Say the Secret Word

Articles From: Interactive Brokers
Website: Interactive Brokers

By:

Chief Strategist

Interactive Brokers

Even though they were long before my time, I’ve always been a fan of the Marx Brothers.  After their movie career ended, Groucho became a television pioneer with his game show “You Bet Your Life.”  I never watched the show in its heyday, of course, but I saw enough re-runs to know that a key element was the “secret word”.  If a contestant said that word during part of the game or discussion, they received an extra $100 and some fanfare ensued.

At this point, you might be wondering why I’m starting today’s piece with such an odd digression.  It’s because at some level the equity market is playing its own game that utilizes secret words.  The difference is that instead of ordinary contestants speaking to a famous comedian, the secret words are uttered by the Federal Reserve Chairman in journalistic settings or by CEO’s in earnings calls or press releases. 

One week ago, we learned that “disinflation” was the market’s secret word for the FOMC.  If you recall, during the early part of Chair Powell’s press conference we saw stocks and bonds both trade lower.  The declines ended when the Chairman utilized the term “disinflation.”  He then proceeded to use some form of that word – either as a noun or the adjective “disinflationary” – a total of 11 times.  Even the thickest of minds can figure out that if something is said 11 times in a relatively short period of time, it must be meaningful.  So began a rally that lasted for the rest of the day last Wednesday and Thursday, coming to an abrupt halt and reversal after Friday’s blowout payrolls report.

“Disinflation” remained the secret word during Powell’s discussion before the Economic Club of Washington yesterday.  He said it early on in his discussion and equity prices launched accordingly.  Those who might have been hoping for a more strident tone from the Chair were originally disappointed.  His talk was with David Rubenstein, former colleague at the Carlyle Group, so it was more collegial and not at all adversarial.  Even so, the original enthusiasm wore off when comments about the need for higher rates to persist proved to be a buzz-kill.  After a brief dip back into negative territory, traders pressed their long bets and bought that dip aggressively, many utilizing aggressive short-term call options.

Yet as we note, the secret words extend to corporate managers.  One of them is “layoffs.”  We have seen several examples of stocks rising after a company announced moves to reduce headcount.  The most recent standout was Zoom (ZM), whose stock zoomed nearly 10% yesterday after disclosing plans for a 15% cut in its global workforce.  OKTA and EBAY had more modest bumps on more modest layoff announcements yesterday.  As we have seen stocks rise on layoff news, the bar gets raised.  The bigger the relative size of the cut, the bigger the bounce.

The secret word “buyback” is a perennial, and for good reason.  Buybacks reduce the supply of available shares in the marketplace, and that reduction in supply should be a net positive to a stock price.  The most obvious example was the nearly 5% bump in Chevron’s (CVX) price on January 27th.  The company reported solid earnings that day, but the positive reaction was bolstered mightily by the announcement of a $75 billion buyback.  (The buyback was so large that it led to political blowback, which caused the stock to give back most of the move on the following day.)  This morning we see Chipotle (CMG) trading 6% lower on disappointing results.  The reaction seems appropriate, but we saw a bounce in the pre-market when social media talk about the company’s $200 million buyback circulated.  The nascent rally faded when other voices reminded that $200 million was peanuts for a company with a $44 billion market capitalization.

The problem with secret word-based trading is that the phrases change.  At the FOMC press conference in July 2022, the secret word was “neutral”, something we noted on Friday.  While “layoff” is currently being evaluated as a positive for tech companies struggling to manage costs after two years of explosive growth, it is typically a negative.  Fast-growing, highly profitable companies need to be adding employees, not cutting them.  The market falls in love with certain words or phrases, and following them can be a profitable trading strategy for a while.  But the market doesn’t tell us when the secret word changes.  Groucho changed them with each show.  Traders should be prepared to do so as well.

Disclosure: Interactive Brokers

The analysis in this material is provided for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IBKR to buy, sell or hold such investments. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Interactive Brokers, its affiliates, or its employees.

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