Stocks advanced fitfully into an oversold condition, so the recent upturn could be stymied or at least take a rest, notes Jon Markman, editor of Strategic Advantage.
In our biweekly tech report, you will learn about the crafty way Netflix (NFLX) executives have attempted to manipulate public and professional views of their financial and creative condition.
Trade on Wednesday was kind of a hot jumble. Industrial stocks ended little changed while rampant short covering in technology issues lifted the Nasdaq (IXIC) to a solid advance of 1.6%. The S&P 500 (SPX) muddled along to 3,959, a gain of 0.6%.
Bears are now in a spot of trouble. Even at the low on Wednesday, the benchmark S&P 500 never declined below its 50-day moving average at 3,920. The strength was remarkable given that one day ago the index surged 2.8%. The bears’ best hope for a reversal will come Thursday morning.
After the close Tuesday, electric car maker Tesla (TSLA) announced second-quarter earnings that beat expectations, yet gross margins slipped almost 7%, to 26.2%. The contraction is the result of ramping up new factories in Austin, Texas, and Berlin. Deflating the Tesla mystique might help bears make a compelling case that investors are still way too optimistic about growth stocks.
Note that even with the gains from the low on Thursday at 3,817, the S&P 500 remains mired in a larger bearish trend. Bears should pounce on any rally to resistance at 4,017, the July ninth gap.
Current support is 3,920, then 3,867 on a closing basis. The latter level represents the 50-day average.
SA TradeView: No positions. We should have more clarity today. I might advise intraday.
The Backstory
The Dow Jones (DJI) rose 0.2% to 31,874.84 and the tech-heavy Nasdaq Composite was up 1.6% at 11,897.65.
Most sectors ended in the green, barring utilities, health, consumer staples, and real estate.
Breadth favored advancers two-one, and there were 38 new highs vs 74 new lows. The new high leaders were West Fraser Timber Co (WFG), Booz Allen Hamilton (BAH), Agree Realty (ADC), Lantheus (LNTH), and Mueller Industries (MLI). This is a weird and small group, showing a transition is taking place.
West Texas Intermediate futures were down 1.9% to $102.26 a barrel. The US ten-year yield was almost unchanged at 3.034%.
In macroeconomic news, a 5.4% drop in June's existing home sales was the highlight of the day's data schedule. Home resales fell month-on-month to a 5.12 million seasonally adjusted annual rate, down 14% year-over-year. "Falling housing affordability continues to take a toll on potential home buyers," said NAR Chief Economist Lawrence Yun.
The Mortgage Bankers Association reported a 6.3% drop in mortgage applications in the week ended July 15 after a 1.7% decline in the previous week. Crude oil inventories fell by 5.4 million barrels in the week ended July 15.
In company news, Netflix (NFLX) expects to increase its paying subscriber base in the third quarter as it progresses with plans for paid sharing of account passwords and advertising after saying late Tuesday that it lost fewer members than anticipated in the three months through June. Shares were up 7.4%. Baker Hughes (BKR) shares slumped 8.3%, one of the worst performers on the S&P 500, after the company's second-quarter results missed Wall Street estimates.
Shares of Biogen (BIIB) dropped 5.8%, one of the steepest decliners on the Nasdaq after the company reported a drop in Q2 sales and earnings.
Now let’s check out the remarkable way Netflix has manipulated opinions about its business.
How Netflix Just Planned Its Death—and Recovery
The secret to effective management is to under-promise, yet over-deliver.
Executives at Netflix on Tuesday delivered terrific second quarter financial results, considering the bar had been set so low. And shares promptly scooted smartly higher.
The shares of other companies may not get the same Q2 earnings love. Let me explain.
Netflix gets a lot of hate. From a fundamental perspective, shares have always been expensive. Even now, with 220 million paid monthly subscribers, execs say the company will only generate about $1 billion in free cash flow in 2023. And this metric has been way worse through the years.
The problem is spending.
Long before the Los Gatos, Calif.-company made the innovative jump in 2007 to a streaming distribution model, executives spent lavishly to build out the infrastructure of the business. The first big spend was software, specifically compression algorithms and recommendation engines. Then came the mountains of cash used to conjure up a content library. According to a report in the Hollywood Reporter, Netflix plans to spend $20 billion on media in 2023 alone, making it by far the biggest studio in the world.
While spending served the company well through most of its history, in 2021 headwinds began to develop. Subscription growth was slowing as the global economy emerged from the covid-19 lockdowns. That’s when Ted Sarandos, chief executive officer, decided to torpedo future expectations. It was an opportunity to begin telling a new story about the company.
It was a giant reset.
Following the Netflix Q1 results Sarandos said the streaming company might lose two million subscribers in Q2. He also shocked analysts with plans to revisit previous decisions that categorically ruled out advertising and password-sharing.
Jump forward to Tuesday evening. With investors expecting the worst, Sarandos said Netflix lost only 970,000 subscribers, and earnings swelled to $3.20 per share, versus guidance of $2.98. Shares jumped 7.5% higher in after-hours trade.
There is a lot to like about Netflix. Advertising should grow subscribers significantly, especially in emerging markets where customers would rather watch commercials than pay a monthly subscription fee. And cutting back on password-sharing should help with subscriptions, too.
News leaked ahead of the Q2 results that Netflix was clamping down on sharing in several Latin American markets.
Bullish investors often use Netflix as a technology company proxy. The streaming media giant reports results near the beginning of the earnings season. It is also big business with a household name. The combination makes it tempting to wager that so goes Netflix, and so goes the rest of tech. That is dangerous. Netflix executives had their reset moment last quarter. Serranos saw a big opportunity to slash expectations and he took it. Shares fell precipitously. There is reason to believe that moment for the rest of tech is coming this quarter, and it may not be pretty.
Investors should be quite careful chasing recent gains. Specifically, I would be wary of many smaller Software-as-a-Service companies. Some of these stocks are 50%-70% off their highs. Nobody wants to admit it, yet share price weakness makes it more difficult for smaller companies to raise capital, retain employees, and most importantly, win new business from larger companies.
Chief information officers in the Fortune 100 are wary of hitching their business to smaller firms that may fail or get bought out in the future.
The bottom line is while Netflix shares may ultimately rally much higher from current levels, investors should be careful about ascribing its brighter prospects to the rest of tech.
The part when executives under promise might be straight ahead.
Strategic Advantage Portfolios
Our Digital Transformation holds list advanced by 1.51% on Wednesday.
Action: We added Netflix shares back into our Digital Transformation list at the opening price Wednesday, $208.17.
Our DT List: Click here to view.
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