The Wheels Fell Off

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The Wheels Fell Off:

Risk happens fast huh?

Stocks and cryptos are in full meltdown mode this year, posting their worst week in 2 years. The major indices fell for a third consecutive week to start the year as investors continued to worry about the prospect of higher interest rates, inflation concerns, and how the Fed will react accordingly.

Let’s take a closer look at some of the returns.

2022 index returns YTD:

• DJIA -6.89%

• S&P 500 -8.31%

• Nasdaq-100 -12.50%

• Russell 2000 -12.53%.

2022 crypto returns YTD (as of 1/22):

• Ethereum -37% (52% off 52-week high)

• Bitcoin -25% (50% off 52-week high)

• Solana -48% (66% off 52-week high)

We’re already below many of Wall Street’s top forecasts for the S&P 500 in 2022. With the heart of earnings season coming up shortly, we will see if these forecasts will be in further danger.

Many of us have been conditioned to think stocks only go up (thanks Fed). However, for those who have been around the block a few times understand pullbacks like this—regardless of the velocity of them—are completely normal. And welcomed I may add. Ryan puts this current pullback into perspective below.

The major indices have also broken below the 200DMA. This week’s decline caused the S&P 500 to break below this moving average for the first time since June 2020—an incredible bull run during the pandemic.

When this level gets broken, many traders will see it as a sign of weakness and further downside may occur. The real metric that I look at is how far the price moves below the 200DMA. I threw together a quick ratio of the S&P 500 level divided by the 200DMA price going all the way back to the year 2000.

For an astute market follower, you can probably name the market scenario that caused every major dip on this chart. The number to look at is the 0.90 to 0.95 range for those who are waiting for a chance to get in if you’ve been sitting on the sidelines. It’s not saying we will even get there during this current drawdown, but history has shown that these have been good buying zones over the long term. Moreover, it has worked well for those who were continually buying every 0.05-0.10 move lower.

At this point, it may be time for a quick sentiment gut check. Have the 2022 declines made you nervous, scared, or optimistic? Your answer to that question could be a barometer for how leveraged and/or overexposed you are to certain areas of the market. I can promise you many of the old school buy-and-hold indexers haven’t lost a single night of sleep yet.

The chart below shows the percentage off of the highs for each index going back to November 2021. The Russell 2000 stands out here as it’s almost down 20% from the November high and outpacing the other indices by a large margin. When the momentum train stops—like it has in the past 3 months—the speculative names (unprofitable high flyers) get thrown out first.

Looking at the histogram of the stocks in the Russell 2000, we can see a breakdown of some of the carnage underneath the index in the individual names. While the Russell 2000 is currently in an 18.62% drawdown, the pain is much worse underneath with the average stock in the index down 37%!

In fact, there are a more stocks in the Russell 2000 down greater than 70% from 52-week highs than there are down less than 10%.

I made a similar chart for the Nasdaq 100 and it doesn’t look as dire—but, once again, the index is masking the pain. While the Nasdaq 100 is in a 12.88% drawdown, the average stock in the index is down 24.6%. Nearly a third of stocks in the Nasdaq 100 are down 30%.

You can probably guess the outlier down more than 80% from the highs.

Spoiler alert: It’s Peloton.

Because Peloton has dropped so much in recent months, it’s getting booted from the index on Monday (1/24) and will be replaced by trucking company Old Dominion Freight Line (ODFL). Lesson: Invest in companies with wheels that aren’t stationary (sarcasm font). As noted by others, the swap between the two names summarizes the ongoing rotation in the stock market, as value stocks become the preferred holding for investors concerned about rising inflation and higher interest rates.

To be clear, Peloton should have never been worth $50B. Even though the pandemic accelerated their business model faster than anyone could have expected, it ended up also being their demise as they couldn’t keep up with the supply chain issues and waning demand. This has been the story for many of the stay at home fitness stocks over the past year.

I understand comparing Ford to Peloton is like comparing apples to golden retrievers, regardless, it’s a fun exercise to go back and look for companies that have been around forever and compare them to these new high flying tech companies with crazy valuations. Just a year ago, Ford and Peloton were trading at the same market cap around $50B.

Now that Peloton stock is more than 80% off recent highs, sub $10B market cap, and creating a ton of bagholders in the process, there’s already speculation of potential suitors. **This post was already written on Saturday, but it was reported late on Sunday night that an activist is pushing Peloton to fire its CEO and consider a sale. Blackwells Capital, which has a stake of less than 5% in Peloton believes they could be an attractive acquisition target for larger technology or fitness-oriented companies.

Apple is the obvious choice for many. I do agree there are a lot of synergies in the health and fitness tracking verticals. However, Apple just hasn’t historically made huge acquisitions—at least compared to how much cash they have on hand. Many of Apple’s top acquisitions have been aimed at building and improving its largest success to date, the iPhone. Four of its largest acquisitions focus on chip performance.

According to CB Insights: Apple has spent over $7.3B on its top 10 deals, over 40% of which went to its $3B acquisition of Beats Electronics in 2014. Regardless, I’d imagine Peloton has popped up on Apple’s radar at this point—and probably Google as well.

While many were swept up in the fervor of their exploding business, it can be hard to delineate between a company having a good product versus having a good stock/business. I’ve owned a Peloton for about 9 months now and it is a solid product. I wish I could use it more but golf is always calling. The odd thing though is I’ve never owned the stock, even as I watched it rise 850% from the lows in only 10 months since the start of the pandemic.

I’ve always been intrigued by these consumer fitness tech products but as many of you know, they’ve nearly always been terrible investments as stand alone brands—see GoPro, Fitbit, et. al. Many of these wearable tech hardware companies are better suited being owned by big software companies that have massive user bases comparitively and can integrate seamlessly into their ecosystems.

Fitbit was one of the early adopters in wearable tech alongside Garmin and Apple. Fitbit went public in June of 2015, just months after the launch of the first generation Apple Watch. The Apple Watch was released in April 2015 and quickly became the best-selling wearable device: 4.2 million were sold in the second quarter of fiscal 2015, and more than 100 million people were estimated to use an Apple Watch as of December 2020.

Fitbit proceeded to hit nearly $10B in market cap after the first month being a publicly traded company, but then subsequently fell 80% in the next 18 months—before eventually being bought by Google for $2.1B in 2019 (deal closed in January 2021). Again, not a great investment.

Ok, fine. I’ll show GoPro’s crappy chart as well. This tech (camera) company still trades at a $1.4B market cap and has essentially flatlined since 2016. The chart doesn’t look all that different to Fitbit.

Takeaway:

The market has taken some bumps and bruises this year but earnings season is right around the corner. Earnings will be key (along with literally anything the Fed says) to stymie this current downtrend and try to put a floor on prices. Without a solid earnings season we could see much lower prices in the indices, even though the invidual names have already been crushed underneath.

The fact that Peloton is already back to its IPO price and potential buyout rumors will continue to circulate may help to put a floor in the name in the short term. But they still have an uphill road to climb.

Who needs to ride a Peloton when you can just get your cardio exercise by looking at Peloton’s stock drop every day?

Before you go, enjoy this hilarious video meme about Peloton. It sums up the story perfectly.