Inflation: The Fed’s Guiding Light and the Biggest Worry for Investors

While indexes did manage to make small gains yesterday, they remain in negative territory for the year. The “buy-the-dip” trading mentality that helped indexes swiftly rebound from downturns the past couple of years has mostly been smothered by uncertainty about Federal Reserve monetary policy in the months ahead.

In other words lots of people are freaked out and a bit nervous about how stocks might perform in a rate hiking environment.

Just keep in mind, from June 2004 to June 2006 Fed Funds went from 1.00% to 5.25%. There were a total of 17 rate increases across this period, each 25 basis points and stocks did not get hammered.

Inflation

Today, inflation seems to be the Fed’s guiding light and investors are extremely concerned that data between now and the central bank’s next meeting on March 15-16 will fail to show any signs that price pressures are easing. That’s largely due to fallout from the Omicron Covid wave that further exacerbated supply chain dislocations and labor shortages.

Those two issues have been key drivers of escalating inflation which has pushed higher nearly every month since June of 2020. The only exceptions are October, when CPI came in flat, and November when it dipped a puny -0.1%.

Data to watch

Upcoming data to watch includes the January Consumer Price Index (CPI) tomorrow, the PCE Prices Index for January on 2/25, the February Employment Situation on 3/4, and March CPI on 3/10.

Today, investors will be scrutinizing the Energy Information Administration’s Petroleum Status Report. The report last week showed an unexpected decline in U.S. crude inventories, as well as raw oil at the Cushing, Oklahoma delivery point for WTI. Cushing inventories stood just above 30 million barrels as of January 28—down from 60 million barrels at the start of 2021, and down from 37 million barrels at the end of 2021. U.S. distillate levels are particularly concerning, with inventories as of January 28 falling to the lowest seasonal level in eight years.

The low inventories, which were -26 million barrels (-17%) below the pre-pandemic five-year average, are likely the result of booming manufacturing and freight demand. The American Petroleum Institute yesterday estimated that distillate inventories declined last week by -2.2 million barrels while U.S. crude supplies likely dipped by over -2 million barrels.

Most oil insiders believe the world oil market is under-supplied with OPEC+ struggling to meet production targets and economic activity rapidly rebounding from the Omicron wave that swept the entire globe.

Analysts think that signs of easing tensions between Russia and the West could stall the current rally in oil prices but it will likely only be temporary as supply concerns escalate.

On earnings front, today’s highlights include Bunge, Cerner, CVS, Disney, GlaxoSmithKline, Honda, Mattel, MGM Resorts, Motorola, O’Reilly Automotive, Toyota, Twilio, and Uber.

A Divergence Between S&P 500 and the Stock Market Breadth May Signal a Market Top

SPX Daily Chart

Based on the comparison between the Percentage of stocks above 200-Day average and the SPX for the past 10 years, the divergence happened since Feb 2021 as the SPX continue to trend higher, the number of stocks participated in the uptrend is getting lesser, deteriorated from 90% to 42% as of last Friday since Feb 2021.

In fact, many growth stocks such as Affirm Holdings (AFRM), CrowdStrike Holdings (CRWD), Fiverr International (FVRR), MercadoLibre (MELI), Sea (SE), Twilio (TWLO), DocuSign (DOCU), Roku (ROKU), PayPal Holdings (PYPL), etc…experienced big drawdowns range from 32%-65% from their all time high.

There are only a handful of outperforming stocks like Apple (AAPL), Microsoft (MSFT), Lam Research (LRCX), Broadcom (AVGO), Qualcomm (QCOM), etc… supporting the S&P 500 index.

The divergence between the SPX and the stock market breadth are certainly not a healthy sign for the bull market especially it has been persisting for nearly 10 months. It might only take a few early capitulations from the funds to trigger a broad market sell-off when the market is at the vulnerable point.

It can be noticed from the chart that 50% level is a support. When the percentage of stocks above 200-Day average dropped below 50%, there was a relatively sharp sell-off in SPX, as highlighted in orange color in 2011, 2014, 2015 and 2018. The market breadth is often acted as a leading indicator before the damage hits the SPX.

Current Market Outlook on S&P 500

S&P 500 did have a rally after an oversold condition at the support area while there was presence of demand as pointed in last week’s article. Detailed analysis can be found by watching the price volume analysis for the market outlook on YouTube.

As shown in the screenshot on 8 Dec from my private Telegram Group for Mastering Price Action Trading course above, the four US major indices – S&P 500 (SPX), Dow Jones (DJI), Nasdaq (IXIC) and Russell 2000 (RUT) are likely in a consolidation with high volatility to both sides.

It is obvious that there was an increase of supply on the down wave since Black Friday selloff, which is yet to be tested. As S&P 500 approaches the resistance zone at 4700, it could be vulnerable for a correction when the sellers step in to lock in profit or initiate short positions. Should a correction happen, the previous swing low near 4500 is a natural area for buyers to step in for bargain hunting.

It is critical to judge the supply level together with the characteristics of the price action (spread and velocity) to anticipate next move. For a bearish scenario, watch out for a Wyckoff up thrust (false breakout) with increasing supply followed by a break below 4650. For bullish case, S&P 500 needs to commit above the resistance level at 4720.

Based on the market breadth and the Wyckoff phase analysis on SPX, a trading range between 4500-4700 is expected. There could be other headwind ahead such as Fed’s tapering of the bond-buying program and an urgency for interest rate hike, which I will be discussing in my weekly live session on Sunday. Click here to visit TradePrecise.com to get your weekly market insights straight to your inbox for free.

Twilio Shares Surge on News of Segment Acquisition; Target Price $375 in Best Case

Twilio Inc, a cloud-based communications platform-as-a-service company, said it would acquire the market-leading customer data platform Segment for about $3.2 billion in an all-stock deal, sending its shares up over 9% in pre-market trading on Monday.

The transaction will accelerate Twilio’s growth with a combined total addressable market of $79 billion, bringing Twilio one step closer to achieving the company’s vision of becoming the world’s leading customer engagement platform trusted by developers and companies globally, the cloud communications platform provider said.

“We believe the pairing could result in a game-changing opportunity for Twilio (TWLO). Segment is a leading independent Customer Data Platform and could act as a catalyst for TWLO to enter the ring with CRM and ADBE for the battle for Customer 360,” said J. Derrick Wood, equity analyst at Cowen and Company, who gave a price target of $350.

The deal is expected to close in the fourth quarter of 2020. Morgan Stanley & Co. LLC is serving as exclusive financial advisor to Twilio and Cooley LLP as legal advisor. Qatalyst Partners is serving as exclusive financial advisor to Segment and Goodwin Procter LLP as legal advisor.

Following this announcement, Twilio’s shares surged over 9% in pre-market trading on Monday, trading 2.7% higher at $321.54. The stock is up over 220% so far this year.

Twilio stock forecast

Twenty-two analysts forecast the average price in 12 months at $313.75 with a high forecast of $375.00 and a low forecast of $225.00. The average price target represents a -1.17% decrease from the last price of $317.46. From those 22, 18 analysts rated “Buy”, four rated “Hold” and none rated “Sell”, according to Tipranks.

Morgan Stanley target price is $270 with a high of $370 under a bull scenario and $200 under the worst-case scenario. The gave an “overweight” rating. Twilio had its price target increased by Argus to $330 from $310. Royal Bank of Canada boosted their price objective on Twilio to $375 from $320.

Other equity analysts also recently updated their stock outlook. Canaccord Genuity boosted their price objective on Twilio to $310 from $215.00 and gave the company a “buy” rating. Robert W. Baird lifted their target price to $340 from $315 and gave the company an “outperform” rating.

Analyst view

“A top-quality asset in our communications software framework. B2C communications has long needed an overhaul, which TWLO is able to provide. COVID-19 can act as an investment accelerant. Gating item to growing today remains how many customers have developers, which could be helped by expanding SI relationships. TWLO’s competitive moat growing. Applications product growth can improve overall margins,” said Meta A Marshall, equity analyst at Morgan Stanley.

“TWLO has seen a meaningful uptick in valuation as COVID-19 led to an acceleration in need for digital communication channels. This outweighed previous concerns over reduced travel/hospitality revenue and long-term growth profile. While enthusiasm is high for the remainder of 2020, concerns around COVID-19 activity in 2020 creating difficult comps in 2021 are weighing on investors’ minds.”

Upside and Downside Risks

Upside: 1) Management breaks out applications growth metrics, drives higher margins. 2) Major SI partner added. 3) New use cases like contact tracing, education and telehealth expand TAM meaningfully – highlighted by Morgan Stanley.

Downside: 1) COVID impact is short-lived, volume falters and investors discount reoccurring vs recurring revenue. 2) Use cases fail to expand, challenges net expansion. 3) Investors put a larger premium on margins.