Morning Bid with David Gaffen

Apple ain’t what it used to be, at least in terms of how investors see it. That is probably a decent thing for those who still believe in the growth story.

The company, which reports results after the close today, is still the most valuable in the nation by market capitalization. And yet, by a number of considered metrics, the stock falls far short of where it’s been in the past.

The stock’s price-to-earnings ratio, about 13.3, compares favorably with a 10-year median of 18.1. Similarly, its enterprise value (pretty much everything on the books plus debt) compared to earnings before interest and taxes sits at a ratio of 8.5. The median is 10.5.

The stock’s big swoon through late 2012 and early 2013 did a bit of revaluing of the shares. This has left Apple in a better position for consistent holders of the shares, as those who were in it for the momentum were flushed out when the stock struggled.

That doesn’t mean that questions don’t persist about the iPhone 6 and anything else that comes next. The popularity of its products and the replacement necessities still make it something of a perpetual cash-generating machine that should help it as it reports results.

The company is expected to earn $1.30 a share; Starmine sees $1.31 as more likely (there are six “five star analysts,” and four of them see $1.32 or better — one at $1.30 and one outlier, at $1.26 a share).

With estimates rising, though, the expectation is for Apple to do well as investors wait to hear more about iPhone – available late in the quarter but selling well – along with iPad (not as great in terms of performance) and its plans with Apple Pay, the PayPal competitor that is just getting going.

Whatever the case, Apple’s reputation as one of the big names that do a lot in the way of equity buybacks and dividends has made it a more attractive name, even if the stock price stumbles.

The company is part of Goldman Sachs’ basket of companies notable for returning cash to shareholders, with a combined buyback yield and dividend yield of about 12 percent, far surpassing risk-free Treasuries and a host of other companies, for that matter.

What that means, essentially, is that these companies (along with IBM) are so focused on funneling cash to dividends or even to buybacks that those who rely on these streams are going to continue to do so.

Goldman points out that its index of those that return cash to shareholders has outperformed the S&P 500 by about 6 percentage points since 1995 — making it advantageous for these companies to continue to pursue such strategies.

We may be seeing some sort of return to calm, at least on some levels. General Electric’s results have futures moving higher – the stock is up 3 percent in premarket action – and there’s a general sense that some of the selling has exhausted itself, at least for the time being.

After several days of rapidly careening lower, the market seemed to hit its washout moment late Wednesday, when a torrent of selling pushed the 10-year Treasury to 1.86 percent and more than 4 million S&P e-mini futures contracts changed hands.

Reuters’ Rodrigo Campos and Dan Bases point out a number of factors in a story late Thursday that suggest the selling may have reached its worst levels, and right now, several days in, it’s that moment in the Star Trek episode when the crew, in mortal danger, takes 5 minutes to put together an actual plan rather than just reacting to mayhem.

Vincent Reinhart of Morgan Stanley does a bit of a step-back in a note today pointing out that the firm’s internal monitor of when the Fed will start raising rates dipped to 12.4 months after rising as high as 12.9 months – right around the time when the fed funds futures started to price out a rate hike for all of 2015 and move it into 2016 (it has since come back to around October).

Fear can do that, and Reinhart points out rightly that the Fed doesn’t have “much tolerance for adverse shocks” – judging by comments from Jim Bullard and John Williams over the last few days where they started to float the idea of a fourth round of quantitative easing (odds on that remain pretty darn low).

But it’s important to keep in mind what volatility and a market that has a lot of similar bets can do to the overall framework.

The dollar value of long dollar bets reached more than $40 billion last week, per CFTC data. We’ll get another look at that later today to see what’s been flushed out of those bets.

There has been a big consensus on higher yields, and that certainly was given lie to after this week’s mess of a market, so much so that mortgage funds had to deal with prepayment issues and do some buying too.

Many funds were out there expecting stocks to keep rallying, and this is one of those weeks that keeps them honest.

Getting back to GE, the big conglomerate was, along with blue-chips Exxon, Boeing and a few others, a favored short position among hedge funds and has actually been partially responsible for any gains that long-short funds managed to put together in 2014 (the stock lost 15 percent on the year through Monday, so it was a pretty successful position for hedge funds).

With the turmoil, GE shares have lost 9.4 percent since mid-August, but they’ve rebounded in the last few days – modestly, about a 1 percent gain – but enough to suggest that hedge funds were at least harvesting some of their gains through the shorting of that stock in order to hang onto their bonuses.

From here, it will be interesting to see if GE can keep up this mini-run of momentum as stocks have been revalued by the market’s losses.

There’s a glut of various stresses operating in the markets right now: Europe’s inability to get out of its own way, the sharp fall in oil prices that probably says more about supply issues and lackluster demand in Asian markets than the United States, the uncertain path of the Federal Reserve and a nagging concern that weak inflation figures show the economy really isn’t healing all that much.

But make no mistake about it – Ebola is a pressure point for markets at this moment, and one only need look at the “scare” moments in markets to really see it.

The S&P 500 has given up about 8 percent from an all-time high reached about a month ago. Valuations were arguably a bit expensive, and if the Fed recedes and volatility normalizes (somewhere below where we are now on the VIX), the expectation would be that a correction of 10 percent or so wasn’t out of the norm of possibilities, or even a meandering market that lasts for more than a few months.

The labor market still appears to be improving, with jobless claims falling, seemingly, on a weekly basis, and while sentiment figures are a bit less robust, they’re also fickle when spending real dollars matters more.

All that is well and good, but doesn’t explain the mass gyrations the market has experienced in recent days, and again, Ebola fears can be tied directly to them:

* On Oct. 8, shares of Chimerix fell more than 18 percent in 40 minutes after news of the death of Thomas Eric Duncan, the first person diagnosed with Ebola in the United States. Duncan had, in the late stages of his illness, been given a drug developed by Chimerix. At the same time, shares of Tekmira Pharmaceuticals, said to be further along in developing a treatment, saw their shares soar about 13 percent.

* On Oct. 13, a massive, rapid selloff of futures contracts occurred at about 3:35 p.m. EDT (1935 GMT), with more than 100,000 S&P e-mini futures contracts trading in five minutes, a volume not matched even by the minutes just before the close of trading – and that, like, never happens. Reports of a plane held on the tarmac in Boston due to a scare related to the outbreak was cited as the catalyst for the declines. The market was already vulnerable, but this sent futures over the edge as volume exploded in little known names like Lakeland Industries, maker of hazmat protective wear, and Ibio, which saw 16 million shares traded – on that day an unprecedented level of trading for this tiny stock.

It may be a stretch to suggest there’s a “short the market and go long Ebola” trade going on, even though some options-market activity is geared around capitalizing on news of these names (most people are too genteel to admit to such a blatant strategy), but the unknown is driving investor action for sure.

* Wednesday saw similar activity in the morning, with another massive selloff in futures around 7:30 a.m. on little to no news at all, with the exception of vague rumors related to Ebola and the possible spread of the disease in Spain. The market fell through the rest of the morning, affected in part by worries about global growth and deflation after weak figures on retail sales and the producer price index, and continued to sag through the session. Once again, Ebola-related names rallied on various other fears, though.

Steve Sosnick, equity risk manager at Timber Hill/Interactive Brokers, summed it up in a comment: “The reaction struck me as very similar to the moves that we saw in the wake of the 2001 terror attacks. In those dark days, the market was hypersensitive to stories about terrorists, anthrax and a variety of societal woes and there was a climate of underlying fear that took a long time to dissipate.”

That says it well. At the moment, when there’s an unknown and a growing concern about the transmission of the disease and ominous statements about its potential spread from the World Health Organization, the effect it can have on the daily habits of people – which extends to spending and travel and all those other things that affect economies – would tend to be a trigger for risk aversion.

Ultimately, barring a zombie apocalypse, oil prices and Europe’s ineptitude will be bigger factors on a broader, longer-term basis. But that doesn’t mean people won’t stop selling the SPX and buying Tekmira at the next headline. It will keep investors on their toes for some time.

The equity market stabilized on Tuesday but only just barely – a 0.16 percent gain on the S&P 500 is nothing to write home about – but that the market bounced off support levels around 1,876 was notable enough.

One thing for sure is that the short-sellers are finally having their day in the sun after many years of walking around with a cloud over their heads, a la Joe Btfsplk from the L’il Abner comic (yeah, we’re busting out Depression-era references here), as Svea Herbst and Jenn Ablan reported in an overnight story.

One short bet the hedge funds have liked, but has yet confounded them, is Netflix, which reports results Wednesday and until recently had been resistant to any negative bets at all. That’s despite a valuation that can generously be called, er, generous, but one that Starmine sees as among its most overvalued on an intrinsic valuation perspective; it sees the stock as worth about $99 a share based on expected growth rates over the next decade, even though it has been trading around $450 or so.

Of course, a stock like this remains one based almost solely on expected growth – it has an enterprise-value-to-sales ratio of about 4, highest in the stock’s history and way ahead of its median 1.2 ratio in the last 10 years. Most of what’s being built into the stock’s valuation right now is the successful push it’s made with delivering original content like “House of Cards” and “Orange is the New Black,” both of which were big presences at this year’s Emmy Awards.

Riding that success, the company has announced several new films it will produce, including a “Crouching Tiger, Hidden Dragon” sequel and four Adam Sandler movies (okay, we can’t always account for taste).

Which, in a sense, makes Netflix a more typical media company, spending on the content which carries its own expenses but on a growing platform that’s just enough of a twist to keep the market fully invested in the story. It’s only recently the stock has started to pull back from the lofty levels it has seen all year, as part of a broader decline in the equity market, but it hasn’t been much – a $40 drop from the $489 peak that, compared to the woes of some other recent high-fliers, is relatively modest.

Short sellers have been largely washed out of this name, with Markit’s short interest data showing only about 6 percent of the shares available for short bets being used for such a purpose – that figure was at 40 percent at the beginning of 2013. It may be that the current ratios – a P/E of 73 on a forward basis – is too high, and won’t be sustained. And then the shorts will get back in and pounce on it after getting away from what’s been a losing bet for so long.

With the Fed pulling back from its monetary stimulus, plenty of weaker names will be washed out, and some overvalued ones will correct. Whether Netflix is one of those remains to be seen.

Time to sit up and pay attention. Monday’s end-of-day regurgitation of 100,000 futures contracts in a five-minute span around 3:30 p.m. (1930 GMT) would have been more nerve-wracking had we not already seen the same thing writ small, when about 30,000 contracts were dumped in the waning seconds of last week’s trading action.

In each case, the activity was striking and a bit disturbing. See, it’s never a great sign when the only thing that ends the selling on a given day is the moment when they turn the machines off (a la Randolph and Mortimer Duke), and Monday wasn’t all that much different.

The selling came for various reasons. Rumors of another Ebola-related scare on a plane in Boston came around that time, but it didn’t happen just after the S&P 500 .SPX dipped below the 200-day moving average (that came earlier in the day). So if you’re linking this to a technical “whoosh” lower after breaking through that average, maybe that’s a part of it, but not entirely – not the violent way the S&P in barely a second was down 0.98 percent on the day and then suddenly 1.08 percent.

As many, including Nanex’s Eric Hunsader point out, liquidity vanished as the market gapped lower. Lots of resting orders were suddenly being pulled by all of those programs putting them out when they might actually, y’know, have had a chance of being filled. Buyers as of yet aren’t rushing to fill those gaps. This is not a market reacting to some namby-pamby moving average, but one driven by other factors.

Once again, it’s tempting to lay out 90 million reasons for all of the losses, but suffice it to say that anything Ebola-related is serving as a real pressure point for the markets right now, with the airlines getting dumped dramatically at slightest provocation. Look how miniscule market-cap names like Lakeland and Ibio posted volumes that they couldn’t muster in the last six months of trading – and how, this morning, those stocks have suddenly taken a turn for the worse as the rest of the market rebounds (though some of this is possibly due to a statement from the World Health Organization saying the rate of new Ebola cases has been slowing).

We can talk about the worries about Europe, about Mario Draghi, James Bullard, the Fed, earnings, etc., but right now it feels like a rotation from “all things in the market” to a few guys making hazmat suits.

This can’t last, so many investors are probably ready to back into things and start buying when the coast is clear. But at a 7 percent drop, and threatening a real correction, investors are just more likely to keep dumping shares into the market. Hedge funds are a likely culprit, too. Credit Suisse data shows that at the middle of last week they were pretty sanguine when it came to how much downside protection they had, so that’s a soft spot that was exploited by the big losses that they then had to react to.

More fun to be had from here.

The focus as we head into this week is earnings, with about 10 percent of the S&P 500 set to report results. That represents about 19 percent of the market capitalization, with reports from Intel, Wells Fargo and several banks coming in the next few days.

But it’s the chipmakers that have people excited; or rather, on heightened alert after Microchip Technology surprised investors last week with a warning that suggests a further slowing in chip demand worldwide.

Intel isn’t the barometer it once was. It is more of a confirming indicator than a leading one when it comes to the chips, but it cannot be entirely discounted, either. Its results, out Tuesday, will say a lot for the tech sector that had, per Goldman Sachs data, outperformed just about all the major industry groups so far in 2014, with gains of 36 percent in the last 12 months and 21 percent since the beginning of 2014. And that’s even with the slack performance of the sector in the last month, down more than 5 percent.

Implied volatility levels are higher as well, particularly for very liquid names like Micron and Intel. What separates Microchip from some of the others, as Eric Auchard wrote last week, is that it recognizes revenue when its distributors book sales to its approximately 80,000 customers. So without that lag, when a company of this type predicts a correction, people tend to take notice.

That raises the question of what to expect from Intel and other chipmakers. David Phipps of Citigroup lays it out, saying that inventory corrections of this type tend to last two or three quarters and happen even in the midst of economic expansions. That’s likely to cause more volatility in these names, given their importance to the global growth picture.

Heading into the end of a violent week and ahead of a slew of earnings reports, the market has swung from one extreme to another, as the average daily move in the S&P 500 rises dramatically, as futures promise another big drop at the open Friday, and as investors try to take stock of what’s happening here in their beloved stock market.

The U.S. economic growth situation hasn’t changed all that much – after all, jobless claims continue to fall and the expectation again is for another strong earnings season. And, as awful as Europe is right now, there’s only so much damage its economy can do to the U.S. The extent of that should be known before long if recent German data is any guide.

Looking forward, it’s probably best to think of what’s happening as a sort of mélange, or rich tapestry, of a whole load of stuff, as Crash Davis might have put it. And some of it is fundamental in nature, some is more inside baseball, so let’s try to separate a lot of what’s going on with a combination of data and simple tricks and nonsense:

* The dollar’s volatility is creeping into the rest of the market. Currency strategists said this would happen – that when the dollar started to gyrate wildly, it was a matter of time before that occurred elsewhere. Some of that results from the fact that carry trades, which depend on low volatility, are being shifted around as markets get used to an uptick in daily moves that makes borrowing a particular asset more difficult due to the uncertain cost of carrying that.

* There is a real concern about what’s happening in corporate earnings. Yes, the overall job market is improving, and economic demand in the U.S. continues apace (not that this has really mattered much for the S&P 500 earnings or for the index’s performance either), but worries continue over earnings. Fourth quarter estimates haven’t shifted much yet – at 10.9 percent now versus 11.1 percent a week ago – but as more companies talk about the dollar’s effect on business, things could shift.

* The Federal Reserve isn’t exactly helping right now. It’s still early in Janet Yellen’s tenure, and while the markets have started to recognize her voice and get used to the signals she’s sending, it’s not entirely clear as well just how much the markets need to discount her comrades in monetary policy.

With the likes of Bill Dudley, James Bullard and others feeling a peculiar necessity to remind millions of investors the markets have things “wrong” as it relates to Fed intentions to raise rates, even though – oh, wait, we intend to go as slow as molasses in that process – well, it adds a bit of uncertainty to the mix.

Fed funds futures and eurodollar contracts show this – they’re now further away from the Fed’s expectations, thanks to Keystone Kops routine going on at the slide-rule committee. Or as the cop in Ghostbusters put it, “You do your job, pencilneck. Don’t tell me how to do mine!”

* There’s some selling going on here that isn’t quite explained by fundamentals either. Hedge funds have had it rough almost all year – trailing through the first quarter after they held on way too long to biotech names and other momentum stocks, then suffering again through the summer as broad markets performed well, to finally turn it around in September as the rest of the market suffered.

Well, October has been another frustrating one – the overall underperformance hasn’t changed on the year, with the HFR Equity Hedge index up just 0.8 percent through the end of last week, badly trailing the S&P 500. According to Credit Suisse data, widely held long positions among hedgies were both A) even more highly concentrated than last month, and B) less liquid.

That exacerbates weakness in those names when sold, and a recent list of important long positions for the hedge funds put together by Goldman Sachs shows those names were worse on Thursday (average loss of 2.8 percent) than the broad-market index (down 1.9 percent). So there may be more pain in store in that area.

Days like Wednesday are the ones that remind investors why the Federal Reserve is what it is, and how some believe the other world central banks cannot compete, even as some expect the European Central Bank and Bank of Japan (to an extent) to take up the slack the Fed will leave behind when it ends quantitative easing in the next weeks and prepares for its first interest-rate hike some time in the third quarter.

The odds on that hike, by the way, shifted late Wednesday after the Fed’s minutes showed there was concern about moving policy too quickly. It’s the pace of increases that worries the Fed, not the idea of doing it at all. The Fed is likely to push rates to about 50 basis points either in July or September (the market is betting on September now, the Fed is probably thinking July), but it’s important to keep in mind that the monetary policy committee is not going to then start doing the one-move-per-meeting thing they did in the last rate-hiking cycle back in the Pre-Cambrian Era.

Thursday will see a round robin of central banker speak: The ECB’s Mario Draghi delivers remarks on developments in Europe and global central banking and then takes part in a moderated discussion with Federal Reserve Vice Chairman Stanley Fischer, at the Brookings Institution. Separately, Bank of Japan Governor Haruhiko Kuroda spoke at the Economic Club of New York on Wednesday, and both central bankers would be forgiven for saying they’ve only got so much they can do to help everyone out here – even though Kuroda did say the BOJ has plenty of options if it wanted to ease policy further.

Draghi’s various “whatever it takes” promises just don’t carry the same weight as a big helicopter full of U.S. greenback, and Jens Nordvig of Nomura has the figures to prove it. He says in commentary that the markets are moving into the second stage of the dollar’s gains, one where markets will continue to see elevated levels of volatility because the ECB and BoJ aren’t going to be able to make up for the Fed’s largesse on the monetary front.

Overall, during its peak, the Fed was injecting about $85 billion in additional market liquidity every month, he writes, and even through the first three quarters of 2014, the average was around $36 billion. The ECB, he estimates, can shovel in about $10 billion to $20 billion through its purchases of asset-backed securities and covered bonds, and its overall injection of liquidity has been between 100-150 billion euros for the entirety of the year. So, that’s not going to replace the Fed on its low end.

The BOJ, meanwhile, can inject about $50 billion a month, but as it’s unclear about its intentions, “one could argue that we have more uncertainty about the pace of asset purchases looking just a few months ahead,” which doesn’t help people figure out where things are going.

As a result, Nordvig sees rates rising and volatility increasing. Well, rates have been pretty stubborn on that front – staying low as the dollar rallies, the price of oil dives, and expectations for inflation are reduced.

Just when the market thought it was out, it got pulled back in. The Federal Reserve will release its minutes later in the day that details what it was thinking during its most recent September policy meeting, but of late, the markets have been of a mind that the expectations for higher rates ought to be tempered a bit.

On Tuesday, New York Fed head William Dudley suggested in remarks that the chances of economic growth in the long-run coming in faster than anticipated is a fantasy that people should get shut of – and so that helped take down the market and not ironically contributed to a further decline in the five-year/five-year forward spread that serves as one of the market’s best barometers of inflation expectations.

See, after slowly working its way into the mid-2 percent range, this measure is now slipping and at about 2.3 percent represents the lowest point it has seen since mid-2013.

Couple that with the recent decline in long-dated bonds – the 30-year hit a low also not seen since mid-2013 in terms of yield – and there’s reason why a number of folks on Twitter on Tuesday were pointing out that the five year/five year rate was starting to get into the range of the spots where the Fed starts another round of quantitative monetary easing.

The bright spot would be that a look at the chart of the five-year/five-year rate of inflation expectations does at least show that inflation rate expectations are hitting higher lows than their previous low points, so there’s some anticipation for higher prices being built in over the long-run rate.

Unless of course various aspects of world economic demand are set to undo that. The United States remains a bright spot in the world economies right now, a fact highlighted by the International Monetary Fund in its big data dump that shows them cutting a big chunk off their estimates for world growth.

The U.S. is now seen as growing 2.2 percent in 2014, but the IMF dropped its estimates for the euro zone to 0.8 percent from 1.1 percent and Japan to 0.9 percent from 1.6 percent. But the growth story is only part of it. Inflation is the other, and with the sharp decline that has brought oil prices down to around $90 a barrel – thanks in part to a big supply glut brought on by the U.S. and other producers – there’s not a lot of price pressure to go around right now.

The IMF’s forecast shows this as well – a 30-plus percentage chance of the euro zone experiencing deflation in the next four quarters. The U.S. is seeing this reinforced by the rise in the dollar and drop in oil prices, which Goldman Sachs says should reduce core PCE by 0.2 percentage point over the next year.

Beware of companies tying their fortunes to one company – something both the debt and equity holders of GTAT Advanced Technologies learned painfully on Monday, when the company filed for bankruptcy. While it’s nice to look ahead at the rest of the world, the mechanics behind some of the selling is so severe that it’s worth delving into just a little bit here.

For the uninitiated, shares of this company’s stock had taken off in the last 12 months as investors grew excited over the possibility that its sapphire glass would be used in Apple applications – it even built a facility in Arizona dedicated pretty much for this. But as with everything, fine print matters, and Monday, it mattered to the tune of an unbelievable 92 percent drop in shares, the kind of thing usually seen only in stocks that trade on over-the-counter exchanges, or, well, names like Bear Stearns.

GT gave Apple an exclusive license for certain applications of its sapphire glass technology, but Apple had no obligation to buy the glass, according to the company’s regulatory filings. So that was a pretty unbalanced contract to begin with, but it’s not as if the company didn’t try to temper some expectations, with its CEO telling people in August that Apple pretty much had its own timeline (good for a 13 percent drop that day). The next straw (not the last one) was after the introduction of the Apple iPhone 6, which did not use GTAT’s sapphire glass and left GTAT at the altar – good for another drop in shares. “It would appear that something very fundamentally broke down in the relationship between Apple and GT Advanced,” Raymond James analyst Pavel Molchanov told Reuters.

Short bets had been steadily rising and people started to pay more for them, too. In February, about 24 percent of the shares were short, per Markit data; as of Friday, it was 43 percent. GTAT had a lot of short interest out there for a while, but it was a bit deceptive – a good portion of it for a long time was related to convertible arbitrageurs – those who were long in the bonds and shorting the stock to a certain extent to offset their long position.

With the stock rallying as sharply as it did, the convertible bonds – which are eligible to “convert” to equity once the stock has hit a certain price – were trading a lot more like a stock, so as the stock rallied, the bonds moved nearly as much. What’s that mean? Convertible bonds due in 2017, traded at about 150 cents on the dollar, had a conversion price of $7.70 a share. With the stock “in the money” as it was trading in the teens, the bonds could be turned into stock at any time. The 2020s were convertible at $12.11 a share, which had been in-the-money until recently. But in order to offset this position that was more or less trading like a stock, investors then short that to a certain amount of stock.

In situations like this, even a bad day for shares – say, a 10 percent drop – is profitable for convert arb types, who likely accounted for more than 50 percent of the holders of the bonds (rather than mutual funds). They show a small loss in the value of the bonds, but make up for it with the short position in the stock. Well, on days when a company goes bankrupt, all bets are off: the convert bonds dropped to about 30 cents on the dollar, and the short stock position isn’t enough to make up for those losses. (They didn’t get killed as badly as those long only the stock or bonds, though.)

That’s a bit deep in the weeds, of course. The thing is, for the convert arbs, the worries about fundamentals were probably starting to crowd them out a bit as more people started to question the stock’s move. Analysts at Markit said that the cost to borrow shares rose to about 9 percent annually of late, compared with 1.88 percent at the beginning of August, a sign more people were crowding their way into this position and as people really started to worry about the Apple relationship. “Especially in momentum names, hope is an overriding thing and hope overcame wisdom with this. I don’t know if it is the most shorted stock of all time, but there were a lot of cues that you maybe shouldn’t long this name,” investor Kim Caughey told Reuters. Bad for the glass, indeed.