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The NASDAQ and the S&P 500 have hit all time highs in price this week. The Dow Jones Industrial Average also moved up but is still below previous highs. Unfortunately, this is not your typical broad market advance that signals a healthy investment climate, growing corporate earnings, and strong economic backdrop for families and small business.
The situation we see now has a small handful of high tech companies powering ever higher while the rest of the market is relatively flat to down. Facebook, Apple, Tesla, Microsoft, Amazon, Alphabet (aka Google), and Netflix – better known as FAT MAAN – continue to move higher in price and valuation. These stocks have become the go-to one decision stocks for lazy portfolio managers – much like Kodak, Polaroid, General Electric, and others during the 1970’s (many of which are no longer around today).
Additionally, there are the COVID stocks that benefited from the changes to our society that were brought about by people forced to stay at home and work from home. Zoom, DocuSign, Roku, Clorox, Sherwin Williams, Winnebago, and many more, have seen their revenues spike higher as work and play has changed for all of us. Some of these will continue to power higher as the societal changes will persist – others of these companies will fall back to earth as they simply pulled their earnings from future years forward to 2020.
Can we just let the good times roll and watch the index move higher on the backs of this fairly narrow list of companies? Historically, the answer is a resounding no. Take a look at these two breath indicators for the NASDAQ Index in the lower panels compared to the strong price trend in the upper panel in the graph above. This is a warning sign that we need to be careful to protect the hard fought gains we have earned after the COVID crash in the indices earlier this year.
But is looking at breadth of the NASDAQ enough? No, that is only one warning sign, but it is in the strongest of the major indices. Below is a graph of the S&P 500 compared to its 200 day simple moving average.
The broad stock market has a natural “highway” represented by an area of plus or minus 10% away from the 200 day simple moving average. The graph above is just a snapshot representing the past year, but you can see three instances of the market moving outside of the 10% boundaries, two of which reversed course and moved in the other direction. You can see to the far right, that we have once again moved above that 10% boundary on the upside which tells me that we need to book some of our hard-won profits to protect them from a coming downward move in the market.
Does this sound too simple? Well, let’s look at a longer period of time:
This is a 20 year view of the same highway. Is it perfect? Of course not, but it is another risk management tool that I keep to tell me when to be aggressive and when to be conservative. This tool is telling me to be conservative.
So that’s it? Uh, no. Here is another tool I use, a set of graphs that combine breadth, momentum, and sentiment indicators so I get a comprehensive, big picture feel for the market at a glance.
These are showing me that along with the breadth in the NASDAQ, the broad market breadth represented by all of the stocks traded on the New York Stock Exchange are weakening as well. Momentum and sentiment are softening as well.
What about sentiment? While the internal stats for this market weaken, investors continue to get more bullish. The weekly Investors Intelligence Advisors Survey has 60% of advisors bullish and just 16.2% bearish. This is the highest extreme since January 2018, which marked the start of a correction short. These stats are contrarian – sort of like when you watch videos of sail boats and everyone gets on one side, you want to be on the other side as that is the one that isn’t heading underwater.
Maybe you have heard the old investment saying “the trend is your friend” which means that if you are aggressive when the stock market goes up, you will make money and if you are conservative when the stock market goes down, you will not lose money. A pretty smart plan. So what is the trend? most definitely up. Check out the two graphs below, of the NASDAQ Index and the New York Stock Exchange:
I use these two graphs because I can easily glance at them and see the brightly colored trend lines – in both case they are moving up. It is a much clearer trend with the NASDAQ as all of the trend lines are in order from shortest to longest moving higher. In the NYSE, some of longer term trend lines are still working on joining the trend. But there is no denying that the trend is up, however if you are having trouble seeing this, jut check out the top panel of the first graph above and the colored lines of the NASDAQ trend are pretty clear.
Anything else? Well, remember the statement above about the Dow Jones Industrial Average not yet back to previous highs? Guess what – they have decided to change the components of the index to better represent today’s industries. So, they are dumping Exxon, Raytheon, and Pfizer from the index and adding Salesforce.com, Amgen, and Honeywell. They are bringing the weighting of the technology sector in the index up, swapping a drug stock for a biotech stock (albeit one of the most conservative drug-like ones), and swapping a narrowly focused industrial for a broadly focused industrial.
We have been long-time owners of Salesforce.com in our growth-oriented portfolios. We bought it initially in 2013 for $38 per share and have added consistently over the years for clients at they came onboard. Today, with the announcement of its addition to the DJIA, it was up 25% so we sold it at $271. Check out the chart below:
You can see today’s big jump in the price of the stock as I have circled it. Has this been a good investment for our clients? Up 875% since the first purchase? Absolutely! Is it a good company to keep owning? That is a more difficult question – trading at a negative P/E of -1512x (based on previous crash-quarter numbers – current P/E is positive 61x), maybe it’s time for them to think about making some money since they are now part of the formerly stodgy DJIA. Just saying.
The NASDAQ is filled with companies that trade on their future prospects, not their current performance. FAT MAAN is different; many of these companies are making actual money (except Tesla, of course). But their valuations are the issue – not exactly at negative P/E’s but at P/E’s that rival those from the 1999/2000 Dot Com Crash era.
Tesla: 1038x Amazon: 127x Netflix: 84x Microsoft: 37x Apple: 36x Alphabet (Google): 35x Facebook: 33x
Taking all of this together, it is time to make a strategy call in client portfolios: we had been adding equity exposure since the crash earlier this year and it has served our clients well. On average, our growth portfolio clients performance is 800 basis points better than the indices year to date. That is real money folks – but it is nothing if we don’t utilize proper risk management when the market tells us that it is nearing a turning point. So now is the time to get conservative, on an incremental basis, to protect profits and raise cash to have on hand for the next downward move in the market. There is no way to know exactly when the market will turn down – the chart points to the 3525 area or 40 S&P points (roughly 1%) above current levels but we are certainly within the margin of error for that area.
The timing is right because we are making the change while the trend is still moving higher and we will implement the change slowly so that we continue to ride the trend as far as possible within reasonable risk management activities. Let’s call it Prudent But Profitable.
OK, for those of you that prefer the original and not the 80’s remake…it’s pre-video but still a good listen