How to Be Richly Rewarded Following the Big Crash

Something utterly unforeseen and unexpected is taking place.  Recent highfliers of Wall Street’s technology space are now dropping like flies.  Can you believe it?

Take Facebook, for instance.  On February 19th, the top social media service bought text messaging application, WhatsApp, for $19 billion.  Shares of Facebook closed out that day at $68.06.  We noted it as a possible signal of a market top…calling it the Mark Zuckerberg Indicator.

At first it appeared Facebook would continue its march onward and upward.  But on March 10th, stock shares peaked at $72.03.  Since then, they’ve dropped 21 percent…falling into the statistical bear market range.

However, Facebook’s not the only technology company whose stock is flaming out.  Not by a long shot.  Many others are slumping over like a half empty commercial grade flour sack.

For example, Tesla Motors, Twitter, and Netflix are down 15 percent, 20 percent, and 25 percent, respectively, over the last month.  Alexion Pharmaceuticals is also down more than 15 percent over the last month.  What’s going on?

Chasing Shiny Objects

In short, the stock market’s bull run over the last 5 years has bid up technology stocks to very high prices.  They’re expensive any way you look at them.  Perhaps they should be less expensive.

But what price constitutes what value?  With technology stocks, or growth stocks in general, these relationships are hard to discern.  When you’re gambling on the next big thing, where earnings can rapidly double and triple, the risk of a high price may be warranted in anticipation of the reward of rapid growth.

Nonetheless, investors and speculators often overshoot the mark.  Their zeal feeds off of each other as prices are bid up to extraordinary heights.  All bearings of rational thought and common sense are lost as these shiny objects rocket into the upper stratosphere.

What’s lost in the race to get rich quick is the simple fact that there’s no such thing as a free lunch.  The mania can only go on for so long before it implodes upon its own dead weight.  Then panic sets in…and the market quickly recalculates the relationship of price and value.

“There’s value somewhere, but since these things aren’t being traded off typical valuations, you can’t go by those metrics, and it’s more about when do you find that stability,” said Mike O’Rourke, chief market strategist at JonesTrading in Stamford, Connecticut.

How to Be Richly Rewarded Following the Big Crash

At the moment, the jury on the NASDAQ is still out.  Since peaking at 4,357 on March 5, the NASDAQ has fallen 6.3 percent.  Maybe this will end up being just a small correction as stocks continue their bull market…or maybe not.  Moreover, is the NASDAQ foreshadowing a drop in the S&P 500?

“I’m not concerned about this spilling over to the broader market.  We’ve been in a trading range, finding resistance at record levels, so this isn’t cause for alarm,” said David Joy, chief market strategist at Ameriprise Financial in Boston.  While Joy may not be alarmed for now, these things have a way of quickly changing.  What’s not alarming today can quickly become alarming tomorrow.

“If the weakness here cascades into other sectors, that would indicate a fundamental shift in the market.  If things keep rolling over, you might want to seek protection or examine your fundamentals,” said Michael Matousek, head trader at U.S. Global Investors Inc. in San Antonio.

Of course, from a fundamental standpoint, technology stocks are grossly overvalued.  Yet the broad market also appears to be expensive.  The current S&P 500 price-to-earnings ratio, based on trailing twelve month reported earning, is currently over 18.  Its long term median is 14.54.  That means prices must drop or earnings must rise to balance things out.

Make of it what you will.  When it comes down to it there are right times and there are wrong times to buy stocks.  The right time is when stocks are cheap.  The wrong time is when they are expensive.

We believe that right now is not the right time to buy stocks…it’s the wrong time.  No doubt, holding some cash and having some patience will be richly rewarded following the big crash.


MN Gordon
for Economic Prism

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