The Nasdaq is trading in a 15% correction and the 200-day moving average is definitely broken. The “internals” of the Nasdaq scope – % members off 52-week highs and number of stocks below the 200-day moving average – have deteriorated. More than two-thirds of tech stocks with high PE multiples are trading 50% or more below their one-year highs.
The Nasdaq has become cheaper in value in the forward P/E ratio and is significantly oversold on relative strength indices. Yet big tech companies trade at the highest multiples of free cash flow to enterprise value. The free cash flow (“FCF”) yield is at the highest level of 3% since June of last year.
There is a distinction between big-tech and “thematic tech”. For example, names like Stitch Fix (NASDAQ: SFIX), Wayfair (NYSE:W), CrowdStrike (NASDAQ:CRWD), Shopify (NYSE: SHOP), Salesforce (NYSE: CRM) among others are trading at a market capitalization-weighted average free cash flow yield of 1.65% (Figure 1).
Source: Bloomberg, NASDAQ
Tech stocks have a much larger average free cash flow than other major indices. But the market also rates free cash flow as attractive to the S&P. Free cash flow to enterprise value is around 2-2.5%, while the percentage of S&P members below the 200-day moving average is falling (Figure 2).
Source: Bloomberg, S&P
The difficult week for the main indices is a fundamental argument in favor of the value. The market has moved away from the pandemic. The inflated values of home stocks such as Zoom (NASDAQ:ZM), Zynga (NASDAQ:ZNGA), take two (NASDAQ: TWO), DocuSign (NASDAQ: DOCU) and Activision Blizzard (NASDAQ: ATVI) are reassessed and adjusted downward as appropriate. The number of stocks with PE multiples above 50 fell to less than 20%.
Yet negative techniques still dominate. Volatility in ETFs like IGV – broadened technology – and QQQ continues to rise as options markets traded on a notional $3 trillion of expiring contracts. The option bias for IGV is at minus 5 log-normal volumes, the lowest in 5 years, and well below the bias of QQQ (Figure 3). Put option volumes for March-June contracts exceed call volumes by a margin of two.
Figure 3: IGV and QQQ shift
Other technical factors of note are the tick up-down index and the advance-decline index for the Nasdaq. The number of stocks that trade down is 2 times higher than stocks that trade up. The gap between the upside and the downside is the most negative since the start of the pandemic.
Figure 4: Tick up and down
The Nasdaq Advance-Down Index is now the most negative in 5 years, and this has coincided with a total correction of 15%. From the recent high, the decline is currently -13.5%, so there is additional selling pressure to be had (Figure 5).
Figure 5: Advance-decline index
Technology is very oversold, brought by Peloton (NASDAQ: PTON) inventory, Netflix (NASDAQ:NFLX) the impact of global competition on the subscriber base, and geopolitical tensions and the flight to security have returned to the market.
Next week and subsequent weeks big tech earnings — MSFT Jan. 25, TSLA Jan. 26, AAPL Jan. 27 — have an implied option move around earnings priced at 7%, matching declines in the Nasdaq and NYFANG so far.
The market is closer to a “bottom”, but a downside buy strategy that worked well last year is less viable. The market has priced the pandemic value of stay-at-home, cyclical, reopening and tech stocks indiscriminately.
To determine if the valuation is attractive, analysis of free cash flow versus enterprise value is essential. Next week’s results and the Federal Reserve could provide an opportunity to re-enter new tech positions. NYFANG is a better opportunity to buy than home-beaten tech stocks.