Notes On A Momentum Market
[BRIEFING.COM - Gregory A. Jones] At the risk of pulling an Abelson/Biggs, there are a few things about this market that worry us. We mention these not to scare you into selling all your stocks and moving into cash, but simply to point out a few trends that deserve attention.
Disorderly Markets
For the first hour of trading Monday, trading in many tech stocks was not orderly. Market makers? Forget it -- in the initial spike higher and in the ensuing plunge, market makers were absent and price swings were exaggerated as a result. It's hard to blame the market makers, they can get destroyed by the momentum moves in many tech names these days, but it is a frightening proposition if you own a stock and want to sell.
Take the case of Emulex (EMLX) this morning. The stock closed at $112 1/2 on Friday. Between 8:00 and 9:30 am in pre-market trading, it rallied from the 116 to 169 -- a 46% pre-market rally on no news! This move was apparently inspired by a Microsoft MoneyCentral article that placed EMLX along with QCOM and BVSN on a list of monthly picks based on a mathematical trading model.
By 9:45 am, the stock was back at 120.
There were probably quite a few investors/traders who learned why market orders are not particularly wise in this market. Once the opening market orders were filled, EMLX collapsed, and its new owners were stuck with a 50 point loss at the blink of an eye.
This is the price that individual investors may pay for the momentum mania that afflicts so many stocks today. We saw it in spades yesterday with the Steve Harmon list of stocks, and many other top 10-picks-for-2000 lists from brokerage firms which drove momentum money into tech stocks. Again, there was no news; all it takes in this market is the mention of a name which can generate the critical mass of individual investors needed to double a stock price -- even of relatively large companies -- in minutes.
The important lesson here is that these momentum plays should be seen for what they are -- don't base an investment (as opposed to a trade) on a top ten list, and don't count on market makers to bail you out of a stock that has been bid up 50 points in a matter of minutes. When the momentum ends, it often ends abruptly, and your chances of getting out of a stock anywhere near the current price are nil -- your sell order might be filled 10 or even 20 points lower than the current bid.
Pre-Market Manipulation
Yet another sign of the heightened degree of momentum trading has been the tendency for daytraders to pounce on a few stocks each day that have no news, nor even any commentary to explain their sudden fame and fortune. Though we have no proof, it appears very likely that many stocks are now being manipulated in pre and post-market trading.
Two developments have facilitated this manipulation. First, the increasing number of momentum traders has created an environment in which a huge amount of cash is always prepared to pounce on a stock that is attracting heavy trading volume (preferably a sub-$5 stock). Second, the pre and post-market quotes now displayed on the CNBC ticker provide a point of focus for these traders to identify the momentum candidates.
A good recent example was the move in Oxis Intl (OXIS). The stock was trading 9/16 on Dec 22. The morning of Dec 23, a huge number of trades started passing by on the CNBC ticker at gradually escalating prices of 1, then 2. By the time it opened, huge amounts of momentum money were piling into the stock, driving the price up to an intraday high of 8 before it ultimately collapsed back to 2 17/32 at the close. Volume rose to a staggering 15.5 mln shares from prior figures in the sub-100K area. There was no news on that day nor has there been news since. The stock is now at 1 15/16 and volume is dwindling.
It is not hard to imagine a few traders getting together and agreeing to trade OXIS back and forth at increasingly higher prices, which gets the ticker and the rising price on CNBC, and attracts the momentum players. There have been many other examples of this, and it's hard to know how or when it will end. But it's certainly a trend that points to irrationality in the markets. Note that we are not criticizing those who manage to get in on these moves and make money on the way up -- making money is the name of the game. We are pointing it out because of what it says about the market.
Brokerage Firm Research
Brokerage firms and individual analysts within these firms are learning how to play the momentum game as well. The trend toward increasingly absurd price targets is one sign of this trend; the other is the increasing use of relative valuations in sell-side research.
The relative valuation game is circular logic at its best. If one or more stocks in a sector rally, then the others in the sector are cheap and must be bid up, which then makes the leaders in the group look cheap again, and so on. You can make money by catching the wave that these brokerage firm calls often create, but you should be aware that this research has a pyramid scheme mentality behind it.
Relative valuations can easily produce the disconnected stock phenomenon that we have written about frequently in recent weeks. Once a stock is only valued relative to other stocks, the price no longer has any link to the company's underlying business. That underlying business will determine future cash flow, and the discounted value of that future cash flow is what determines a company's worth. In a market correction, discounted cash flow analysis is what can help you determine where to find bargains.
But don't look to the brokerage firm analysis to bail you out in a correction -- because the analysis is all relative, the price targets and recommendations that make sense on the way up will be worthless if the tide turns. If you buy based on these price targets, don't be fooled into thinking that they provide any meaningful guide to the long term potential for the stock; they only speak to the short term momentum of the stock. (We will write more in the future about discounted cash flow analysis.)
What It All Means
So obviously we see a 50% crash coming soon, right? Wrong. The aforementioned trends are definitely worrisome, but they do not necessarily indicate that the end is nigh.
As Robert V. Green wrote on this page yesterday, another possibility is that we will see "rolling thunder" corrections in which money quickly shifts from cold to hot sectors, leaving big losers and winners in their wake, much as we saw in 1999.
But what we are trying to point out is that traders/investors who are buying into momentum stocks, whether it is an Emulex, an Oxis, or the one with the biggest price target today, must be aware of the risks. The risks are as follows:
Just as the market was disorderly on the way up, so will it be on the way down. Getting out of a momentum stock or sector when the momentum shifts can be a painful experience.
The initial momentum in the stock may have been the result of manipulation, and thus the reversal of the momentum will occur almost immediately.
When the momentum leaves a stock or a sector, the brokerage firm research that might have initiated the momentum will be meaningless, as it was based on relative valuation analysis that is of no long term value.
Parting Shot
Though the momentum mania worries us, it has also benefitted many of our B2B picks. Our top picks -- VIGN and CMRC -- have both rallied 77% since we wrote about them and ARBA and FMKT have also done well. PCOR has been a laggard due to its upcoming secondary offering, but it remains one of our longer term favorites.
Greg Jones - gjones@briefing.com |
