Signs Are Building That A Stock Market Bottom Is In
Summary
- Volatility levels spiked to near record levels.
- Investors may be assuming the worst.
- Details from companies suggests otherwise.
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Just as the crowd was leaving the arena, and we thought the fight was over, the FOMC decided it wasn't. In a rage, the Fed hit the market from behind with a vicious right hook, sending the market to its knees. The Fed screamed at the market "you want a rate cut, take 50 bps, you happy now!" Disgusted, the Fed left the ring. One can only wonder if a third rematch will take place at some point down the road.
Rate Cut
The Fed made a shocking move on Tuesday, announcing it would cut rates by 50 bps. Rate cut or not, the market seemed to already be saying that market bottom may be in.
Vol Hits Historic Levels
Volatility has surged, and signs are emerging that volatility will now begin to fade. The VIX index hit a high of nearly 50 on Feb. 28, which is typically associated with peak fear levels, historical levels this high have been connected with turning points for volatility, and a bottoming process in stock prices.
Options traders are betting that the VIX plunges by the middle of March. We have seen bets in the VIX serve as indications of rising and falling volatility in the past. For example, on Jan. 16, in an article, I noted that there was a tremendous amount of call buying taking place in VIX options, and of course, as we know now, volatility surged, a topic which we recently talked about in my Marketplace service.
VIX Spikes
The VIX spiked on Feb. 28 as the S&P 500 plunged. The VIX hit levels that day not seen since February 2018. We can see that going back to 2007 the VIX has only peaked above 30 on a handful of periods. It also has reached above 50 on even fewer occasions.
It would indicate that the VIX hit near-historic levels of fear during the latest sell-off. In the past, when the VIX hit these types of levels, they have been associated with at the very least market bottoms. It didn't always indicate a reversal of the trend in the S&P 500, but again it could be suggesting at this point that the lows on Friday may have been the bottoming point.
Betting Vol Declines
Some options traders also are betting that volatility levels fall. The open interest for the puts at the 20 strike price rose by around 82,000 contracts on March 3. According to the data from Trade Alert, the puts traded on the ASK, and are indicating that a trader is betting that the value of the VIX falls below 20 by the middle of March.
Valuations
Based on current earnings estimates provided by S&P Dow Jones, the S&P 500 is projected to earn $173.04 in 2020 and $192.78 in 2021. It leaves the S&P 500 trading at 17.9 times 2020 earnings estimates and 16.1 times 2021 earnings estimates. However, since 1988 the S&P 500 has traded at a current-year PE ratio of 18.9 and a one-year forward PE ratio of 17.5. Currently, the S&P 500 is trading well below the historical norms.
However, and interpretation of the recent stock market sell-off has been for no earnings growth in 2020. If assuming that, and using 2019 earnings in the S&P 500 of $157.15, the S&P 500 is currently trading for 19.7, with the S&P 500 trading around 3,100 on March 3. However, in February, when the S&P 500 fell to a low of 2,855, the S&P 500 was trading at 18.2, a nice discount to that historical average.
Are Fears Overblown?
But for no growth in 2020 to occur, we would need to see earnings estimates decline by about 9.2% from their current levels. However, the market, to some extent, may be overshooting the potential impact. Several companies that I monitor and observe to this point have only indicated mild implications to their March quarterly results.
NXP Semiconductors (NXPI) noted an impact on revenue in its first quarter of $50 million, with the potential for up to $150 million. Analysts currently estimate that the company will have revenue in the first quarter of $2.18 billion.
Meanwhile, Diageo (DEO) recently noted a potential impact on revenue in a range of $290 million to $420 million for the second half of 2020. Analysts expected that the company to have total revenue in 2020 of about $17 billion for the year.
Mastercard (MA) warned it would have slower first quarter growth, and based on that slower growth, it appears to amount $120 million hit to revenue in the first quarter, on what analysts estimated to be around $4.3 billion for the quarter.
Qorvo (QRVO) was one of the latest companies to note it would miss first quarter guidance. It now sees the first quarter revenue of about $770 million, which is about $50 million below the mid-point of the range of their prior range.
Not Growth, But May Be Slower Growth
While all of these companies are suggesting a hit to revenue and what's likely to be a hit to earnings, they do not seem to indicate no earnings growth in 2020.
If one assumes slower growth in 2020, perhaps of just 5% in 2020, then earnings estimates for 2020 should be around $165. At that value, the S&P 500 would be trading for 18.8, in line with the historical norms.
But as we look forward, and assume the 10% growth estimates been imply for $181.50, leaving the S&P 500 trading at 17.1, slightly lower than the average.
Overall, it seems on several indicators the equity market has likely bottomed and is likely to stabilize in 2,900 to 3,100 area. But, of course, the market can stay irrational for very long periods of time.
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About The Author
I first fell in love with the stock market when I was 16 years. Now, 25 years later and after a long career as a buy-side trader, I share all of my experience with you daily with timely thoughts throughout the day in Reading The Markets. I use fundamental, technical, and options market analysis to identify individual stock ideas for you.
This article was written by
Mott Capital, aka Michael Kramer, is a former buy-side trader, analyst, and portfolio manager with 30 years of experience tracking market fundamentals. He focuses on long-only macro themes and studies trends and unusual options activities to identify long-term thematic growth opportunities.
He leads the investing group Learn more .Analyst’s Disclosure: I am/we are long NXPI, MA, DEO. 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.
Mott Capital Management, LLC is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Past performance is not indicative of future results.
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Comments (24)
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"Several companies that I monitor and observe to this point have only indicated mild implications to their March quarterly results. NXP Semiconductors (NXPI) noted a potential impact on revenue in its first quarter of $50 million, with the potential for up to $150 million"
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This is wrong because this $50m isn't "potential" at all; it's what NXP told us they've *already* seen as of this past weekend. Excerpt from their PR:"... we currently expect the impact to revenue in the first quarter to be in the range of $50 million to $150 million. At the lower end of this range, the $50 million impact is what we’ve actually seen so far, with the weakness most pronounced in the weeks after the Lunar New Year holiday, however, we have now seen more normal order levels in the last two weeks. The $150 million upper range is estimated on a scenario where we would see a return of weakness in the coming weeks, like what we saw right after Lunar New Year."
All this means is that this kind if fear is unwarranted and the moment it becomes clear within next two weeks(when kits are available) that % of deaths are not high the markets will shoot up.
"If fear is unwarranted why did the Fed crap their pants this AM?"Because market wanted it and it would have fallen even more. Only Therapeutic medicines and vaccines can reduce the fear.The number of cases is going down in China and even South Korea. This fear is unwarranted. Q1 revenues will be lower by 2% to 3%. This is not end of the world.
