The NASDAQ is in Trouble
History is suggesting a truly unprecedented move in the NASDAQ
If you’ve held large cap stocks or indices, you likely haven’t quite experienced the crash that’s been happening below the index. Nearly 2/3 of the NASDAQ composite is currently in bear market territory and only 25% of stocks are trading above their 200 day moving average. In other words, large cap tech is likely the only thing keeping the market “looking” ok. This is likely to change in the coming weeks/months.
It has become apparent, as hindsight is always 20/20, that we were and still are in an unprecedented liquidity fueled bubble caused by the Federal Reserve. When the Fed conducts QE, we are significantly more likely to see asset price inflation rather than CPI inflation (this is driven by other forces). At the rate the Fed was printing since March 2020 bottom, $120B/month, there has never been a time like it. Now the liquidity is being taken away and the markets are still pricing this in. Think of this as a vacuum being taken to money supply, because that’s exactly what is happening. When the vacuum is on, asset prices fall under pressure because buyers have less buying power. But, sellers still exist.
It is important to understand that when it comes to the broader markets, this is a process and requires a break down of the most popular and strong businesses.
This stems from how asset managers must position their portfolio as they are measured on their performance relative to the index. Lately they have noticeably flew to safety. Specifically in Large Cap’s with high liquidity and large market caps. Now, all these stocks have a target on their back and what comes next can be a major risk to many investors.
In this publication, I will share the data I have gathered for you. We will look at:
Historical price action of where the NASDAQ drops to
Fundamental data supporting the price target
My shorting strategy and approach to my growth portfolio
Conclusion
This content will be member only as I will discuss both risk and opportunity
I am keeping this content member only because I do think this is both an opportunity and a risk. In other words, I think there’s a trade here that could pay off with the right risk management strategies. The other day I posted this:
I still believe this. I think growth stocks and secular compounders are likely to begin forming a bottoming pattern. Many of our favorite stocks like GLBE, DLO, MELI UPST and others have already been torn up. It has been confusing recently why these haven’t moved with the NASDAQ but this has began making more and more sense. It’s related to both human psychology and how fund managers have positioned their portfolios.
Wall Street is Highly Concentrated in Large Caps and When the Liquidity Vacuum Turns on, We Have Both Opportunity and Risk
In the financial markets, anything is possible and of course this trade can fail which is why I wanted to talk about the strategy I am going to approach this with. This will include technical indicators and price targets I will be watching for and following. But first, let’s talk about what history tells us.
The NASDAQ Historically Falls to the 200 Week EMA
When we look at what has happened in previous tightening cycles, it’s becoming clear that there is an area of support that is respected.
Note the 200 week EMA. We can recall several different tightening cycles and the drops where the NASDAQ saw major support around this area. In 2015 and early 2016, this was the last time the markets hikes rates after a very large QE cycle. Essentially, this was the first time the Federal Reserve raised rates since the bottom of the 2008 financial crisis. At the bottom, notice how in early 2016 the NASDAQ bounced off the green line which is the 200 week ema.
In 2018, when the market began quantitative tightening and began to see a major sell off it once again respected the 200 week EMA. During the COVID lock down panic, once again, it dipped slightly below but respected the 200 week EMA. How far is this now?
This puts us in a range of 11,000 on the NASDAQ or approximately a 27% decline from here.
From a technical perspective there are a few warnings signs that are leading indicators here. The first I notice is how the MACD has been declining since February 2021. After that I notice a continued bearish divergence in the RSI. But, the most important indicator I see is how the NASDAQ is breaking the 40 week ema. If you look at the other times the NASDAQ has broke through this with meaning, you find yourself in some pretty substantial market correction/crash territory.
The Fundamental Reason Why This is A Scenario
Aside from the Fed taking a vacuum to the U.S. money supply, fundamentals and valuations do support a drastic draw down in large cap stocks.
It really is scary to see these valuations, truthfully. It’s one of those data points you look at and you’re like, “whoa, 1999 comparable…” Rest assured, this isn’t 1999. You can see that the euphoria was centered in technology. But, prices are extremely high. If we go back to the 200 week ema, that justifies a 27% in decline in the NASDAQ. Assuming the S&P follows with a lower decline, lets say 25%, this will normalize valuations substantially and these are on a forward basis. This could put valuations back at 25% and we’re out of bubble territory.
What to take away from this is that there’s a TON of room for prices to decline. A drain in liquidity from the financial system would be exactly the thing to do it too. Selling begets selling and draining the financial system of liquidity typically initiates this.
This is about the NASDAQ specifically, because I think that’s where there’s the most opportunity/risk. Let’s take the top 10 companies of the NASDAQ and their waiting as a % of the QQQ (which is the top 100 companies of the NASDQ, or 90% of the NASDAQ)
Apple 11.27%
Microsoft 10.11%
Amazon 7.79%
Alphabet class C $GOOG 4.19%
Facebook 4.04%
Tesla 3.9%
Alphabet class A $GOOGL 3.87%
NVIDIA 3.78%
PayPal 2.3%
Adobe 2.15%
Of these top ten, let’s take a look at their TTM P/E and their NTM P/E ratio.
Apple: TTM 31x P/E, NTM 31x P/E
Microsoft: TTM 38x, NTM 37 P/E
Amazon: TTM 67x, NTM 53x
Google: TTM 29x, NTM 26x
Facebook: TTM 23.5x, NTM 22.5x
Tesla: TTM 330x, NTM 122x
NVIDIA: TTM 93x, NTM 59x
PayPal: TTM 45x, NTM 25x
Adobe: TTM 47x, NTM 40x
The average TTM P/E of the top 9 companies is 78x and the average NTM P/E is 46x. On any sort of historical metric we can put into place, this is very high. If we took the two top weighted companies, Microsoft and Apple, we can quickly take note that we’ve witnessed a very large multiple expansion over time.
Microsoft Historical Multiple
Apple Historic Multiple
The Point I am Trying to Make
The conditions are perfect for a major multiple contraction, or, a normalization. From a technical perspective, the MACD is trending downward with the RSI signaling an over bought negative divergence. In addition, it looks like it broke the 40 week ema and previously the trend line. From a fundamental perspective, the top businesses in the NASDAQ have enjoyed very nice multiple expansion for years. What is more concerning is that Apple is only projected to grow 10% over three years, a forward P/E of 32 and an average weighting of 11% of the NASDAQ. There isn’t a scenario here where Apple selling doesn’t put pressure on the broader financial markets.
All we have needed was the needle to pop this balloon and the Federal Reserve hiking rates is exactly what has always done it over time. The first rate hike should be a catalyst and is likely to take place in March of this year.
Shorting/Hedging Strategy
I recently covered my ARKK short due to not truly believing that it has much downside left in it. If the index’s correct downward, I do think it could fall further but I am wondering if there will be any sort of meaningful selling. In this case, I don’t think this will be a compelling short.
My strategy has moved to a hedging strategy on a 1:1 basis shorting QQQ and going long on growth stocks. This essentially means I am betting on the broader market to decline more than my favorite growth stock picks $GLBE, $MELI, $DLO, $PUBM and $MDNY are among my favorite at these exact valuations.
Normally, I wouldn’t place a bet like this but all my stocks have been bombed out due to market sentiment. I am in the camp that growth stocks could be bottoming here and could see a meaningful reversal before the broader market recovers. They appear to lead the market up and lead the market down over time.
My technical setup and the trends I follow. This is in my TD Ameritrade App and can be adjusted to be similar to this on all major platforms.
When shorting stocks, I follow a few key technical indicators:
5 ema
7 ema
150 ema
RSI
MACD
The strategy is simple. If the 5 ema is below the 7 ema, the stock is in a short term down trend. If the 5 ema is above the 7 ema, the stock is in an uptrend. My shorting strategy is focused on following trends. The rule is:
When price action (stock price) falls below the 150 ema, you hedge/short the ETF/stock as long as the 5 is below the 7. Once the trend reverses and the 5 crosses above the 7, you remove your hedge and enjoy the ride back up.
Pay attention to divergences with RSI and MACD
Set tight stop losses that should be moved to certain price targets as technical trends evolve
This acts a lot like putting the breaks on as you go down hill. But, stocks move faster than ETF’s. It will not prevent your portfolio from all losses. It just reduces them, especially if you run a high beta portfolio. If you guys have any questions, reach out to me via Discord:
I plan on hedging my portfolio on a 1:1 basis during this, what would be perceived as, leg down in the markets. I have chosen to do QQQ over ARKK due to the thesis that I think growth stocks are bottoming and large caps are needed to fall.
Conclusion
The markets are not looking extremely healthy and it is concerning. The Bond market is in full swing when it comes to 4 rate hikes. I often look to Bonds to see what they think the Fed will do. Sometimes, they are early or slightly over shoot but the provides a nice guide that’s about 70% - 80% right. In other-words, if the Bond market is saying it, it’s likely that it’s going to happen. That means stocks will come under more pressure in the weeks/months to come.
I do believe growth stocks provide fantastic entry’s and I do plan on continuing to allocate as much capital as possible into my portfolio for this year. Remember, like I’ve mentioned many times, 2022 is an accumulation year. It will be very hard for multiples to expand unless the Federal Reserve back peddles, which is unlikely given stock valuations today.
I’ll continue to update you guys on the emerging data points I’m seeing out there. I appreciate all you guys, BluSuit Members.
Stay Tuned, Stay Classy
Dillon
Although only two days have passed, you seem to be right this time too. Luckily I am learning from you and applying some of your adviceד. Many thanks.