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Traders brace for wild action and historic volume ahead of Tesla’s entry into the S&P 500

Electric vehicle maker Tesla is poised to enter the S&P 500 in what will be the largest rebalancing in the history of that index.

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Traders work on the floor of the New York Stock Exchange.

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Electric vehicle maker Tesla is poised to enter the S&P 500 in what will be the largest rebalancing in the history of that index.

The new index with Tesla in it begins trading on Monday, but all the trading action happens at the close on Friday.

The trading volume will be so heavy, some are concerned it could result in fireworks at the close.

S&P estimates that approximately 129.9 million shares of Tesla will need to be purchased to add to the S&P 500. At the current market price of $655, indexers would need to buy $85.2 billion in Tesla stock at the close on Friday. However, there are billions more that will need to be bought by “closet indexers” that do not officially pay S&P, but nonetheless track the index. No one knows how much these “closet indexers” will buy, but it could be 50%-100% above the “official” $85.2 billion estimate.

Even at the lower estimate, that means that more than $85 billion in the rest of the S&P 500 will need to be sold. This will be by far the largest rebalancing in the history of the S&P. The prior record of $50.8 billion was in September of 2018.

“This will be one of the largest trading days in a long time,” Harry Whitton from market maker Old Mission told me, noting that the large dollar amount involved could make it the largest trading day in history.

How Tesla will change the S&P 500

The sheer size of Tesla will have a significant impact on the S&P 500, which is weighted by the free-float market capitalization of each company.

Here’s how Tesla will change the S&P 500:

  • Ranking: 7th largest
  • Weighting: 1.52%
  • 2021 P/E ratio: from a (pricey) 22.3 to a (even pricier) 22.6

Source: S&P Dow Jones Indices

Like all mega-cap stocks, it will not take much of a move in Tesla’s price to move the S&P 500: For every $11.11 dollars Tesla moves, the S&P 500 will move 1 point.

Index rebalancings: big affairs now

Index rebalancing has become important because so much money is now tied to these indexes through “passive” investing, which merely seeks to mimic the behavior of the indexes.

Rebalancings usually involve changes in the weighting of the companies listed in the indexes, but it can also involve additions or deletions to the indexes, which is the case with Tesla. Mutual funds, ETFs, and others who seek to mimic the behavior of the index must then buy or sell the stocks in proportion to their weightings in the indexes.

What could go wrong?

The addition of Tesla into the S&P would itself be an enormous trading event, but it is also happening when the S&P itself is rebalancing all of the existing constituents.

It’s also occurring on what is known as a quadruple witching, the quarterly expiration of index futures and options, and individual stock futures and options.

“Two unprecedented phenomena will be converging,” Steve Sosnick, chief options strategist at Interactive Brokers, wrote in a recent note. “The index has never added such an immensely large stock at the same time that options volumes and open interest are at record highs.”

Sosnick is concerned that the combination of the Tesla addition, the quadruple witching, and the rebalancing in the rest of the S&P 500 could result in very high imbalances in demand for stock that could cause price dislocations. “There is a potential for massive market on close imbalances because this is the biggest stock entry ever. There is an awful lot of money that will be sloshing around at that time,” he said.

“Because this is such an event, we could be in for a much more volatile market on close than people are used to, particularly with so many retail traders involved in stock options that could swing in or out of the money,” Sosnick added.

Others are concerned that the sheer volume of trading could cause glitches, especially since most of it will be concentrated in the few minutes toward the close.

Nasdaq, which is the exchange where Tesla is listed, recently put out a statement saying it was ready: “As Nasdaq and the securities industry prepare for the upcoming quadruple witching and S&P 500 rebalance, Nasdaq is highly confident that its systems will provide the reliability and capacity required to ensure a smooth, successful rebalance.”

S&P 500 owners: buying Tesla high

The addition of Tesla to the S&P highlights a major problem for passive investors: They often buy stocks at high prices, and in the case of Tesla, which is up 600% this year, at stupendously high prices.

Indexers often claim that the addition or deletion of stocks to indexes do not change prices. While prices do not usually change drastically between the price at 3:59 PM on the day of an addition or deletion and the 4:00 PM final price, prices can and do change significantly in the run-up to index changes.

On November 16, S&P Dow Jones Indices announced that Tesla would join the S&P 500 Index on December 21. However, the stock had been running up for months. Some of this was likely due to Tesla’s strong fundamentals, some due to retail traders infatuated with Tesla.

But much of the run-up was also likely due to speculation Tesla would soon be added to the S&P, as Rob Arnott, Vitali Kalesnik and Lillian Wu from Research Affiliates noted in a recent report:

“From the beginning of 2020 to the announcement date, Tesla’s share price rose 400% from $83.67 to $408.09. Most of that run-up occurred after the media began speculating in March about Tesla’s likely addition to the index. From the announcement date through December 7, Tesla’s share price rose another 49% to $608.32.”

“That decision to include Tesla in the S&P in November 16th created $200 billion in worth for Tesla shareholders,” Sosnick told me.

Tesla’s price rise is exceptional, but Arnott and his associates found that stocks do indeed rise going into the S&P and fall when coming out. In a 2018 study of stocks that had gone into and out of the S&P 500 from 1987 to 2017, Arnott found that the average mega cap stock (ranking in the top 100 or higher by market capitalization) outperformed the S&P 500 by 127% in the 12 months prior to the close of the rebalancing day. The average deletion loses 31% over the same time span.

Tesla: what happens next?

Not surprisingly, the pattern reverses after the addition and deletion: The added stocks tend to underperform, the deleted stocks tend to outperform. Arnott found that the average addition rises an additional 1% relative to the market on the day after it is added to the index, then loses about 2% relative to the market over the following year. The average deletion drops 1% more the day after its removal from the index, then beats the market by an average of 20% over the next year.

What does all this mean? “The S&P 500 is designed to buy high and sell low,” Arnott concluded.

Tesla’s size raises another point of concern: Typically, only 2 to 3 of the top 10 stocks ranked by global market-cap remain in that list 10 years later.

Arnott concluded that the weight of history is working against a similar massive rise in Tesla’s stock in 2021: “Given all the classical signs of a bubble in Tesla’s stock, and the evidence of 31 years of S&P additions and deletions, December 21-22 likely marks the beginning of a reversal in Tesla’s share price.”

Source: https://www.cnbc.com/2020/12/18/traders-brace-for-wild-action-and-historic-volume-ahead-of-teslas-entry-into-the-sp-500.html

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Explaining the volatile stock and bond market moves this week following the Fed’s update

The Fed unleashed a huge repositioning in markets, as investor reacted to a world where the central bank no longer guarantees its policies will remain easy.

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The Federal Reserve unleashed a huge repositioning in global financial markets, as investors reacted to a world where the U.S. central bank is no longer guaranteeing its policies will be dovish — or easy.

The dollar surged the most in a year over a two-day period against a basket of currencies.

Stocks were mixed around the world on Thursday, as were bond markets. Many commodities sold off. The Nasdaq Composite was higher, while the S&P 500 and Dow Jones Industrial Average slid. Tech gained, and cyclical stocks fell.

The central bank delivered a strong message Wednesday when Fed Chairman Jerome Powell said officials have discussed tapering bond buying and would at some point decide to begin the process of slowing the purchases. At the same time, Fed officials added two rate hikes to their 2023 forecast, where there were none before.

“It’s the end of peak dovishness,” Bleakley Global Advisors chief investment officer Peter Boockvar said. “It’s not going hawkish. It’s just we’re past peak dovishness. This market response is as if they were already tapering.”

Not an immediate shock, but volatility ahead

Strategists say the Fed’s slight step toward tightening policy didn’t shock markets Wednesday, but it will likely make them volatile going forward. The Fed, in essence, is acknowledging the door is now open to future rate hikes.

It is expected to make a fuller declaration about the bond program later this year, and then within several months start the slow process of bringing $120 billion a month in purchases down to zero.

The yields of shorter-duration Treasurys, like the 2-year note, rose. Longer duration yields, such as the benchmark 10-year, fell. That so-called “flattening” is a go-to trade when interest rates rise. The logic is that longer yields fall since the economy may not do as well in the future with higher interest rates, and short-end yields rise to reflect expectations of the Fed raising rates.

U.S. longer-dated Treasurys, like the 10-year, have been lower than many strategists had expected lately. That’s in part because they are highly attractive to foreign buyers due to negative rates in other parts of the world and liquidity in the U.S. markets. The 10-year yield shot to 1.59% after the Fed news, but was back down at 1.5% Thursday afternoon. Yields move opposite price.

Commodities-related stocks, like energy names and materials shares, were down sharply Thursday afternoon. Energy was the worst-performing S&P 500 sector, falling 3.5%. Materials lost 2.2%.

“It’s a massive flattening of the yield curve. It’s an interest rate trade, and it’s the belief the Fed is going to slow growth,” Boockvar said. “So sell commodities, sell cyclicals… and in a slow growing economy people want to buy growth. It’s all happening in two days. It’s just a lot of rewinds.”

Boockvar said the curve flattening has been happening swiftly, too. For instance, the spread between the 5-year yield and 30-year bond yield quickly compressed, moving from 140 basis points to 118 basis points within two days.

“You’re watching an incredible unwind of positioning in the bond market. I don’t think people thought the Fed would do it,” BlackRock CIO of global fixed income Rick Rieder said.

“We thought the flattening trade was the right move when we saw some of the news out of the Fed. That was something we jumped on pretty quickly. I have to say we’re letting some Treasurys go into this rally,” Rieder told CNBC.

For stock investors, the shift in cyclical stocks goes against a trade that has been popular as the economy reopened. Financial stocks fell on the flatter yield curve, but REITs were slightly higher. Technology stocks rose 1.2%, and health care gained 0.8%.

“The implication is higher stock market volatility, which I think we’re going to have and going to continue to have,” BTIG head of equity and derivatives strategy Julian Emanuel said. “Yesterday changed things. This whole idea of data dependency — the market is going to trade it like crazy, particularly given the fact that the public participation remains very elevated and the stocks the public is most interested in are high multiple growth stocks that have been leading the last several weeks as the bond market remained range bound.”

Even as Powell acknowledged inflation was higher than the Fed expected, the central bank also pressed its message that inflationary pressures could be temporary. The Fed’s boosted its forecast for core inflation to 3% for this year but was at just 2.1% for next year, in its latest projections. Powell used the example of the rise and fall of lumber prices to illustrate his view that inflation will not be long lasting.

But Emanuel said it will be difficult to tell whether inflation is fleeting , and the economy’s emergence from the pandemic has been difficult to predict. “Whether it’s the Fed or paid economists on the sell side, or paid economists on the buy side, the ability to measure what’s going on in the economy is really nothing more than … educated guess work at this point because the statistics are just all over the place,” Emanuel said, adding inflation readings have all been hotter than expected.

He expects the market will trade in a range for now, with the bottom at 4,050 on the S&P 500 and the top at 4,250. The S&P 500 closed at 4,221 on Thursday, down just 1 point. The Dow was of by 0.6% at 33,823, and the Nasdaq rose by 0.9% at 14,161.

The late-July Fed meeting now looms large. That could add even more volatility as investors wait to see if the Fed will provide more details on tapering after that meeting. Many economists expect the Fed to use its annual Jackson Hole symposium in late August as a forum to lay out its plan for the bond program.

The bond purchases, or quantitative easing, were launched last year as a way to provide liquidity to markets during the economic downturn that started last year. The Fed purchases $80 billion in Treasurys and $40 billion in mortgage securities each month. Rieder expects the Fed could slow purchases by $20 billion a month once it starts the tapering. Once the Fed gets to zero, it could then consider when to raise interest rates.

The market expectations for rate hikes have moved forward, and the euro-dollar futures market now sees four rate hikes by the end of 2023, according to Marc Chandler of Bannockburn Global Forex. Prior to the Fed’s announcement Wednesday, futures showed expectations for about 2.5 rate hikes.

Strategist expect some of the Fed reaction is just temporary, and reflects investors who were too far offsides in some positions. “I’m still a commodities bull,” Boockvar said. Commodities had already begun falling ahead of the Fed announcement, after China announced plans to release metals reserves.

“The Fed needed to reign in the inflation story. They did it only very very slightly, but at least they accomplished it, and they’ve squeezed out inflation expectations and they’ve seen a pullback,” he said. “The question is can they through. To raise rates in two years or baby step tapering is not going to do it, but at least for two days they’ve succeeded in calming things down.”

The dollar index jumped 0.8% on Thursday afternoon, about the same as Wednesday’s move.

Chandler said the dollar move could also be a temporary adjustment and not part of a much bigger move. The dollar index’s gain largely reflect the dollar’s move against the euro, weaker as the European Central Bank continues to sound dovish.

“Norway signaled [Thursday] that they are going to hike rates in September and yet the dollar rallied against Norway. I think what happened yesterday set off a new wave of positioning in the currencies. … If it’s not done it’s nearly done,” he said.

The biggest component of the dollar index basket is the euro. “The correction is long in the tooth. It began in late May. That’s when the euro put in its last high,” said Chandler.

Source: https://www.cnbc.com/2021/06/18/explaining-the-volatile-stock-and-bond-market-moves-this-week-following-the-feds-update.html

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The Fed moves up its timeline for rate hikes as inflation rises

However, the central bank gave no indication as to when it will begin cutting back on its aggressive bond-buying program.

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The Federal Reserve on Wednesday considerably raised its expectations for inflation this year and brought forward the time frame on when it will next raise interest rates.

However, the central bank gave no indication as to when it will begin cutting back on its aggressive bond-buying program, though Fed Chairman Jerome Powell acknowledged that officials discussed the issue at the meeting.

“You can think of this meeting that we had as the ‘talking about talking about’ meeting,” Powell said in a phrase that recalled a statement he made a year ago that the Fed wasn’t “thinking about thinking about raising rates.”

As expected, the policymaking Federal Open Market Committee unanimously left its benchmark short-term borrowing rate anchored near zero. But officials indicated that rate hikes could come as soon as 2023, after saying in March that it saw no increases until at least 2024. The so-called dot plot of individual member expectations pointed to two hikes in 2023.

Though the Fed raised its headline inflation expectation to 3.4%, a full percentage point higher than the March projection, the post-meeting statement continued to say that inflation pressures are “transitory.” The raised expectations come amid the biggest rise in consumer prices in about 13 years.

“This is not what the market expected,” said James McCann, deputy chief economist at Aberdeen Standard Investments. “The Fed is now signaling that rates will need to rise sooner and faster, with their forecast suggesting two hikes in 2023. This change in stance jars a little with the Fed’s recent claims that the recent spike in inflation is temporary.”

Markets reacted to the Fed news, with stocks falling and government bond yields higher as investors anticipated tighter Fed policy ahead, including the likelihood that the bond purchases will slow as soon as this year.

“If you’re going to get two rate hikes in 2023, you have to start tapering fairly soon to reach that goal,” said Kathy Jones, head of fixed income at Charles Schwab. “It takes maybe 10 months to a year to taper at a moderate pace. Then you’re looking at we need to start tapering maybe later this year, and if the economy continues to run a little bit hot, rate hikes sooner rather than later.”

Even with the raised forecast for this year, the committee still sees inflation trending to its 2% goal over the long run.

“Our expectation is these high inflation readings now will abate,” Powell said at his post-meeting news conference.

Powell also cautioned about reading too much into the dot-plot, saying it is “not a great forecaster of future rate moves. “Lift-off is well into the future,” he said.

Powell did note that some of the dynamics associated with the reopening are “raising the possibility that inflation could turn out to be higher and more persistent than we anticipate.”

Powell said progress toward the Fed’s dual employment and inflation goals was happening somewhat faster than anticipated. He particularly noted the sharp rebound in growth that now has the Fed seeing GDP 7% in 2021.

“Much of this rapid growth reflect the continued bounceback in activity from depressed levels, and the factors more affected by the pandemic remain weak but have shown improvement,” he said.

Officials raised their GDP expectations for this year to 7% from 6.5% previously. The unemployment estimate remained unchanged at 4.5%.

The statement tempered some of the language of previous statements since the Covid-19 crisis. Since last year, the FOMC had said the pandemic was “causing tremendous human and economic hardship across the United States and around the world.”

Wednesday’s statement instead noted the progress vaccinations had made against the disease, noting that “indicators of economic activity and employment have strengthened. The sectors most adversely affected by the pandemic remain weak but have shown improvement.”

Investors were watching the meeting closely for statements about how Fed officials see an economy undergoing rapid expansion since the depths of the pandemic crisis in 2020.

Recent indicators show that in some respects the U.S. is expanding at the fastest rate since World War II. But that growth also has come with inflation, and the central bank has faced pressure from various sources to at least start curtailing the at least $120 billion in bond purchases it is making each month.

At his post-meeting news conference Chairman Jerome Powell noted that Fed officials “had discussions” on the progress made toward the inflation and employment goals relative to the asset purchases, and will continue do do so in the months ahead.

Markets had been looking for the possibility that the committee would address its open-market operations where it provides short-term funding for financial institutions. The so-called overnight repo operations, where banks exchange high-end collateral for reserves, have been seeing record demand lately as institutions look for any yield above the negative rates they are seeing in some markets.

The committee did raise the interest it pays on excess reserves by 5 basis points to 0.15%.

In a separate matter, the FOMC announced that it would extend dollar-swap lines with global central banks through the end of the year. The currency program is one of the last remaining Covid-era initiatives the Fed took to keep global markets flowing.

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“This is not what the market expected,” said James McCann, deputy chief economist at Aberdeen Standard Investments. “The Fed is now signaling that rates will need to rise sooner and faster, with their forecast suggesting two hikes in 2023. This change in stance jars a little with the Fed’s recent claims that the recent spike in inflation is temporary.”

Source: https://www.cnbc.com/2021/06/16/fed-holds-rates-steady-but-raises-inflation-expectations-sharply-and-makes-no-mention-of-taper.html

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Oracle guidance misses expectations, stock drops

Oracle reported better-than-expected results and showed accelerating growth compared with the immediate impact of the coronavirus last year.

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Safra Catz, co-chief executive officer of Oracle Corp.

David Paul Morris | Bloomberg | Getty Images

Oracle shares fell 5% in extended trading on Tuesday after the company offered lower quarterly revenue guidance than expected as it plans to increase capital expenditures to support cloud computing workloads. The guidance came on Oracle’s earnings call after the enterprise software maker issued better-than-expected earnings and faster revenue growth than last quarter.

Here’s how the company did:

  • Earnings: $1.54 per share, adjusted, vs. $1.31 per share as expected by analysts, according to Refinitiv.
  • Revenue: $11.23 billion, vs. $11.04 billion as expected by analysts, according to Refinitiv.

With respect to guidance, Oracle CEO Safra Catz called for 94 cents to 98 cents in adjusted earnings per share and 3% to 5% revenue growth in the fiscal first quarter. Analysts polled by Refinitiv are expecting fiscal first-quarter adjusted earnings of $1.03 per share and the equivalent of 3% revenue growth.

“We expect to roughly double our cloud capex spend in FY 2022 to nearly $4 billion,” Catz said. “We are confident that the increased return in the cloud business more than justifies this increased investment, and our margins will expand over time.”

Revenue rose 8% year over year in Oracle’s fiscal fourth quarter, which ended on May 31, according to a statement. In the prior quarter revenue grew 3%. The accelerating growth benefited from a comparison against the quarter last year when the coronavirus arrived in the U.S. and Oracle’s revenue fell some 6%.

Oracle’s top segment by revenue, cloud services and license support, generated $7.39 billion, which was up 8% and above the FactSet consensus estimate of $7.32 billion in revenue. The company said revenue from its second-generation cloud infrastructure doubled in the quarter, but it did not provide the figure in dollars.

The cloud license and on-premises license segment contributed $2.14 billion in revenue, up 9% and more than the $2.05 billion consensus.

The company’s hardware revenue, at $882 million, was exactly in line with analysts’ estimates, declining 2%.

During the quarter Oracle announced new public-cloud computing options that draw on Arm-based chips, and the U.S. Supreme Court ruled on a longstanding case between Oracle and Google, declaring that Google’s copying of Java code was fair use.

Notwithstanding the after-hours move, Oracle stock is up 26% since the start of the year, while the S&P 500 index is up 13% over the same period.

In May, Barclays analysts lowered their rating on the stock to the equivalent of hold from the equivalent of buy after the price had moved upward as investors rotated out of growth and into value. “To see further relative outperformance a growth acceleration at Oracle is needed, and we don’t have enough tangible data points for this yet,” the analysts wrote.

WATCH: The great tech tug-o-war

Here’s how the company did:

Source: https://www.cnbc.com/2021/06/15/oracle-orcl-earnings-q4-2021.html

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