What’s Happening?

The technology heavy NDAQ 100 has been getting really hammered in the last few days. On Monday, for example, the NDAQ 100 is down 2.7% in contrast with the Dow falling 2.2% and the S&P 500 down only 1.9%.

Friday’s 40% plunge in LinkedIn shares and the 5% drops in Facebook on Friday and Monday (despite an initial positive response to FB earnings) indicates not only that there is a valuation crunch underway in momentum names, but also with traders taking a “dump first and ask questions later” approach we may be in a capitulation phase.

Meanwhile, The NDAQ is approaching its August 2015 low where a retest could end in a double bottom or a breakdown. Whatever comes out of this could indicate whether the current bear is near an end or just getting started.

 

Fundamentals:

The NDAQ Index has historically been more heavily weighted in technology and momentum growth stocks which tend to carry higher valuations in the market (Price/Earnings ratios, which measure how much traders are paying for earnings), but because of this, tend to be more volatile in both directions.

Traders count on growth stocks delivering growth to justify high market valuations. For example, the NDAQ 100 is currently trading with a P/E/ of 19.4x, well above the 16.5x current P/E of the S&P 500. The P/E ratios based on forecast earnings 1 year out are 13.9 and 13.5 times respectively, indicating that traders expect more growth out of NASDAQ companies to close the valuation gap over time.

The overriding theme of the latest earnings season, however, has been one of slowing growth. Many major companies across a wide variety of industries have been reporting strong Q4 earnings but guiding downward for 2016.

During a time of falling growth expectations, the amount traders are willing to pay for growth is also falling. On the other hand, companies that fail to deliver promised or expected growth can be punished severely.

Because of this, stocks that have been counting on traders continuing to pay for growth have been getting hammered lately as their P/E multiples evaporate. LNKD for example, is trading at 33.7 times forward earnings after a 40% drop in its stock price. Other high growth high multiple stocks that have been crushed in recent weeks and months include Amazon.com (still trading at 106x forward P/E), Netflix (337x forward P/E), Tesla Motors (181x forward P/E) and Facebook (31x forward P/E).

The other thing that momentum stocks are running into currently is the end of the liquidity party. With the Fed having raised interest rates once already and planning additional increases this year, the days of borrowing cheap money and plowing it into high flying momentum stocks appears to have come to an end for now. This may also be contributing to the valuation crunch, and may not be finished yet with traders still at odds over how many more interest rate increases could come this year.  

So the big question facing traders now is whether multiples have come down enough to bring expectations back in line with reality, or if further haircuts could be on the way?

 

Technicals:

Recent trading action in the US NDAQ 100 suggests that although individual stocks may still have room to fall, the broader index has reached a point where it may start to attract some support.

After selling off in August, a rally in the index peaked in a triple top between mid-October and mid-December. Since the beginning of this year, the index has been in free fall. Recently it took out the 4,000 round number and its January low near 3,980 to signal a new downleg. It has fallen to retest its August low near 3,900 which could become a key technical turning point.  

If support holds at 3,900 it would complete a double bottom, indicate strong support there and provide a base for a significant bounce. A failure, however, would confirm bears continue to dominate and signal a new downleg that could potentially test the October 2014 low near 3,705.

The RSI indicator suggests we could be nearing a bottom. Not only is the RSI getting oversold again, short and long-term divergences suggest that downward pressure may be peaking and we could be close to a selling climax.