Post-Pandemic Gains Negated - Don't Be Remiss

Relentless Selling

For many individual stocks, the post-pandemic gains have not only been negated, but share prices are now lower than pre-pandemic highs. The accommodative monetary policies, Covid related stimulus, asset purchases, and market liquidity are coming to an end. Now, raging inflation, impending interest rate hikes, Federal Reserve tapering, omicron ebb and flow, continued supply chain disruptions, and geopolitical issues have culminated into the current market swoon. The latest market weakness has been persistent over the past few months while being exacerbated in January and February to start 2022. A third of the Nasdaq 100 stocks are off at least 30% from their highs; half of the S&P 500 has fallen 15% or more while the median biotech stock has sold off by 60%. Taking a look at a composite of high-flying growth stocks using the Ark Innovation ETF (ARKK) as a proxy, this cohort is down 60% as well.

The recent multi-month sell-off from November 2021 through mid-February was met with heavy and vicious selling. Valuations have been decimated overall, and cold water has been thrown on investor enthusiasm, especially in the more speculative stocks in cloud software, SPACs, and recent IPOs. The tremendous selling volume has inflicted damage across the board, with whole swaths of the market auto-correlating into a downward spiral. Now many opportunities are presenting themselves as valuations have been greatly reduced. Being too bearish may prove ill-advised over the long term as we're witnessing the 2020 Covid-induced sell-off unfold all over once again. Portfolio balance is key in any environment and deploying the cash portion of one's portfolio during periods of moderating valuations is exactly where this cash can be advantageous. Cash can be used opportunistically for snapping up heavily discounted stocks of high-quality companies during periods of indiscriminate and heavy selling.

Figure 1 – The current bear market has resulted in a third of the Nasdaq 100 stocks selling off at least 30% from their highs, with half of the S&P 500 falling 15% or more while the median biotech stock has sold off by 60%. Using the Ark Innovation ETF (ARKK) as a proxy for the high-flying growth stocks, this cohort is down 60%.

Deploying Capital

The market sell-off has disproportionally impacted financial technology, software stocks, e-commerce apps, fading trends, sports-betting plays, and stay-at-home plays. Some valuations have come down by 60-80%. PayPal (PYPL), Square (SQ), Robinhood (HOOD), Docusign (DOCU), Peloton (PTON), Beyond Meat (BYND), Zoom (ZM), Ark Innovation ETF (ARKK), Biotech ETF (XBI), and Twitter (TWTR) to name a handful of stocks in this bucket.

For any portfolio structure, especially an options-based portfolio having cash on hand is essential. This cash position provides investors with flexibility and agility when faced with market corrections. Cash enables investors to be opportunistic and capitalize on stocks that have sold off and become de-risked. Initiating new positions or dollar-cost averaging in these weak periods are great long-term drivers of portfolio appreciation. Many household names are off 20%-50% from their 52-week highs. Even the broad market indices such as Dow Jones (DIA), S&P 500 (SPY), Nasdaq (QQQ), and the Russell 2000 (IWM) are significantly off their 52-week highs. The Dow Jones, S&P 500, Nasdaq, and Russell 2000 recently touched down 10%, 12.5%, 18%, and 23%, respectively, off their highs.

Buying opportunities have been presented, and deploying some of the cash-on-hand is prudent. During these correction/near correction periods in the market, putting cash to work in high-quality long equity is a great way to capitalize on the market weakness for long-term investors. Absent of any systemic risk, there are a lot of appealing entry points for many large-cap names. Don't' be too bearish and ignore this potential buying opportunity because it may not last for long.

Risk-Defined Options

This multi-month period of sustained weakness has been accompanied by extreme volatility. As such, options trading has been very challenging as well. However, with the increase in overall volatility, implied volatility becomes advantageous for option traders as rich premiums can be collected. This type of environment reinforces why risk-defined options (i.e., put spreads, call spreads, and iron condors) are critical if one chooses to leverage options as a component of an overall portfolio strategy. Risk-defined option trades allow one to leverage a minimal amount of capital while maximizing return of capital.

Overly Pessimistic Backdrop

The Federal Reserve will begin withdrawing its stimulatory monetary policies and discontinue its asset purchases. The Federal Reserve will also increase interest rates over the course of 2022. As this pivot unfolds, risk appetite towards equities has faltered. The speed and degree of at which rate increases hit the markets will be contingent upon inflation. Unfortunately, the Federal Reserve is behind the curve and needs to take a stand to stomp out inflation. This situation places the Federal Reserve in a precarious situation to combat inflation without derailing the economic expansion. Inevitably, rates will rise, and the market has priced-in initial rate hikes, but the pace and magnitude of rate hikes are unknown. Regardless, this background will continue to have a negative impact on equities.

Conclusion

The post-pandemic gains have not only been negated, but many stocks are now lower than their pre-pandemic highs. This is because the accommodative monetary policies are coming to an end. Unfortunately, the Federal Reserve is behind the inflation curve and needs to take a stand to contend with rampant inflation. This situation places the Federal Reserve in a precarious situation to combat inflation without derailing the economic expansion. The pace and magnitude of rate hikes are unknown and will likely continue to have a negative impact on equities over the short term. The geopolitical issues have exacerbated this domestic situation and adds more complexity to the Federal Reserve's actions.

A third of the Nasdaq 100 stocks are off at least 30% from their highs; half of the S&P 500 has fallen 15% or more while the median biotech stock has sold off by 60%. Using a composite of high-flying growth stocks via the Ark Innovation ETF (ARKK) as a proxy, this cohort is down 60%. With the correction in the markets, many opportunities are presenting themselves as valuations have been greatly reduced. Being too bearish may prove ill-advised over the long term as we're witnessing the 2020 Covid-induced sell-off unfold once again.

During these correction/near correction periods in the market, putting cash to work in high-quality long equity is a great way to capitalize on the market weakness for long-term investors. For any portfolio structure, having cash on hand is essential. This cash position provides investors with flexibility and agility when faced with market corrections. Cash enables investors to be opportunistic and capitalize on stocks that have sold off in a meaningful manner.

Noah Kiedrowski
INO.com Contributor

Disclosure: Stock Options Dad LLC is a Registered Investment Adviser (RIA) firm specializing in options-based services and education. There are no business relationships with any companies mentioned in this article. This article reflects the opinions of the RIA. Any recommendation contained in this article is subject to change at any time. No recommendation is intended to constitute an entire portfolio. The author encourages all investors to conduct their own research and due diligence prior to investing or taking any actions in options trading. Please feel free to comment and provide feedback; the author values all responses. The author is the founder and Managing Member of Stock Options Dad LLC – A Registered Investment Adviser (RIA) firm www.stockoptionsdad.com defining risk, leveraging a minimal amount of capital and maximizing return on investment. For more engaging, short-duration options-based content, visit Stock Options Dad LLC’s YouTube channel. Please direct all inquires to in**@st*************.com. The author holds shares of AAPL, ADBE, AMZN, ARKK, AXP, BA, BBY, C, CMG, CRM, DIA, DIS, FB, FDX, FXI, GOOGL, GS, HD, INTC, IWM, JPM, MRK, MSFT, NKE, NVDA, PYPL, QQQ, SPY, SQ, TWTR, UNH, USO, V and WMT.