2013 was definitely reminiscent of the dot com, or the roaring 20s ... especially for the Nasdaq 100, which delivered a stellar performance. But is it time for the bubble to burst? I have many reasons to believe so, and not just for the Nasdaq 100, but other stock indices, as well. After explaining these with some detail, I express the belief that it's time to sell or hedge particular sorts of long positions, and to get some inverse exposure to the Nasdaq 100.
Bear x3 ETF volumes have gone wild since January.
The Average Daily Trade Volume for x3 Bear leveraged stock index ETFs has more than doubled since the beginning of the year. Although this is definitely not a traditional market indicator, I believe it reflects a growing sense that the markets are going into decline. To substantiate this, let's take a look at the graphs for: NYSEARCA: SDOW, NYSEARCA: SRTY, NYSEARCA: SPXU, NASDAQ: SQQQ.
The Nasdaq 100 has clearly and officially "rounded the top"
A study of NASDAQ: QQQ's graph shows that the Nasdaq 100's steady climb has rounded off. This indicates a loss of momentum, perhaps preceding a lateral movement, or decline. Although climb is still conceivable, this is typically regarded as a classic sell point. Gradual reduction of momentum has been building up organically since January. The index reached a turning point in early March, and now appears that it might be going into decline.
Index P:Es are much higher than last year.
One could definitely ask whether the market's "high altitude" is somehow justified by an improvement in the collective financials of the underlying companies. It's not. Well, actually elements of the Dow and S&P 500 are looking a tiny bit healthier than last year, but let's take a look at the P:E for Nasdaq 100 and Russell 2000:
As you can see, the P:E for the index is weaker than it was a year ago. Now perhaps the underlying companies have brighter prospects of earnings ... I have to admit there could be good reasons for a higher P:E, but the Fed's policy statements are not conducive to this outlook. Moreover, one must consider the fact that the Nasdaq 100 strictly pertains to 100 specific companies which one might argue have become "overbought", relative to the market as a whole. Although they are handpicked for being great companies, they do still have a finite value which is not "open ended". The Nasdaq index itself could theoretically broaden with new additions to the index, but by definition the Nasdaq 100 speaks strictly to the combined market cap of 100 companies whose combined P:E is now roughly 33% worse than it was last year, when investment was being strongly encouraged by the Fed (as opposed to discouraged, as we see today).
Nasdaq 100 Put:Call ratios favor shorts.
Put:Call Ratios are strongly supporting the view that the market considers the Nasdaq 100 to be overpriced. The CBOE Put:Call shows bearish sentiments prevail in the options market. This metric tells us which direction the options market expects the index to go. As you can see, it's been favoring bears since January, with bearish sentiment growing. The Fed's January tapering caused this to escalate madly, and March has made it even more extreme. Put:Call still favored bears on Friday, and the Fed plans to taper $55B more over 6 months. I expect to see this ratio escalate until the market reaches equilibrium, or the Fed reverses its decision to shorten its schedule.
The Fed's projected policy for 2014 is purely subtractive, and the economy just isn't that strong.
Yellen tells the market she intends to remove all stimulus in just 6 months. January's $10B stimulus is already slamming particular Nasdaq stocks down as badly as 10-20%, or more, and causing a very substantial reduction in the index. The market is not keeping up with the tapering. In light of that observation, I have to say the Fed policy for 2014 is liable to be purely subtractive, unless you cherry pick interest-friendly positions. But for ordinary stocks, and especially volatile Nasdaq stocks with weak earnings, the risk of downside from tapering is substantial. In fact it would be silly not to expect it.
You might ask "Well, what if the economy actually is getting stronger?" If the economy really were as strong as they are saying, I would still wait to see what their tapering party is going to do, before committing to long Nasdaq 100 ... because whether the economy is stronger or not, the Nasdaq 100 is beginning to underperform the tapering schedule. Some stocks will grow despite Fed policy, but in terms of the index itself, I'm just not convinced. Even if the growth were for real, I don't think the economy is as strong as the market is expensive. Look back to Nasdaq's P:E. Furthermore, consider employment statistics. Overall, NON-employment is still growing. Many of the short term unemployed have fallen off the statistical radar as long term unemployed, because they have been out of work for much longer than this flawed unemployment statistic tracks. I'm not saying this proves the economy won't recover, I'm saying it suggests that it's just not as strong as they say it is, and that the economic climate was not right for the fed to escalate the tapering schedule.
What Has Been Done can be Undone, but Don't Jump the Gun.
The Fed won't necessarily press the hard tapering schedule. I have a hunch that they will reverse the March taper once investor sentiment wastes away and the market stalls, or worse ... However, I don't believe it's reasonable to invest in receding Nasdaq stocks when Fed policy scorns them. Until the Fed removes the remaining incentives, and for as long as removing incentives is detrimental to investments, I'm thinking the Nasdaq is "overpriced" based on a pending schedule of negatively-impactual tapering.
How to Play it Until Then
If you're long, the simplest solution might be to sell volatile rate sensitive stocks, and wait it out ... or to hedge stocks with puts. If you aren't holding stocks, and don't want to, you could just hold puts, or go short the index and hedge with calls ... My personal response to the Fed's announcement was been lazy but effective: DUST to hedge my gold miners, and SQQQ to play the Fed's policy shift, but in fact I think puts on the index could be a more efficient & less exposed form of inverse exposure. Of course, if you look at any stock index over enough time, barring acts of God, zombie outbreaks or a nuke war (etc.), it will climb based on population growth, alone ... so you have to time this sort of thing carefully in terms of target and/or entry/exit timing and strategy. Moreover, and I can't emphasize this enough: Be attentive to Fed meetings ... they can reverse their policy in the blink of an eye, but until they do, I believe the game is still on for the midterm.
The growing volume on 3x bear funds & the market trend itself confirm me in the belief that it's a good mid-term decision to get some inverse exposure to the market; even if you are holding long, inverse exposure can help you to hedge positions during times of doubt ... I think the Nasdaq 100 is a particularly good candidate for this. Its 2013 climb was disproportionate to earnings, it's already starting to stall, indicating resistance, and many of its tech stocks tend to be particularly sensitive to Fed policies. The Fed seems to be out of touch with what its last taper did, because the Nasdaq was still stalling on January when March was announced. I do expect they will probably consider reversing their March decision ... but until they do, the Nasdaq 100 (and other markets) are reacting to bearish expectations, which makes them prime candidates for many forms of inverse exposure. If you decide to proceed with that strategy, I strongly advise to pick entry/exit points carefully, to remain mindful that the market inherently grows with time, i.e. that pullbacks don't last forever, and that the Fed can reverse itself, but I do believe one of the best plays of 2014 is probably shorting the bubble of 2013.
Disclosure: I am long SQQQ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. I intend to play this position watchfully, and could sell it at any time if the market breaks trend, such as what would be induced if the Fed were to reverse its tapering schedule decisions. Other than such things, I expect it to be gainful, and I'm holding onto it.