April 13th, 2023

Volatility Changing Of The Guard

We’ve been following the inflation story for months now and yesterday’s Consumer Price Index report came in slightly better than expected.  The month-over-month number rose, but it rose at a slower rate than expected.  Same with year-over-year.  The other categories were in line with the consensus estimates.

We will start to see the market shift from a worry about inflation to a worry about a recession, and the inflation-led volatility of the last year will shift to market volatility based on declining growth from stocks.

We saw that a little yesterday when the market was mostly choppy around the various announcements. It was nice to see the day trade like any other instead of the market tanking 2% based on month-old data. See, things are improving! Inflation data is still important, but everyone is hyper-focused on growth prospects than the cost of eggs.

With this volatility changing of the guard, the analyst team at Goldman Sachs said they prefer equity derivatives such as short-dated put spreads, S&P 500 longer-dated collars, and long forward volatility strategies as a method of hedging against stock declines.

I think what this means is that we could see wider swings in the market than in recent times – certainly since the previous quarter – and stocks with low growth will get punished as money flows into stocks with positive growth potential. I’m looking at you, AI stocks.

Yes, companies with growth potential usually get the attention of investors, but I think we will see fewer stocks get more attention. Remember when I wrote that something like 90% of the S&P 500’s gains in 2023 has come from 7 stocks?

We don’t have to look further than NVIDIA (NVDA), which started 2023 around $148 and has gone nearly straight up to a high of $280 in four months. That’s an 89% return on a stock in four months, and I’m not talking about a small-cap stock either.

I guess my point is that I think you’ll need to be very selective if you’re trading directionally through the end of the year. This isn’t going to be like 2021 when you could randomly pick any stock out of a hat and end up with gains at the end of the year.

I think you’ll continue to see some areas of tech do well, but there are only so many people they can fire and so many cappuccino machines to remove before they have to get back to growing revenue rather than concentrating on reducing expenses. I’m bullish on tech but not convinced this type of move will continue through the end of the year.

Now, the potential growth in the market can come from the Fed if they are done raising rates after next month. I think we’re likely to see another 0.25% increase and then the Fed will announce a pause. I don’t think they are going to cut rates, but I believe they will keep rates elevated. You saw the numbers above – inflation is dropping, but rather it’s slowly gliding down. The market may be ok with the pause and still drift higher – with or without a recession.

I know everyone wants trades they can do today, but it’s more challenging since I don’t typically like to trade through earnings. So, here’s a solid company that I’m stalking.

Let me start off with years of EPS growth and sales growth. These two graphs are nearly perfect – they’ve continued to climb higher year over year, even though Covid. Yes, I wish the 2023 numbers looked better, but year-over-year stair-stepping growth is exactly what I like to see.

The stock is down from around $317 at the start of the year to $290, an 8.5% drop while the rest of the market is up.

Zoom out some and here’s the weekly chart going back into 2022. It’s trading in an upward channel with higher highs and higher lows and right now it’s at the bottom of that channel.

Now, this company has earnings coming up on 5/16, but after that, the stock tends to rise. Actually, it’s a stock that typically does ok through earnings. Even if it drops the day of earnings, it tends to recover and drift higher over the next 5 days or so, but this isn’t an earnings play.

The company is none other than Home Depot (HD). Here’s the daily chart and this is why it’s not ready yet.

It’s under the 50-day moving average (orange line) and I’d like to see it trade higher before investing any money. It has a real consolidation problem at the $300 level that it needs to clear. 

It’s hard not to like the EPS and Revenue growth charts with a little seasonality sprinkled on top. Over the last 10 years, HD has traditionally performed well after its earnings announcement and through the summer months. Its best 8-week period for the year traditionally starts just after June 27th.

While it may not be ready for a trade yet, this is certainly a company that is going into the bullpen and may be called upon soon. It first needs to clear its 50-day moving average as well as the $300 level though.

If you have any questions, comments, or anything we can help with, reach us at any time.
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Jeff Wood

Editor, Filthy Rich Dirt Poor
Coach, Options Testing Lab

Any trade or trade idea discussed is for educational purposes only.  They will not be tracked as an official trade recommendation. 


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