Like Alibaba founder Jack Ma’s favorite movie character Forrest Gump, the Chinese e-commerce colossus has accomplished amazing feats of triumph and success that no one thought it ever could. From its humble beginnings in China some 15 years ago, Alibaba has grown into the world’s largest internet company with the largest IPO in history last Friday, valued at over $25 billion after some institutional investors exercised their option to sell additional shares.
Yet Alibaba may have inadvertently accomplished something it hadn’t intended – it may have killed the market’s bull. Perhaps not killing it outright; but certainly knocking the wind out of it.
Since the morning of Alibaba’s IPO on Friday, equity markets have been tumbling – with the Dow Jones 30 large caps losing 0.8% over the past two trading sessions, the broader market S&P 500 losing 1%, momentum stocks losing 1.55%, the tech-laden NASDAQ losing 1.75%, and the Russell 2000 small caps losing 2.75%.
What’s going on? Has Alibaba taken investors’ confidence as well as their money? Will the bull regain its footing?
Defensive Posturing
There is evidence that shows the market’s recent pullback may not be over. We find that evidence by following the money trail leading up to Alibaba’s IPO, noting where the money came from and where it went.
After a shaky July, the markets enjoyed a nice run-up in August, with all of the above mentioned indices gaining from 4.5% to 6% into Labor Day. The gains held nicely through September’s first half until the week before Alibaba’s IPO when they started to unravel – as noted in the graph below.
Source: BigCharts.com
The liquidation began on Thursday the 11th and continued through to the close of Friday the 12th, as large institutional investors needed to free up some cash to get their hands on some Alibaba shares on their debut the following week. Naturally, the stocks that would be liquidated the most would be those that had risen the most in August – such as the momentum stocks (blue) which were up 6.5% since the low of August 7th, the tech and biotech laden NASDAQ (orange) which was up 6%, and the small caps (gray) which were up 4.6%.
Yet something happened on Monday the 15th that turned everything around. By then, many institutional investors had learned how many Alibaba shares they would actually be getting – far short of what many had been anticipating. As a result, many had liquidated more money than they would need, and thus started to put the excess cash back into the market – which explains the run-up from Monday the 15th to Thursday the 18th.
But do you notice where those excess funds were put back to work? As noted in the graph above, most went into the defensive large caps, with the largest inflows enjoyed by the large and mega caps of the Russell 200 (yellow), Russell 50 (black), and Dow Jones 30 (green). Those that received the least portion of the returning cash were the momentums (blue), the NASDAQ (orange), and the small caps (gray).
This was a signal that the market was turning decidedly defensive. The smart money knew that Alibaba’s IPO would mark something of a climax, leaving the markets exhausted after the event.
But we can’t simply blame the recent downturn on Alibaba alone. Sure, $25 billion is the largest IPO in history, which took a lot of cash out of other stocks. But with total U.S. equity capitalization at over $20 trillion, Alibaba sucked out little more than one tenth of one percent.
Clearly, then, there had to have been other culprits behind the recent downturn.
Alibaba’s Accomplices
At least three other events have coincided with Alibaba’s IPO to turn market sentiment pessimistic: poor economic reports, triple witching week, and end-of-quarter rebalancing.
On Monday the 15th, industrial production and factory utilization in the U.S. came in below estimates and below their prior month’s readings – the former shrinking by 0.1% where the expectation was for an expansion of 0.3%; the latter falling to 78.8% where 79.2% was expected.
On Thursday the 18th, new housing starts fell to 956,000, down sharply from the expected 1.03 million and from the prior month’s 1.12 million. Yesterday came more bad news for housing, this time for existing home sales which fell to 5.05 million, down from the expected 5.2 million and from the prior month’s 5.14 million.
The forward looking leading indicator published by the New York research firm Conference Board on Friday’s added to the pessimism with a reading of 0.2%, down from the prior month’s 1.1%, a portent of poor economic growth heading into the end of the year.
“The leading indicators point to an economy that is continuing to gain traction, but most likely won’t repeat its stellar second quarter performance in the second half,” announced Ken Goldstein, a Conference Board economist.
Other poor economic reports out of China and Europe added to the expectation of slower growth ahead as the demand for U.S. commodities and products slows, which triggered Friday’s and yesterday’s sharp sell-offs in important industrial commodities including oil, iron and copper.
In the midst of all these downbeat economic reports came Friday’s triple witching expiration of major options and futures which led to more profit taking and rolling of positions. As I explained in Friday’s triple witching article, the week following a triple witching event is historically fraught with losses. It’s not only the last week of the month, but of the quarter as well, a time when funds and institutions rebalance key portfolios, locking-in gains through sales which puts downward pressure on stocks.
Yet while the selling pressure is most likely not over just yet, there are some positive events on the horizon that should make this recent pullback a fantastic buying opportunity.
The Road Ahead
Once we get through this final week of the quarter, October should mark the start of another leg up in U.S. equities for at least three reasons, all of which are political or government related.
First up is the mid-term elections this November, which historically give the markets a shot in the arm. In many cases the mid-terms reshuffle some of the seats in government office – kind of like opening a window to let in some fresh air, reinvigorating investors and economists with optimism that things “might” change.
Then in January we have the start of the third year of the presidential cycle, which historically is the strongest of the four years. According to the Stock Trader’s Almanac, since 1833 the Dow Jones Industrial Average has gained an average of 10.4% in the third year of a presidential cycle.
In turn, this is followed by the second strongest year of the presidential cycle, which has averaged gains of 5.8%. Hence, we may have two full years of strong growth prospects ahead.
But this optimism is not based just on statistics, but on actual government policy – the continuing dovish stance of the Federal Reserve, which is still staunchly adhering to its low interest rate strategy. The magic phrase everyone was looking for after the recent FOMC meeting last Wednesday – “for a considerable time” – was retained, indicating the central bank is determined to keep rates low until the economic data show prolonged signs of recovery, not just sporadic ones.
The central bank may yet become even more dovish still, as it will soon lose its most hawkish member – Federal Reserve Bank of Philadelphia president Charles Plosser, who will be vacating his post in March, a year before his term expires. Plosser has been a long-time dissenter of the Fed’s low interest rate policy, and his absence may have removed the largest hawkish voice in the central bank, promoting an even more dovish atmosphere than before.
So while the immediate term of the next few days and perhaps week or two will bring a measure of madness and mayhem in equities, be prepared with some extra cash on hand to snap up some bargains. Analysts have been raising their estimates since the end of the FOMC meeting last week, with 2,100 for the S&P 500 and 18,500 for the Dow by year’s end being very attainable. The current slump may be your last chance at some really great prices for a while.
Alibaba has not killed the bull. It has only knocked the wind out of it… but just briefly.
Joseph Cafariello
