Stock of the week : Trading the surge in Omicron
Anyone looking for a Santa rally at the start of December was sorely disappointed, as volatility surged, and stocks whipsawed higher and lower with a particularly sharp sell-off in the tech sector. The drivers were a hawkish Fed who appear ready and waiting to taper asset purchases, disappointing US Non-Farm payrolls, which came in at 210,000, far below the 581,000 predicted by economists, and growing fears about the Omicron Covid variant after the first cases were detected in the US. Interestingly, the worst performing stocks in the US last week were some of the names that one may have thought would weather the latest news about Omicron the best. Below we take a look at the stocks that we believe could have further to go on the downside, and some names that could rebound now that investors have had the weekend to gather their thoughts.
What’s up with the tech sector?
In the last two years we have seen a pattern emerge: when US yields fall, when payrolls come in weaker than expected, and when Covid fears are escalated, the tech sector tends to do well. However, investors reacted in two unusual ways at the end of last week. Firstly, they mostly concentrated on the unemployment rate in the US, which fell to its lowest level since the pandemic began. Thus, even though the NFP number was disappointing, this labour market report was not weak, and opens the door to Fed tapering down the line. Secondly, investors are having to balance the prospect of a more hawkish Fed with the potential for the Omicron Covid variant to derail the US economic recovery. However, even though Omicron has now been detected in 15 US states and cases are likely to rise in the coming weeks, some of the smaller tech stocks that fared well in prior Covid waves fell sharply last week, including DoorDash, PayPal, and cloud provider Salesforce. For example, DoorDash slipped more than 5% at the end of last week. This suggests to us that even though Omicron is spreading around the world at a rapid clip, the market continues to believe that there won’t be mass economic lockdowns, and the US economic recovery won’t be derailed by Omicron. Instead, the price action suggests to us that the Fed is a bigger concern right now and the prospect of higher interest rates in the short term (the two-year Treasury yield rose last week by 9 basis points and closed the week at 0.6%), is causing investors to fear higher discount rates that may lower some tech stocks’ valuations in the medium term.
November inflation report missing piece of puzzle for the Fed
This is important to note. In the short term we remain in an environment where little is known about Omicron and the market is reacting to the latest headline-driven news. So far, the latest data from South Africa suggests that Omicron can spread rapidly but it is less deadly than Delta. This is why the November CPI data from the US, which is scheduled for release on Friday, could be more important for smaller tech names in the medium term. The November CPI data could be an immediate influence on the path of future Fed action, and it may be used as justification for the Fed to start tapering its QE programme at a faster pace than they originally intended. The market is expecting a 0.7% rise in CPI last month, which may push up the annual rate which was 6.2% in October. One of the chief contributors to higher prices has been energy, and although gas prices fell over the month of November, they were still higher than gas prices in October. Thus, if we get an inflation reading above 6.2% on Friday, it may leave the Fed no choice but to formally announce a pivot to a more hawkish position when it meets later this month.
In this environment there are two stocks we think could recover this week, even if US inflation is strong, and there are two stocks that we think could continue to come under downward pressure.
Recovery play:
Disney: This stock has been under pressure since it released its Q3 trading update in November. Its stock price has fallen from $176 to $146 at the time of writing. The stock also came under some pressure last week as streaming services were sold off. It is worth noting that Disney outperformed Netflix last week, thus while there may be some future turbulence for this stock, we believe that we are closer to the bottom than we have been in the past month. Added to this, when inflation is high, investors crave dividends, and Disney has a decent semi-annual dividend of $0.84 per share. Thus, if inflation surges in November, Disney could come back into fashion. We also think that Disney has the expertise and the staying power to weather this storm, and with the latest season of global sensation Mandalorian coming back on Disney + in January, the tide could be turning for Disney.
Apple: In an environment where interest rates are expected to rise and inflation is surging across the globe, the big players in the Nasdaq are likely to outperform some of their smaller peers. Apple is one of the world’s largest companies. It is cash rich and has global reach. In a sign of its resilience, news last week that demand for its iPhone 13 had slowed did not dent its share price. In these highly uncertain times, a blue chip with an amazing track record of generating revenue, with low debt and a huge cash surplus is a big attraction for investors. Likewise, Apple’s quarterly dividend of $0.22 per share may also sustain demand for Apple stock if we see inflation remain persistently high in 2022. Apple’s share price fell 1.17% at the end of last week, which could be a good entry point for new investors that would like to own Apple as we move towards the end of the year.
Stocks that may struggle this week:
Tesla: This stock could face more punishment in the near term because its valuation had been growing out of control in recent years. Tesla sunk more than 6% on Friday, as it was considered one of the more vulnerable stocks from a hawkish Fed. We believe that this stock may struggle this week for two reasons: 1, the technical picture points to more losses. A key support level comes in at $976, the 38.2% Fibonacci retracement from the May low to November high. If the sell-off continues, then this level could act as decent support and may trigger some buying interest. Added to this, Tesla has never paid dividends on common stock, which makes the stock less desirable in an inflationary environment.
Zoom: Not even a new Covid variant can save Zoom, and the technical picture also leaves us cold for this stock. It’s share price sunk to its lowest level since May 2020 last week, momentum remains defiantly to the downside, and this month its stock price has sliced through the 61.8% Fibonacci retracement level from the early 2020 low to the stock’s peak in October 2020 at $252. The sell-off didn’t slow down even after breaching this level and Zoom is currently trading around the $183 mark. Thus, with a technical picture this weak, it’s hard to see a situation where Zoom may start to recover in the short term.
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