Market Insider

The Fed and Alibaba Effect

Alibaba Effect hangs over stocks
Alibaba Effect hangs over stocks

The Fed meeting and Alibaba's upcoming initial public offering (IPO) are hanging over the market this week and both could influence stocks again Tuesday.

Stocks have traded nervously before the outcome of the Fed's two-day meeting, which starts Tuesday. Traders are awaiting Wednesday's statement, which some Fed watchers believe could signal a more hawkish tone.

The Alibaba IPO, meanwhile, got even bigger Monday when underwriters raised the price range after signs of strong demand. The Chinese e-commerce giant is now expected to price its IPO in the range of $66 to $68 per share, valuing the offering at as much as $21.8 billion.

Traders on the floor of the New York Stock Exchange.
Brendan McDermid | Reuters

On the calendar Tuesday, producer price index inflation data is expected at 8:30 a.m. ET, and Treasury international capital flows data are scheduled for 9 a.m.

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Stocks sent a mixed message Monday, with momentum names getting crushed, but the Dow rose 43 points at 17,031 and the S&P was off just 1 point at 1984. Both the Nasdaq and Russell 2000 fell more than 1 percent. The worst performing S&P big cap sector was technology, followed by consumer discretionary and health care.

Among internet names, Facebook slumped 3.7 percent, Linked In slid more than 7.6 percent, and Pandora fell more than 4 percent. The U.S. e-commerce giant Amazon was down 2.2 percent. Biotech stocks also traded lower, with the iShares Nasdaq Biotechnology ETF (IBB) off more than 1.2 percent. China ETFs and China shares were also hit, but traders said weak Chinese economic data was also a factor.

"Anyone that wants to make room for Alibaba in their prospective fund would sell some of the high momentum names," said Michael O'Rourke, chief market strategist at JonesTrading. O'Rourke said a Wall Street Journal interview with Benchmark partner Bill Gurley also spooked the sector. Gurley has invested in Uber, Zillow and other web startups, and he said that Silicon Valley and the venture capital community are taking on an excessive amount of risk now, at levels unprecedented since the tech bubble era in 1999. "That gave the market two good reasons to sell."

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The types of stocks that got slammed were the same group that the Fed called out in its Monetary Policy report in July. At the time, it said: "Equity valuation of smaller firms as well as social media and biotechnology firms appear to be stretched."

O'Rourke said JonesTrading created an index of those momentum and small cap stocks highlighted by the Fed. That index fell sharply Monday. Critics who say the Fed has provided too much liquidity to markets point to the same hot areas of the stock market

"It's totally a divergence right now," said O'Rourke. "It's good to see people discriminate between different equities."

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There has been speculation underwriters would increase size of the Alibaba offer, the biggest ever, but they just raised the price instead. The IPO prices Thursday.

"People are pruning their portfolio ahead of Alibaba to get rid of over weights in competitors to raise money for Alibaba," said Art Cashin, director of floor operations at UBS. "The usual cat and mouse game is bigger than normal."

O'Rourke said the Fed could be a factor for stocks as it meets, and he said investors are also watching the situation in Scotland, where voters go to the polls Thursday to vote on independence from the United Kingdom.

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The Fed is expected by some Fed watchers to drop the language that says it will keep rates low for a "considerable period," which traders see as a sign the clock is ticking on rate hikes, expected next year. "It's enough to keep the markets on pause (Tuesday)," said Mark Luschini, chief market strategist at Janney Montgomery. "It'll be hanging over it again…the markets seem to have reacted poorly in anticipation, perhaps this dropping of the 'considerable period' jargon."

—By CNBC's Patti Domm