From its March low to its recent high on Wednesday of last week, the Nasdaq had gained 82%. There were a number of indications that the stock market rally was venturing into dangerous territory. Some of the “red flags” included weakening market breadth, excessively bullish sentiment, and historic levels of stocks being overbought by some measures.
This increased the market’s vulnerability to a major selloff. Between last Wednesday’s high and Friday’s low, the Nasdaq has lost 11%, essentially wiping out August’s gains.
This is the first significant pullback since early-June when the Nasdaq lost 6.3%. Pullbacks can offer low-risk, attractive entry points for stocks that you want to own for the long-term. It might also be appealing to anyone who’s patiently been waiting for markets to dip before entering long positions.
Of course, there’s a divide between people who anticipate that the dip will lead to a V-shaped rebound back to new highs and those who see it as the start of a more extended correction.
Tech Stocks Look Iffy
While there is a great deal of focus on the big swings in the indices over the last week, one interesting development is that many of the “reopening” stocks like airlines, cruises, hotels, and restaurants are demonstrating some constructive price action. Fundamentals are supportive in terms of case counts dropping in hotspots and the continued month over month recovery in the economy.
Many are trading in a tight range and look primed to make a big move. So far, they have not participated in the sell-off. Additionally from a bottom-up level, a handful are starting to break out of their ranges on high volume.
In contrast, technology stocks have been the weakest among all groups during the first two days of this sell-off. It’s possible that rather than a correction, this is a rotation from overextended tech stocks into beaten-down sectors.
Another piece of evidence to support this thesis is the difference in performance between the Invesco QQQ Trust (QQQ) aka the Nasdaq 100 ETF and the iShares Russell 2000 (IWM). While QQQ is down 11% from Wednesday’s high to its low on Friday, IWM was only down 6% over the last two days.
Valuations in tech stocks have hit extreme levels. On a technical level, they’ve also become very overbought. QQQ hit a record at Wednesday’s peak by being 35% over its 200-day moving average.
These factors mean that there is more downside risk. In an extended correction scenario, tech will sustain the heaviest losses as valuations come in and prices revert to the mean.
And if it’s more like a V-shaped dip then other sectors, showing accumulation, are more likely to outperform.
3 Stocks to Avoid
Within the tech stock universe, you want to avoid companies that have some combination of an earnings miss, high multiples, and disarray in their business. Intel Corporation (INTC), Alteryx (AYX), and Fastly, Inc. (FSLY) have some of these characteristics and are three stocks that you should avoid.
At first glance, INTC looks like a great opportunity. Unlike FSLY and AYX, it has low multiples.
INTC has a price-to-earnings (p/e) ratio of 9.2 which is a third of the S&P 500’s p/e of 27. It pays a 2.64% dividend which is four times the 10-year Treasury’s yield of 0.68%.
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