Why You Shouldn’t Let this Pullback Scare You Away

The tech retreat that started last Thursday has continued this week. The tech-heavy Nasdaq opened down by more than 2.5%, while the Dow and S&P 500 started trading almost 2% in the red.

Big Media’s favorite theory for why this happened is Japan’s tech and startup conglomerate Softbank Group Corp. (SFTBY). We knew from earlier filings that the company poured about $4 billion into U.S. tech stocks in the spring.

Last week, reporting by the Financial Times and the Wall Street Journal revealed the firm had also been buying billions of dollars’ worth of call options on those same stocks, to juice their returns.

That’s a valid profit-making strategy when used in moderation. But billions of dollars flowing into the options markets sent options premiums and the VIX fear gauge up even as stocks were rising.

That’s usually a bad sign and has historically preceded pullbacks.

Of course, in its desire to find a convenient scapegoat, Big Media’s focus on Softbank is leaving out some other culprits.

The Reality Gap is that things are a lot messier than just Softbank having both created and stopped this summer’s tech rally all on its own.

Take the so-called “Robinhood traders,” for example. Named after the zero-commission stock and options trading app that made day-trading look almost like a mobile game, these traders entered the market in the spring, when the stock rally started.

Used to stocks only ever going up, they have increasingly been only buying call options rather than stock. That can give you more bang for your back. Provided you’re right about where stocks are going, of course. This had a similar effect to Softbank’s actions.

The reality is that stock markets were due for a pullback, with most indicators showing a heavily overbought and overly excited market.

Add to that the news that one of the summer’s best-performing stocks, Tesla Corp. (TSLA), did not get included into the S&P 500, and you have the makings of a continued dip. After Tesla’s last quarter showed a profit, it seems many Robinhood traders were betting heavily on the electric vehicle company getting included in the S&P 500.

Had it been included in the S&P 500, that would have forced all the many funds and portfolio managers who are bound to follow the S&P 500 to start buying Tesla stock, pushing share prices even higher.

Late last week, we officially found out that’s not going to happen, and people are now unwinding their bets. As I’m writing this, Tesla stock is down 18% today alone.

That’s dragging down markets in general, even though the firm isn’t in the S&P 500 or the Dow.

Having said that, we’re by no means heading back down to the March lows. The underlying reasons for this summer’s rally are still here. The Fed is pumping trillions into the system, while low interest rates make the stock market the only way to get any returns on your money.

With that in mind, there are some key earnings reports this week to keep an eye on. Four big retail names report, with Lululemon Athletica Inc. (LULU) starting things off today after markets close. The move to working from home has pushed the athleisure apparel maker to new highs this year, and it’s possible today’s earnings report will cause a small pullback as traders “sell the news.” Buy any dip, because the firm will continue to outperform.

American Eagle Outfitters Inc. (AEO) reports its earning tomorrow morning, followed by online pet food retailer Chewy Inc. (CHWY) and exercise equipment maker Peloton Interactive Inc. (PTON), which both report on Thursday afternoon.

Both Chewy and Peloton have had huge run ups this year, and both reports should be big sell-the-news events.

And don’t miss Kroger Co.’s (KR) report on Friday morning. As the largest U.S. grocery store chain, Kroger has benefited from the closing of restaurants and bars. The firm’s earnings will be a key indicator for how consumers are doing.

And amid this tech retreat, two tech companies reporting earnings this week are Coupa Software Inc. (COUP) and Slack Technologies Inc. (WORK).

Coupa is a business-spend management company, which is a fancy way of saying that its software helps firms decide what parts of their business can be outsourced. The stock has been struggling since last week and the earnings report will be a sell-the-news event.

Slack has been very uneven this year, and has been struggling to gain momentum for weeks. That’s going to continue, and the earnings report may even see the stock break down through resistance, especially amid this tech retreat.

Great trading, stay safe out there and God bless you,

D.R. Barton, Jr.

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