The question of whether the market is going into a longer, broader correction is one with a lot of wrinkles.
Whether these high-flying stocks are going to come back is the easier question to answer. Why? Because unlike stocks where most of the embedded value is in existing earnings and existing growth – things a person can cling to, like the utilities or telecom – these stocks ride based on their expected growth for years down the line.
And when the unknown is combined with optimism you get price-to-sales ratios of something like 20. So when they cheapen – that is, sell off – those price-to-sales ratios (just another way of valuing a company) they drop to 15 times sales, which when compared with the S&P 500 is still ridiculous (the whole index tends to run around the 1.7 area of late). Which tells you of course that valuation was never the name of this game to begin with.
So with the valuation not there, and investors no longer getting the gratification from seeing stocks rise as soon as they buy them, there’s a couple strikes against them. A third one is supply. Motivated sellers, knowing they bought the stock at higher prices, are therefore champing at the bit to get out of positions if the market surges to a level they’re satisfied is enough to either lock in profits (if they’ve been in a while), get out at even (if they bought recently) or get out with losses because they know they’re screwed. Because, make no mistake about it, people who bought these high-flyers this year are underwater, sometimes seriously so, and unless sentiment does a complete about-face, these “investments” suddenly don’t look like so much fun to own. Broken momentum stocks are an ugly thing – just ask those who rode shares of Crocs into oblivion.
How are we so sure of this? Using volume-weighted-average price data (and a big tip to Mike O’Rourke of JonesTrading for cluing us in on this). Using Datastream, we found that some of your momentum favorites have been on average purchased at much, much higher prices this year than they stand now.
A group of 24 big-gaining names with most of their value wrapped in future expectations, as identified by Credit Suisse, have disappointed those who jumped in this year hoping for lots of gains.
We won’t go through all 24 here, but here are five favorites, listing the VWAP, or average price investors have paid this year, along with Thursday’s closing price, and the difference between the two:
- 3D Systems $71.90 $48.78 -32.2%
- Twitter $56.81 $41.34 -27.2%
- SolarCity $71.17 $55.13 -22.5%
- Workday $94.28 $75.62 -19.7%
- Netflix $385.91 $334.73 -13.2%
Not much to like there at all. On average, investors in Twitter in 2014 are down 27 percent from where they bought the stock, and it’s not even as if a 27 percent gain will get them to break-even - at $41.34, that stock now needs to rise by 37 percent to get back to this break-even VWAP level.
That’s a tall order, especially when sentiment is moving against the shares and hedge funds are correcting themselves from being more overweight in momentum than they were any of the other style factors that strategists measure (which include things like beta, volatility, earnings yield, dividend yield, and a few other metrics).
If there was one area that wasn’t constrained by the hedge fund managers, it was momentum – thanks to a rosy 2013 that many figured would just roll on in 2014. It’s been anything but that. Now, some strategists are warning that earnings are the next point of measurement and sure, that’s true – but that’s more for companies within a small range of where most think they’re valued. These stocks are different – the forecasts for growth over coming years vary wildly, because with names like this, things are just inexact (and even more so with biotechnology names, which are frequently all-or-nothing stocks).
Momentum works two ways – and now it’s working in the wrong direction for the bulls.