNC and USB, we are now getting results from big regional banks. Unlike Wells Fargo, which is largely a consumer banking company, or Comerica, which is largely a commercial bank, many of the regional names are mixes of retail and corporate banking.
Federal Reserve Chair Janet Yellen's statement about "stretched valuations" is getting some play this morning, but it should come as no surprise. She is right to raise the issue.
In a report provided to Congress in conjunction with her testimony, Yellen noted that "valuation measures for the overall market in early July were generally at levels not far above their historical averages," but then made this comment: "Nevertheless, valuation metrics in some sectors do appear substantially stretched-particularly those for smaller firms in the social media and biotechnology industries, despite a notable downturn in equity prices for such firms early in the year."
What smaller firms in social media and biotechnology could she be talking about? Heck, that's not hard to figure out.
I wrote about this in my Trader Talk last week.
There are several obvious culprits.
Pandora (P) at $5.5 billion market cap, is trading at 156 times forward earnings.
Groupon (GRPN), at $4.4 billion market cap, is trading at 67 times forward earnings.
Zynga (ZNGA), at a $2.8 billion market cap, is trading at 150 times forward earnings.
In biotech, most trade at multiples well north of 20. Many make no money at all.
Among smaller firms, Cubist Pharmaceuticals (CBST), with a market cap of $5.1 billion, trades at 129 times forward earnings
Alkermes (ALKS), with a $6.9 billion market cap, is trading at 96 times forward earnings.
Akorn (AKRX), with a $3.6 billion market cap, is trading at 40 times forward earnings.
It is no surprise that a couple sectors have stretched valuations. They have stretched valuations because investors believe these groups will see explosive revenue and (eventually) earnings growth, if all the potential is realized.
Of course, that usually does not happen. There will be many failures.
And, often, investors will simply run out of patience, en masse, with an entire sector.
Which is exactly what happened with the dot.com bust in 2000.
It is in the nature of all momentum stocks to have stretched valuations. At some point, they come down to earth as they stop periods of explosive earnings growth.
That's exactly what happened with famous momentum names like Microsoft (MSFT), which was the Mother of All Momentum Stocks during its period of explosive earnings growth in the mid-1990s. MSFT went from $1.4 billion in net income in its fiscal year ending in June 1995 to $9.4 billion in the period ending in June 2000.
Of course, many other names in that period never had a chance to mature. They simply ran out of capital, many without making anymoney at all.
Markets were treated to a plateful of U.S. economic data on Tuesday. As usual, the offerings were mixed: the New York Empire survey beat expectations, but June retail sales disappointed—but there was an upward revision to the prior month.
Bank of America/Merrill Lynch reportedly raised its second quarter gross domestic product (GDP) forecast to 3.2 percent to 3.6 percent on the retail sales figure.
Meanwhile, people were expecting a moderately hawkish tone from Fed Chairman Janet Yellen in her Congressional appearance.
Yellen hawkish? Forget about it! Yellen has never indicated that she would be more hawkish, and seems to have re-iterated this in a New Yorker interview. "And so even when the headwinds have diminished to the point where the economy is finally back on track and it's where we want it to be, it's still going to require an unusually accommodative monetary policy," the magazine quoted her as saying.
Weighing in on the recent battle over how stocks trade, Wall Street's major trade group is proposing changes in how exchanges pay participants and other stock trading rules.
SIFMA (Securities Industry and Financial Marketing Association) is essentially the representative for all the brokerage firms in the U.S.--everyone from Goldman Sachs to Morgan Stanley on down to the smaller firms. Its membership also includes asset managers, like Vanguard and Fidelity.
In a statement released today, SIFMA proposed:
First: Access fees charged by exchanges should be "dramatically reduced or eliminated." There's been a lot of discussion about rebates--fees exchanges pay and charge to customers to trade on their venues.
Exchanges charge an access fee when traders want to "remove" liquidity (market orders to buy or sell a stock) and provide a rebate when they "add" liquidity (post offers to buy or sell that are not immediately executable).
The complaint: A) High fees drive some traders to other trading venues (mostly dark pools) that charge lower fees or none at all, and b) the high fees have led to an explosion of order types that have made the system too complex and encouraged excessive trading.
SIFMA recommends the SEC should reduce the current maximum fee (now roughly 30 cents per hundred shares) the exchanges can charge to "remove" liquidity to no more than five cents per hundred shares.
What would this do? It would make it cheaper to trade on exchanges, and this--presumably--would drive more trading to exchanges.
This may not seem to be in the best interests of all brokerage firms, since many own dark pools that are alternative trading vehicles to the exchanges.
But on balance, I think most participants would rather see lower costs of trading trump any economic interest in a dark pool. And most of the 300 or so members of SIFMA do not own dark pools.
IntercontinentalExchange (ICE) CEO Jeff Sprecher (the owner of the NYSE) has already voiced support for reducing or eliminating rebates.
SIFMA is also recommending the SEC look into the large number of order types. Some order types may be encouraging excessive message traffic, for example.
Second: Broker-dealers should not be required to connect to trading venues that do not add substantial liquidity to the market. There are now 11 different exchanges. Several have very little volume; yet, under Reg NMS--the major SEC rule governing market structure--all brokers are required to connect to them.
This is expensive and adds a lot of complexity to the markets. SIFMA is proposing broker-dealers should not be required to connect to a trading venue with less than one percent of average daily volume in all stock trading.
Since dark pools do not publish prices, this would not include them.
What's the practical effect of this? It's likely that three or four exchanges would drop off from the requirement that all participants connect to them.
Third: Improving SIPs. All users of market data should have access to data at the same time. There has been much debate over the fact that the market data feed provided by the NYSE and NASDAQ, the SIP (Securities Information Processor), is slower than so-called "direct" feeds exchanges offer for a higher price.
SIFMA says: "Market data feeds provided by the SIPs and the direct feeds provided by the exchanges must be distributed to all users at the same time."
However, SIFMA also said it would ultimately like to see multiple processors competing on performance.
Everyone agrees the SIPs should be upgraded and made faster, yet it's not clear what the effect of perfect parity between the SIP and the "direct" fees would be.
Exchanges, for example, charge fees for participants to be near their servers, a process known as "colocation."
Would parity lower or eliminate the value of colocation? What is the value of colocation if the speeds are provided at parity?
Fourth: Regulators should require brokers to provide public reports of order routing statistics. Much debate over whether brokers--particularly discount brokers like Charles Schwab or TD Ameritrade--should be collecting payments for directing their orders to specific venues.
SIFMA is only asking for more disclosure to demonstrate payment for order flow is not violating a directive for brokers to provide the best prices available.
These recommendations may seem modest, and there are still many differences of opinion, but there is a subtle change in the market debate occurring.
For the past fifteen years, we have seen a market structure that encourages "financial innovation:" more exchanges, more dark pools and more order types.
The result: More trading, but also more spread-out trading. A more complicated market.
But we may now be moving toward a somewhat different model. The other model could be called the "utility model," where regulators, exchanges and market participants agree to limit the amount of exchanges and dark pools and order types, either because they are not as financially viable or because of complexity issues.
What happens from here? SIFMA will be meeting with policy makers--Congress and the SEC--to discuss the recommendations.
Most of these recommendations are roughly in line with comments made by SEC Chief Mary Jo White at her June 5 speech at the Sandler O'Neill conference.
Which means there will likely be some changes made some time in the near future.
Global markets are rallying, having been given a boost by a surprisingly strong earnings report from Citigroup. Overseas, Shanghai stock exchange is near a one month high, joining the market surge around the globe.
Part of the rally may be the proliferation of deals—Shire upping the bid for ABBV, Lindt's tie-up with Russell Stover, Whiting Petroleum buying Kodiak Oil & Gas, and Mylan buying assets from Abbot for over $5 billion.
The most interesting deal is Whiting offering to buy Kodiak in an all stock-transaction worth $3.8 billion, plus the assumption of $2.2 billion in debt. The marriage creates a new top producer in North Dakota's massive Bakken shale formation.
Is the housing remodeling boom over? A fairly grim report from Lumber Liquidator is acting as a possible canary in the coal mine.
After the bell yesterday, Lumber, which specializes in flooring and has been a mainstay of the remodeling boom, cut second quarter guidance practically in half: to 59—61 cents versus consensus of 90 cents. Estimated revenue of $263.1 million was also well below expectations of $302.8 million. Same store sales are now expected to be down 7.1 percent, against expectations of a gain of 6.7 percent.
Wow. Those are big misses. What happened?
Here's a hint: this time, the weather wasn't to blame. In management's own words: "The improvement in customer demand we experienced beginning in mid-March did not carry into May, and June weakened further."
June same store sales tomorrow. The Container Store disaster notwithstanding, we should get strong numbers from the handful of retailers that sill report monthly sales.
Employment, housing and consumer confidence have all improved. Traffic levels appear to have improved. Weather has been good. Discounting is still strong, which will lure shoppers to stores, but could hurt margins.
RetailMetrics estimates same-store sales could jump 4.9 percent, which would be the biggest, non-Easter impacted gain since January 2013.
That would be nice! Despite all this talk about an improving economy, the retailers haven't seen any signs of it.
Wal-mart CEO Bill Simon came on our air yesterday and implied the lack of wage growth is the main problem. He's likely right; though, WMT is apparently having trouble fending off the likes of Family Dollar (FDO), which has been aggressively cutting prices. Wal-Mart has been out-Wal-Marted!
Which brings me to The Container Store (TCS), down 10 percent today to a new low on volume nearly 10 times normal.
What happened to this darling of retail analysts? Same-store sales down 0.8 percent? Traffic DOWN 2.3 percent?
CEO Kip Tindell's now famous comment, "Consistent with so many of our fellow retailers, we are experiencing a retail 'funk'" has analysts scratching their heads.
This stock was a favorite of analysts for several reasons: 1) We all have too much stuff and TCS was going to show us how to organize it, and 2) the demographic appeal is similar to Restoration Hardware (RH), i.e. on the higher end.
Morgan Stanley's analyst, Simeon Gutman, had it right: "...the 0.8% comp decline and negative traffic are disappointing for a business with such an under-penetrated growth opportunity."
So what is going on? It's unlikely that TCS' upper-end client is in a genuine funk.
Second, there is some evidence that a slower pace of household formations is hurting sales.
Third, these container products--we're talking everything from storage boxes to full closets--aren't bought very often. They are durables, not consumables, and a lot of analysts seem to have made that mistake, assuming there would be more repeat-traffic than has actually materialized.
But the big factor is TCS is being affected by the same trend to e-commerce sales all retailers are facing: Amazon is eating into everyone's business.
One thing's for sure: The company seems to be recognizing that its future lies in the upper-end consumer. TCS is planning to unveil a new line of luxury installed closets in the fall of 2014.
One thing that bugs me: Of seven analysts who cover TCS, six have a "Hold" rating, only one has a Buy rating, and NONE have changed their ratings today, even though ALL of them lowered their full-year earnings estimates, most of them by roughly 15 percent.
This, despite the fact the stock is now at a historic low of $24 and change, after going public in November at $18 a share, and OPENING at $35.
It's been a tough week for small caps stocks (not to mention the broader market), but both that sector and financials should be watched closely.
Small caps have suffered the most in the last couple days:
Russell 2000 down 3.0 percent
S&P Midcap down 1.7 percent
S&P 500 down 1.1 percent
Utilities up 0.9 percent
I would be more worried if we have continued deterioration in some large-cap banks, including regional names:
I awoke this morning to emails alerting me to a BIG STORY. This is one of those stories that is a METAPHOR for the broader stock market, so pay attention, you morons who don't understand metaphors.
Which would be me.
The story: Crumbs Bake Shop (CRMB)--supposedly the world's largest cupcake company--closed its doors last night after being delisted from the NASDAQ on July 1. It went public with a bang in 2010, charging $4.50 a cupcake. It rapidly expanded to 65 stores, and then discovered...anyone can make a cupcake! And sell it for less than $4.50 a pop.
Read MoreCrumbs shows dangers of focusing on single product
The stock went from $14...to $0.04.
This, I am told, is a metaphor for the rest of the market. If not that, then it's a metaphor for momentum stocks.
Beware, I am told, of getting too ga-ga about businesses that can be easily disrupted.
What? My beloved Pandora (P) is kind of like...a really expensive cupcake?
I normally laugh at these kind of mindless analogies, but really, think about it.
Biotech down. Solar stocks down! Oh my god, the market is correcting!
Calm down. Biotech and solar stocks do not represent the stock market. They represent a tiny sliver of the market: Small-cap momentum stocks. And they are not even the most important part of that market.
More important are the internet/social media stocks that are again showing signs of stress. This is the second time this has happened, after a decline in March and April.
Good. Someone is finally starting to ask some reasonable questions. Like, exactly how much are we paying for this stuff?
Pandora (P) is trading for roughly 155 times forward earnings--this when the S&P is trading at roughly 15 times forward earnings. Ten times the S&P multiple!
These are small-cap names (all $4-$6 billion in market cap) that occupy far more attention than their size would dictate is reasonable.
Get the point?
We all know that much of the growth in the last year--probably half--is due to multiple expansion rather than earnings growth.
You get multiple expansion when investors believe additional value has been created in a company.
But with momentum stocks, at some point, multiples almost invariably get stupid.
And investors start to question whether they are getting this right. And that's what's happening now with a lot of the internet/social media names.
Good for them! Good for all the people who are saying, "Pandora at 155 times forward earnings? Really? Is there some way we can continue to justify this?" Maybe. Maybe not.
That's what they should be asking!
This is why I hate momentum stocks: Because most of the trading is done by guys who don't give a rat's butt about multiples, or multiple expansion...they only follow trends. And if they can make money on a stock that moves a lot, particularly in one direction, well that's what we're here for!
Until one guy in a hundred says, uh, Pandora at 155 times earnings? Really, fellas?
Then the other 99 get that deer-in-the-headlight look. Uh-oh. Are we doing something stupid?
Momentum stocks have unique problems. These stocks have a large percentage of their float held by "weak hands," traders who will cut bait and run at the first sign of trouble.
The Facebook lovers will scream at me and say, "Pisani, you idiot, we are not buying Facebook on a one-year forward multiple! We are much smarter than that! We are buying it on earnings of 2017, and even 2019!"
"Really? You believe you know what Facebook's earnings will be three years from now?"
"Yes! We have estimates! They are, uh, right here, on our Excel spreadsheet..."
Whenever I hear this, I am astonished. Because I have been a financial reporter for 24 years, and I am at least humble enough to admit I am not very certain about what will be happening in the next QUARTER, let alone what will be happening in 2017 or 2019.
No matter. There are, obviously, far more intelligent people than I who are willing to throw a lot of money at...a spreadsheet from the future. A miraculous piece of paper from 2017.
Good for them. That's what makes a market.
As for the rest of the market, we have seen a MODEST move up in earnings from a year ago and a MODEST multiple expansion. I will worry about the broader market when names and sectors that do not have stupid multiples begin to break down on heavier volume.
Until then, pass the cupcake.
The second quarter earnings season starts today, with Alcoa checking in after the close. According to S&P Capital IQ, we are expecting an improvement in Q2 earnings for S&P 500 components over the first quarter:
Q1: 3.4 percent
Q2 (est).: 6.6 percent
Q3 (est): 8.8 percent
The Q2 projection is a pretty hefty number. It's typical for the final number to beat by two or three percentage points, so it's possible we could see earnings growth of 8 percent or more.
The lack of volume in this market might make it hard for the rally to continue, says veteran trader Art Cashin.
The mid-term election will be a disappointment—but that's a good thing for Wall Street, says hedge-fund manager Todd Schoenberger.
Charles Schwab has lost a case against Morgan Stanley, accusing it of improperly recruiting brokers from a Schwab San Francisco branch.