foxex: Dangerous Concentration

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Chart Advisor | Focus on the Price

By Gordon Scott, CMT

Friday, August 21, 2020 Headlines

1. Investors concentrating too heavily into tech names?

2. Are Apple's ratios a problem now?

3. Investors take max bullish stance on Nvidia

Market Moves

The Nasdaq 100 index (NDX) and the Dow Jones Industrial Average (DJI) closed .68% higher today. However, the Dow Jones Industrial Average actually closed lower for the week while the Nasdaq was on the rise (see chart below).

Why the disparity? To use an analogy from the movie-making industry, it seems as though people prefer the promise of a comfortable sequel to the risk of an uncomfortable original. In talking about a move in the markets, investors seem to believe that if a stock has moved favorably in the recent past, it will continue to do so in the near future. Investors therefore tend to flock to stocks that have risen strongly in recent days. This concept is at the heart of momentum investing.

The problem comes when this momentum creates a dangerous concentration of investor money into a small number of stocks. If a significant portion of investors withdraw their money (sell their shares) at the same time, it can lead to stark and unexpected price drops. It is useful for investors to keep an eye on option pricing to determine whether conditions are becoming dangerous.

The second chart below shows the first indications of this danger. The CBOE Volatility Index for the Nasdaq (VXN) shows an interesting pattern where Invesco's Nasdaq 100 ETF (QQQ) is making new highs, even though VXN is failing to make new lows. This implies that option sellers are keeping their option premium higher, something they typically do when they identify an elevated risk of stock prices falling in the days and weeks ahead.

[NEW READER SURVEY: We are running another two-week survey of our U.S.-based readers to gauge your sentiment and see what moves, if any, you have been making with your money given the market recovery, and current economic conditions. We'll share the results, as always, and we thank you for your time and participation.]

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Are Apple's Ratios a Problem Now?

An additional warning signal for such stocks (those that may have investors buying shares with more enthusiasm than solid information) can often be found in the fundamental ratios. The chart below compares the price pattern of Apple (AAPL) with two simple fundamental ratios: the Price/Earnings Ratio and the Price/Sales Ratio. Both of these measures seek to compare the current price with the money the company has reported earning in the last quarter on the basis of gross (sales) or net (earnings). The shocking reality is that AAPL shares are trading with levels of these ratios higher than they have been any time since the 2008 financial crisis.

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Investors Take Max Bullish Stance on Nvidia

Earlier this week when Nvidia (NVDA) reported earnings it had already made a 50% gain over the previous quarter. It seemed logical to expect that the price would pull back somewhat. It did, but only very briefly. Today the stock broke above five hundred dollars a share, and closed above the upper line of the linear regression channel (see chart below).

It is hard to imagine a more bullish response to the recent news on the stock. It is a great outcome for those investors who are holding the stock already, but it should be a big warning flag for those thinking of buying in right now.

The Bottom Line

Stocks moved higher today and more notably among technology sector stocks. Option sellers seem to fear a pull back in prices, if only a mild one. Investors notably bought up Apple and Nvidia shares today, perhaps too enthusiastically.