Beware Fakeout Rallies, Like GE From Last January: Taking Stock

(Bloomberg) -- The 150+ handle bounce in the S&P 500 since Christmas has yielded sharp moves to the upside for a number of important stocks in this market, but a continuation over the next week or two should be served with a side of caution.

This last rally came during a holiday week when trading pads were half empty and at a juncture when big swings are the norm, as Mohamed El-Erian stated last week when he said 1,000-point jolts in the Dow Jones Industrial Average are the "new reality." Thus, I highly doubt that the recent upticks will sway the naysayers or remove any trepidation in this tape.

Neither will the brutal China PMI figures from last night, with the Caixin index slipping below 50 for its lowest reading since May 2017 and new orders notching their weakest level since June 2016. This result set off a sharp decline in the Shanghai Composite and an ensuing 2.5% peak-to-trough reversal in the e-minis.

But even if we quickly shake off this rough start to the new year (the futures remain lower by ~35 handles) and return to the gains of last week, I’d still argue that the damage done over the past few months remains palpable and unlikely to be forgotten for a very long time.

Beware Fakeout Rallies, Like GE From Last January: Taking Stock

For example, with just hours to go before the ball dropped, Citi’s Tobias Levkovich shrugged off the four-day rip and slashed his 2019 S&P 500 target to 2,850. He cited growing risks reflected by the selloff over the prior three months: "A roughly 25% jump in the index by next December now looks overly aggressive as our prior price target was set when the markets were higher."

Meanwhile, Bay Crest Partners’s Jonathan Krinsky said he won’t remove his cautious view simply because the calendar has turned -- "Despite some capitulatory breadth readings in late 2018, most trends remain bearish with plenty of overhead supply" -- he is calling for strength to be capped at the ~2,600 mark, or 93 points higher from where we ended on Monday.

A Rally With Legs

And so there’s certainly a shot that last week’s move carries over into this week or the next couple of weeks. And if it does, I’d point readers to some cringe-worthy gyrations at the beginning of 2018 that could be used as reference points if the quasi-bullish mood quickly sources back to where we were a couple of weeks ago.

Take GE. Everybody knows that the industrial conglomerate had a no-good, stomach-churning, painful and shocking year, sinking 57 percent to lows unseen in almost a decade. But that wasn’t the case at the beginning of the year.

In fact, the stock was among the leaders of the Dow in the first week and a half of 2018, a shocking result after ending the prior year at the bottom of the index. We even wrote a story on Jan. 11 titled "This Year’s Biggest Surprise Stock Mover May Be General Electric" that clearly didn’t age well -- I guess you could say we top-ticked the rip as GE hit its 2018 intraday high of $19.39 on that day only to end the year at $7.57.

Beware Fakeout Rallies, Like GE From Last January: Taking Stock

Buyer’s remorse set in shortly thereafter as the rally quickly fizzled out and shares sold off for seemingly months at a time, eventually getting the boot from the Dow. The stock spun further out of control once the rest of the market took a beating.

You know who else had a smashing start to 2018 only to get crushed to smithereens as the year wore on? Nvidia, which ran up ~15% in the first week and a half of 2018 only to end the year down more than 30%. Similar fakeouts were seen in several other big tech names and a host of energy stocks like Schlumberger, Hess and Baker Hughes.

Netflix: Possible Buyer’s Remorse?

Netflix may be the perfect momentum stock to watch in this context. It was the second-biggest gainer in the SPX in the past four sessions with a 14%+ rally, which is reminiscent of how the streaming giant performed all year prior to the market meltdown that began in October. It also ended the year as the best-performing member in the FAANG cohort.

Not surprisingly, the stock is getting clipped by ~2.5% in the pre-market with the rest of the tape, but I could see the recent rally having legs given 1) all of the hype over its original thriller "Bird Box" starring a blindfolded Sandra Bullock, which nabbed a record 45 million viewers in its first seven days, and 2) reports that the company poached Activision Blizzard CFO Stephen Neumann, who spent a large chunk of his career at Walt Disney and in private equity prior to a two-year stint at the video game company.

Beware Fakeout Rallies, Like GE From Last January: Taking Stock

But a broader reversal in the tape, especially one that tests the lows form December, is likely to hit tech and momentum stocks the most as investors continue to assess and reassess growth prospects and valuations. In the most recent downturn from October through Christmas Day, Netflix plunged more than 37% for one of the bigger single-stock selloffs in the S&P 500.

Aside from Netflix, other stocks that appear to have a lot of momentum coming into the new year include Amazon, Salesforce, Applied Materials, Chipotle, MGM Resorts, and med tech majors like Boston Scientific, Abbot Labs and Intuitive Surgical. The below graphic shows the best and worst performers in the S&P 500 over the past four sessions.

Beware Fakeout Rallies, Like GE From Last January: Taking Stock

Notes From the Sell Side

There’s a good amount of movement among the med techs today following separate 2019 preview notes: 1) Citi rebalances the group towards value, upgrading both Baxter and Zimmer to buy and downgrading Medtronic to neutral and Abbott to sell; 2) Morgan Stanley continues to favor growth, though recommends boosting exposure to value and also upgrades Baxter to an equivalent buy while downgrading both Hologic and Globus.

Speaking of 2019 outlooks, JPMorgan is cutting estimates and shifting some ratings in the life insurance sector (upgrading Torchmark and downgrading Aflac) to reflect the market selloff, though sees compelling valuations amid "very negative" investor sentiment. While various concerns, like credit trends deterioration, are valid, the analysts expect the group to be better positioned given improved capital and liquidity levels in addition to de-risked liability profiles than prior to the financial crisis.

RBC is removing its underperform rating on Wells Fargo, which has been in place for close to a year (WFC fell 24% in 2018), as shares now fully discount the company’s regulatory problems. The analysts are separately upgrading Citizens Financial to an outperform on valuation and the expectation that the company will continue to execute on its plans to improve profitability.

Tick-by-Tick Guide to Today’s Actionable Events

  • 9:45am -- Markit U.S. Manufacturing PMI
  • 10:30am -- Barrick CEO Mark Bristow on Bloomberg TV

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