Bring on Big Tech, Thinking About Small-Caps, Cybersecurity's Surprising Winner

So, it begins. 

Today is Tuesday. They say that Tuesday's child is full of grace. Well, I don't know much about Tuesday's child, but this Tuesday (today) is the first truly busy day of quarterly earnings releases aside from the banks for this earnings season. This Tuesday, we'll react before the open to key industrials, staples, and defense contractors. Then, after the close, we'll have to dance with mega-cap tech in stereo. 

This evening we'll hear from Alphabet GOOGL and Tesla TSLA. Both of those stocks had charged higher into early July only to find sellers as a rotation out of the high-flying super-caps and into everything else, especially smaller caps, ensued.

On Monday, as we had seen late last week, that rotation cooled off a bit, as various parts of the market that had behaved in an "either, or" manner as Helene Meisler likes to say, have started to behave a little more normally. While not exactly correlated, equities in general have been moving at least in the same direction through recent sessions. 

So, as that closing bell rings in about a dozen or so hours (I write this column early), we, as traders, will have to decide if we want to game the fact that Israeli cybersecurity start-up Wiz has called off a $23 billion acquisition deal proposed by Alphabet or the expectation for decreased margins on declining sales of electric vehicles by Tesla.

One Has to Wonder...

Think, think, think, think... if (difficult to not say "the") Wiz calling off the proposed deal with Alphabet has anything to do with the mishap at CrowdStrike CRWD over the past few days. Wiz will supposedly focus on moving ahead with an IPO instead of a potential marriage into a much larger tech firm. Are CrowdStrike's customers scrambling in an effort to find new providers? Are all users scrambling in general, just to find improved cloud-based cybersecurity?

Readers know that I came into this recently defective update to CrowdStrike's Falcon platform long the shares and have been forced to trade the stock (less than masterfully) around my core position as the stock gave up roughly 28.5% over the past five trading sessions.

CrowdStrike's reputation had been damaged and that damage has been exacerbated by hackers who sought to take advantage of CrowdStrike clients by setting up malicious software disguised as patched updates from CrowdStrike itself.

Those looking for help, one might have thought, would turn to Zscaler ZS, but that stock is also down five consecutive trading days. Palo Alto Networks PANW is up the past two days, but also is lower than it was five days ago. The big beneficiary of this turmoil in the cybersecurity business appears to be an affordable stock that I have been mentioning for months. SentinelOne S is up 15.1% over the past two trading sessions.

It's SentinelOne's AI-assisted Singularity platform that has clients and potential clients excited. Last week, the firm announced that CISA, which is the Department of Homeland Security's Cybersecurity and Infrastructure Security Agency, will be using the Singularity security platform as well as Singularity Data Lake, SentinelOne's infinitely scalable data storage platform.

Should There Even Be a Rotation?

The S&P 500, market-cap weighted as it is, gained 1.08% for the day versus a 0.83% gain for the equal-weighted S&P 500. The Nasdaq Composite rose 1.58% for the Monday session, as the Russell 2000 advanced 1.66% and the S&P SmallCap 600 gained 1.49%. One can see that the unloved 493 and the smaller-caps, as they had late last week, performed in line with the "elite."

We must ask ourselves, should there even be a rotation? Sure, we all know that a rally led by smaller-caps would be better for the U.S. economy and for the majority of employers at large. We all know that a broad-based rally is more reflective of a healthier marketplace than would be a more bifurcated experience.

Honestly, though, for the second quarter, according to FactSet, we are expecting S&P 500 earnings growth of 9.7%. For the Russell 2000, we expect to see a second-quarter earnings contraction of 5.6%. That's not all, according to Jim Grant's Interest Rate Observer, for the trailing 12 months as of March 31, Russell 2000 constituents generated an operating margin of 4.7%, while in aggregate, the membership of the S&P 500 posted an operating margin with a 13% handle. Additionally, also from Jim Grant, Russell 2000 components carry aggregate net debt of 4.4 times trailing EBITDA, whereas the comparable number for the S&P 500 is 1.5 times.

Simply put, the shares of smaller-cap firms in general have not earned equal footing with their large-cap cousins, and given the state of the economy, and where interest rates are versus where they have been, cannot earn equal footing for some time unless investors are patient. Certainly, generally expected lower interest rates will help considerably as far as debt service and allocation of cash flows is concerned.

Those rates will not come in as quickly as folks hope for unless the economy truly buckles, which would not help small-cap stocks one bit. Then there is the possibility/probability for a reacceleration of consumer-level inflation late this autumn into winter. Perhaps this recent pause in outperformance for the small-caps is simply the way it should be until what had been resistance is tested as support.

Remember the cup pattern that I showed for the iShares Russell 2000 ETF IWM? I did say that the development of a handle might be required prior to proceeding higher. I have seen nothing to this point that has changed my mind.

Interesting News from the Chip World

Advanced Micro Devices AMD President Victor Peng, who had been CEO of Xilinx prior to its acquisition by AMD, will retire effective August 30. Peng has worked at AMD from 2005 through 2008 earlier in his career and had been there when AMD first started to make inroads in the CPU market, rivaling and then ultimately surpassing Intel INTC in market cap.

Senior Vice President Vamsi Boppana will take over at least some of Peng's responsibilities, including Instinct data center artificial intelligence accelerators. This is the company's fastest-growing business ever and is paramount to its efforts to mount an effective challenge to Nvidia's NVDA dominance in that field.

The Race Is On

It appears that Vice President Kamala Harris has secured more than enough pledged delegates to clinch the Democratic Party nomination for president in just the two short days since President Joe Biden announced his withdrawal from the race. The event also opened the spigots as cash poured into the Harris campaign. Much of this had been pent-up funds as donors had tried to force the president to back out of the race by turning off the flow of capital.

Is it a race now? I would think it probably is. Any who were betting on a Trump trade, probably need to slow down on that. Though former President Trump still appears to have a lead in many swing states and polls just about as well against Harris as he has against Biden, the flow of funds will almost certainly help down-ballot candidates, making it much less likely that the Republican Party takes the presidency and sweeps the legislature.

Economics (All Times Eastern)

08:55 - Redbook (Weekly): Last 4.8% y/y.

10:00 - Richmond Fed Manufacturing Index (July): Expecting -7, Last -10.

10:00 - Existing Home Sales (June): Expecting 4M, Last 4.11M SAAR.

16:30 - API Oil Inventories (Weekly): Last -4.44M.

The Fed (All Times Eastern)

Fed Blackout Period.

Today's Earnings Highlights (Consensus EPS Expectations)

Before the Open: DHR (1.57), UPS (1.99), SPOT (1.13), GM (2.68), KO (0.81), LMT (6.46), GE (0.99)

After the Close: GOOGL (1.83), TSLA (0.61), CB (5.14), TXN (1.16), V (2.42), COF (3.39)

At the time of publication, Guilfoyle was long LMT, GE, CRWD, S, AMD and NVDA equity.