December 13, 2021
Behind The Street Newsletter
What if I told you that we are in a severe bear market? Would you think I’m crazy?
Well, with all major indexes at or near record highs you may say so, but let’s look behind the street. Follow me.
Many of the high beta growth stocks are now down 35% or more with the popular “stay at home” covid stocks having given up all their gains, making complete round trips back to where they were trading at the start of the covid rally. Only 27.49% of NASDAQ stocks are above their respective 200-day moving averages.
Notable names such as $ZM and $PTON, once covid darlings are now being punished the most. Zoom has given up over 400 points or 70% while Peloton is down 77% or 133 points. To me it seems as if the “stay at home” bubble has popped, so why are indexes still near all-time highs? To find the answer we need to look to the mega cap tech stocks such as $MSFT, $AAPL, $GOOGL, $FB, and $AMZN.
Together, these stocks make up a combined 23% of the S&P 500. With mega cap tech holding up strong making new record highs almost daily, it is no wonder why indexes are masking the true damage under the hood of this market. I guess you can literally say that software is eating the world because rarely the S&P 500 has been so concentrated at the top.
This has created a massive divergence in the market and chances are, if you are not in an index fund your portfolio may be in the red, deep red. This market environment is what you call a severe lack of breadth. Breadth refers to how many stocks are participating in the overall market rally, and right now we are experiencing an extreme weakness in over all breadth.
For example, if we look at the NASDAQ Advance Decline Daily Line, we will see that two week ago only 718 stocks were up and 2790 stocks were down. A similar situation went on when we look at the NYSE Advance Decline Daily Line, only 665 stocks were up with 1819 down. As we can see this market is extremely thin, meaning only a handful of stock are participating in the rally. Should the mega cap tech stocks start to lose steam, it could mean big trouble for major stock market indexes.
Out of every bear market comes opportunity to those who are patient. If you are in the business of buying individual stocks, I would not make any new buys until you can identify a major change in trend. This is usually when a stock makes a new swing high or has 2 consecutive green days on greater than normal volume.
Remember, a stock in trend usually stays in trend and right now the trend for growth is down. A great resource to help identify major trend changes would be to read the book “How to Make Money in Stocks” by William J. O’Neil. You will learn about the concept of a follow through day. A follow through day usually comes on day 4 or 5 of an attempted stock market rally where the NASDAQ or S&P rises on stronger than normal volume from the previous trading day. This signals that institutional investors are accumulating shares of stock.
Right now, the market is considered in correction, and we have yet to have a follow through day. One thing to remember about follow through days comes from a quote from Investor’s Business Daily founder William J. O’Neil: “Not all follow through days will work, but no bull market started without a follow through day.
Earnings Matter:
Now is the time to focus on the stocks that are best in class at growing their earnings and revenues quarter over quarter. Now that valuations have come down, should growth stocks report fantastic earnings, over time they will grow into their valuation. Before the growth stock crash many companies were trading at extreme premiums probably due to low interest rates and easy money policy from the Federal Reserve. Over the past few weeks, Fed Chair Jerome Powell has hinted at the fact that they may need to start tapering faster than expected and start to raise interest rates to fight off inflation.
Last week we got a massive CPI print of 6.8% and this will put pressure on the federal reserve to raise rates before inflation gets out of hand, many would argue it’s already out of hand. I believe money managers on Wall Street are front running the fed by selling off high beta growth names in anticipation of higher rates. Why does higher rates mean a sell off in growth stocks? Higher interest rates can put pressure on tech stocks with sky high valuations based on future profits. Higher rates mean that earnings and profits years from now are worth less today, and the market will adjust for that.
Most investors stop paying attention when stocks are down, this is the exact opposite of what you should be doing. This is the time to build your new buy list in anticipation for the next rally in growth. Take this time to do deep dives into company earnings reports. Visit the investor relation page of a particular stock you would like to own in the future and listen to their latest earnings conference call.
This information is free to access for all investors, retail and institutional. Look for relative strength, what stocks are holding up better than others during the market sell off? What stocks are rising in a declining tape? Pay attention because these tend to be the new leaders once the next bull trend starts. Focus on quality, only the cream of the crop during this time. Avoid stocks with no earnings. Earnings Growth, Revenue Growth, Return on Equity, Profit Margins, Expanding TAM (total addressable market). Most importantly, stay optimistic and stay in the game.
Fed Week:
This week we will hear from the Federal Reserve. The Feds two-day meeting ends Wednesday at 2pm est and forecasts call for a faster wind-down of asset purchases. Many believe that the Fed may cut purchases by upwards of $30 billion per month, twice the current pace. If this happens, the program would be concluded in March 2022. A faster conclusion to the asset purchase program will open the door for earlier rate hikes. Many are expecting at least two to three rate hikes next year. I am skeptical as to if the Fed will end their purchase program or just keep kicking the can down the road. My bet is that the Fed will continue to buy it all and keep rates suppressed.
Housing Data:
The National Association of Home Builders reports its December builder confidence survey, and the Commerce Department releases its November housing starts/building permit data. This is important to watch to gauge future demand for housing and forecast the health of the housing market. Usually, developers will not make the investment into getting the permits for new builds if they do not see demand for houses. These permits can be expensive, and should data come in strong we can conclude that housing demand should continue well into next year. I like to use this as a leading indicator.
Last week we saw evidence of a continuation to the strong housing market with positive earnings results from Toll Brothers $TOL. Q4 EPS surged 97% as revenue popped 19.5% to $3.04 billion. Toll Brothers said it expects to deliver 2,000 units in fiscal Q1 with an average price per home of $865,000. Low interest rates are adding fuel to the fire in the housing market, and I would argue that only the top 10% of Americans are benefiting from these gains.
Americans in the top 10% tend to already own homes and equities that have been on a tear since the covid lows, providing even more power for them to acquire more assets and price the middle class out of the market. If you notice, the demand in the luxury real estate market is great judging by the strong report from $TOL as well as luxury furniture maker $RH. $RH reported EPS rising 13% to $7.03 and revenue increasing 19% to $1 billion.
When we put the pieces together, we can follow the trend. Demand for housing creates demand for furniture to put in those new houses. We are seeing the demand remain strong in the luxury market.
Many investors are scratching their head after seeing so much positive data come out of the housing market while the Federal Reserve continues to buy Mortgage-backed securities. You would think in an environment where home prices are skyrocketing and we have bidding wars across multiple housing markets in the Unites States, that the Federal Reserve would stop buying mortgage-backed securities to stimulate the market.
Stay Away from The Junk:
Often, I get emails asking about the latest meme stock or coin and NFT. I’ll tell you the truth. Stay away. Completely ignore all media coverage and conversation in relation to $GME, $AMC, Doge, Shiba, and the next latest and greatest NFT. Don’t even waste your time thinking about these. They are garbage and the vast majority will revisit their covid lows if not go to zero all together.
I’ve been doing this for 9 years now and I’ve seen this time and time again, they are all passing fads. The point to investing is to develop a systematic investment process where you can replicate for years to come. If you buy a meme stock and make money, good on you. But that is not a systematic investing process that you can use to make money and grow your portfolio over 50-60 years. There is no process to buying stocks based off a hot tip on reddit or from watching a YouTube video. (My videos included)
If you are serious about investing you need to strive to develop a systematic process for your investing that can be replicated over time. Top money managers on Wall Street do not invest based off hot stock tips from reddit. They pay attention to earnings in companies in large total addressable markets. Every week in IBD they sit down and interview the best Mutual Fund Managers on the street, read the interviews to get a look into what a true structured investing process looks like. Top down, bottom up, systematic process. Stay away from the junk. Read Common Stocks and Uncommon Profits by Phil Fisher
VIX Update:
VIX is the ticker symbol for the Chicago Board Options Exchange’s CBOE Volatility Index. The VIX has since collapsed nearly 45% from last week’s high of 35.20. Usually when we have large spikes in the VIX it is wise to go short volatility and get long the market. Options traders in this environment must also be careful, had you gone long puts last week as many did to hedge their portfolios, chances are you are in the red on those positions due to volatility crush.
Options tend to be “expensive” when volatility is high, when we have a dramatic move down in the VIX, options premium tends to decline even if the market moves in the direction you wanted. I attached a photo from Investopidia.com showcasing the inverse relationship between the VIX and the price action in the S&P 500. Most of the time when the S&P 500 is moving lower, implied volatility is moving higher. Volatility is a major component in pricing options contracts, Please see photo attached.
200 Day Moving Average – Long Term Trend
The trend is your friend on Wall Street and as the great investor Paul Tutor Jones says “My metric for everything I look at is the 200-day moving average of closing prices. I’ve seen too many things go to zero, stocks and commodities. The whole trick in investing is: “How do I keep from losing everything?” If you use the 200-day moving average rule, then you get out. You play defense, and you get out.
I tend to use the same rule. Once a stock breaks trend below the 200 – day moving average its time to protect capital and call it a day. Wait for a new trend to emerge and get long. For clarity, I have an account where I have been dollar cost averaging into the S&P 500 since I was 16 years old, the rule does not apply here. I will continue to automatically buy the S&P every month without selling until I reach 65 or retirement age.
However, in my actively managed long/short portfolio you need to protect capital to grow it. I let the market force me to cash by breaking below a major moving average such as the 200 day. I cut all my losses in my actively managed account at 7% maximum. I have attached photos of some of the major growth stocks that have now broken below their respective 200 days.
No new buys unless these stocks can regain major moving averages. You don’t want to get caught in a situation where you are trying to catch a falling knife on a $ZM and $PTON that are now down over 70%.
As of June 29, the following are the five largest S&P 500 index constituents by weight:
1) $AAPL - 5.89%
2) $MSFT - 5.63%
3) $AMZN - 4.07%
4) $FB - 2.32%
5) $GOOGL - 2.03%
Bitcoin:
Speaking of the 200-day moving average Bitcoin seems to be finding support right at its key moving average. However, a break below would confirm a larger bear trend for the crypto asset. As you know, I am not a trader of Bitcoin. I hold Bitcoin for the long term through bull and bear cycles. I would like to introduce you to a fantastic twitter handle @WClementeIII. He is a great follow for his extensive insights into on-chain analysis.
Distribution Days: (Days where index sells off in heavier volume than previous day. Signaling institutional selling. 5 - 6 distribution days in the span of 4 weeks signals market weakness) Investor’s Business Daily
Current Distribution Count: Market in correction
Leaders up in volume: $SIMO, $MSFT, $MP, $BLDR
Leaders down in volume: $LULU, $LOVE, $TRU, $ZIM
Thank You