- Nasdaq’ worst month since 2008 – but we need to see more
- My own portfolio felt pain – here’s how I did
- Why Amazon could easily go to $2,100
At the start of this month we were talking about April’s strong historical record.
But as we know, records mean nothing.
This month was brutal for stocks and especially the Nasdaq.
For example, the Nasdaq Composite posted its worst monthly performance since 2008.
The Dow dropped more than 900 points Friday and I would not be surprised to see more selling Monday.
But here’s the thing:
The selling so far has been orderly.
There has not been any panic. Instead, what we have seen is a grind lower.
To that end, not until we do see a strong ‘flush’ in stocks — can we say with more conviction we are closer to a market bottom.
Let’s take a look at what the ‘flush’ is said to mean.
Need to see a ‘Flush’ in the Market
In my experience, markets are closer to the bottom when we see a healthy amount of fear.
At that point, investors are dumping stocks no matter what.
The “babies are thrown out with the bathwater”
Now I find the best proxy for this is what we see with the VIX.
The so-called “fear index”.
The VIX – for those less familiar – is a measure of what investors are paying for put options.
Put options are basically insurance.
They provide the buyer with the certainty they can sell their stock at an agreed price in the future.
And for that security – they pay a premium.
As I say, it’s no different to buying insurance on your car or your house.
For example, you might own Microsoft. Today it trades around $280. Now as a stockholder – you might be worried it could trade below $260 in the coming months.
However, you want to be certain you can sell it for $260 no matter how low it trades.
To insure your position in Microsoft you would buy a $260 strike put.
And pending how long you would like the insurance – this will impact the price.
For example, if I look at the July $260 puts for Microsoft, that insurance will cost you around $10.78 (see first column against $260)
July 2022 Strike Puts for Microsoft
So that’s how “put option” insurance works.
And these “puts” get more expensive as the VIX rises (and vice versa).
Today put options are starting to get expensive – however I personally would like to see the VIX a lot higher.
Now recently, I shared this long term chart for the VIX where it spiked at various times:
Long-Term VIX
As part of my research – I looked at the performance of the stock market when buying the market with the VIX at 35 and 45.
You can read my analysis here.
Let’s now look at where we are with the VIX today:
VIX – April 30 2022
At the time of writing – the VIX is trading for 33.4
To be fair, it’s higher than average however it’s not anywhere near ‘panic’ levels.
What I’m hoping for (and we may not see it) is the VIX to push a level of around 45 (labelled “11”).
Because at that point, the market bottom will be within sight.
To be clear, it probably won’t be the near-term bottom (look at what we saw in March 2020)
But we will be closer.
And it’s at the point I will look to meaningfully add to my positions for the long-term.
S&P 500 – Expect More Selling
From mine, over the past 6+ months (even longer) things have traded ‘per the script’.
I’ve written at length in recent weeks (months) about where I felt the market was likely to ‘top’ and where it could find support.
Today, the critical zone for the S&P 500 is around 4100.
At the time of writing, we are very much trading within that zone at a level of 4131.
And I think next week I think there’s a high probability that level breaks.
April 30 2022
At 4131 the market is only 14.2% off its highs.
Again, think about how far we’ve come the past few years.
For example, at the beginning of 2018 the S&P 500 traded for 2700.
We are 53% higher than that level in just 4 years.
If we assume a full 4 years – that CAGR Is 11.2% excluding dividends (e.g. closer to a 13% total return annualized)
From a fundamental lens, at a level of 4131 (with expected forward earnings of ~$230 p/share) we’re trading at a fwd PE of ~18x
So what does that look like should the market drop?
- 4000 / 230 = 17.4x
- 3900 / 230 = 16.9x
- 3800 / 230 = 16.5x
From mine, if we see the market trading with forward PE of below 17x (i.e. the market drops below 3900) — I think we will see a lot of buying support.
Today I think the market is ‘reasonably’ priced given real rates are likely to remain negative for at least 12 more months.
However, if we see a fwd PE ratio closer to 16x in this climate – this is cheap.
Now coming back to the VIX – if we see a spike to say 45 – it’s reasonable to assume the S&P 500 will be below 4,000.
There will be panic selling.
And it’s at this point, you step up and buy for the long-term.
Amazon: Could See $2,100
Before I close, a note on Amazon and the price action.
It was a brutal day for the eCommerce and Cloud giant – and something I warned readers of ahead of their earnings announcement.
I assessed each of the big five tech stocks – and I felt Amazon was most at risk.
I offered a chart (see this post) which posed the question “is Amazon about to break?”
It broke.
Let’s update the weekly chart and where I think the stock is likely to trade:
AMZN: April 30 2022
Unfortunately, the stock traded as I forecast last week.
I say “unfortunately” as Amazon’s drop also hurt my own portfolio (as has Google, Apple, Microsoft and many others).
That said, I did lighten my Amazon position into the earnings print (by about 35%) on the strong probability the number would disappoint in this climate.
I was lucky it was the right move (as I didn’t enjoy selling the stock around $3,300) – but it paid off.
From here, I think we could see Amazon trade as low as $2,100
Now if Amazon is able to earn around $55 for the full year (note – they are forecasting earnings per share of $12 and $13 the next two quarters) – this puts their forward PE at 38x
On the surface, that’s still expensive in this climate.
However, the company is likely to continue growing at rates of at least 30%.
Therefore, if we divide the forward PE by their average 5-year growth rate (38 / 30) = 1.3x
That’s not an unreasonable ‘PEG’ ratio.
But let me stress, there’s no guarantee that Amazon finds support at $2,100.
The chart suggests the next support level lower is $1,600.
Therefore, all I can suggest is investors think hard about their allocation.
At the time of writing, for me, Amazon carries a total portfolio weight of ~6%.
And I think it deserves this weight…
I know I am telling you nothing when I say Amazon is a global Cloud (growing at 40%) and eCommerce market leader.
Not to mention, they have built a world-class advertising business with annual revenue of around $8 billion.
Put another way, the company has an incredible moat.
Unfortunately like any investment – there will be times (like now) where you are going to wear some pain.
That’s how it goes.
It’s never up in a straight line.
But I choose to remain invested in this name (and similar quality stocks) as I fundamentally believe in the business.
Putting it All Together
April may have been a painful one for some investors.
For example, the Nasdaq suffered its worst month since 2008.
That is not insignificant.
And my own portfolio was not immune.
After finishing Q1 with a slightly positive return (a good result in this market) – April was less forgiving.
Year-to-date my portfolio is down 6.77%
And given (quality) tech names are my largest positions (Apple, Google etc) – that’s where the pain was felt.
That said, with the S&P 500 down ~14% year-to-date – I have ‘outperformed’ by a little over 7% YTD
My Portfolio (red-line) vs S&P 500 (blue-line) – 2022 YTD
Disappointing?
Sure.
But personally I’m not too concerned with my portfolio being slightly lower so far this year (especially given what we’ve seen).
As an aside, I’m sure Cathie Wood would “kill” to be only down 6.77% this year with her ARKK ETF.
This year, the popular tech fund is down from $100 to just $48 – a fall of 52%.
However, from its highs in 2021, the fund is down from $160 (70% off its highs)
Now I would be disappointed if my portfolio was down 70%!
Moving on, I’m genuinely excited at the prospect of the S&P 500 potentially falling below 4,000.
Very excited!
This is the time where you want to be sharpening your pencils – getting your watchlists ready – as this will be a great long-term buying opportunity.
You might wear pain for a few months or maybe even a year – but that’s ok.
Stocks like but certainly not limited to – Google, Amazon, Apple, Microsoft etc etc – are offering investors a great chance to add these to the core holdings.
And in many cases, the prices you’re paying today are as low as they have been in more than a decade (e.g., as a function of earnings, growth etc).
Have your watchlists ready – opportunity is coming!