Based on yesterday’s big drop, and futures that were showing a big rebound today, it seems that volatility is back. That is great news for traders, who typically thrive on big, two-way swings, but not so much for longer-term investors. For them, it is worrying. The market has clawed back most of the losses that came in the month following the February 20 high for the S&P, which reinforces the belief that it always bounces back. But does that mean that you should be looking to buy on any weakness this time too?
The answer is yes, but selectively. Should yesterday prove to be the beginning of another extended period of volatility with a downward trend, then it will be for basically the same reason that the initial drop happened. This time it will be more to do with the speed of recovery from Covid-19 than the initial response to it, but the principles are the same either way.
It follows from that that what worked the first time will work this time too, although there are differences.
You should still be looking for companies that stand to benefit from lasting changes that follow as things return to a semblance of normal, but you might have to look a bit harder. It was obvious to some, even to me, that Amazon (AMZN), for example, shouldn’t have fallen by over twenty-five percent because people were stuck at home. Nor was it hard to foresee a rapid bounce back in the more defensive sector ETFs, such as utilities (XLU) or healthcare (XLV).
Most of these are close to their previous highs, with some even setting new levels. Assuming they get dragged down again in this newer, wiser market, they will still outperform. It is likely they will offer extremely limited upside even after a decline, making them poor choices to buy should there be a second dip.
Nor would I be in a hurry to jump on stocks that have driven the recent market gains. Airlines, cruise companies, hotel chains and the like didn’t bounce because they should never have fallen, as was the case with AMZN. They bounced because people began to think the whole virus thing was over. If it isn’t, they will sink again and probably stay low for some time.
The recovery was driven by states beginning to relax stay at home rules, and so far, even as cases spike in many of the states that led that movement, there are no signs of a reversal in that trend. The attitude seems to be that it may cost a few thousand lives, but we have to get back to work at some point. If the lives of their citizens isn’t enough to deter states from re-opening, nothing will. Re-opening looks set to continue regardless of its effects.
That doesn’t mean, however, that all businesses will bounce back quickly. Even as we return to “normal,” individuals will make decisions based on reality, not politics. Flying, cruising and staying in hotels will take a long time to get back to where they were pre-pandemic. There may be some short-term trading opportunities in those areas on any good news, but the risks are too high for long-term holding.
I would rather look to companies in sectors and industries that could benefit from lasting changes in work and personal habits, but which, for whatever reason, have lagged others on the way up.
An example would be something like NetApp (NTAP), a business-focused software, systems and services company.
As you can see, they didn’t bounce as hard as other tech companies over the last couple of months. The stock has been grinding up in a channel but has never really taken off. That is probably because NetApp is perceived as having fallen behind in cloud services because the big boys -- Amazon, Microsoft (MSFT) et al -- have grabbed market share.
There may be some truth to that, but they are still extremely profitable, with an operating margin of over 17%, EBITDA of well over a billion dollars and free cash flow of just under a billion. They also recently made a move to improve their position in cloud computing when they bought a young Israeli cloud company, Spot.
Even if that deal doesn’t add as much as expected, NetApp can benefit as businesses return to something like normal. Many have learned that working from home can work, and that a virtual presence, even for business-to-business companies, is essential to success. Both of those things make an increased IT spend in the near future likely and that will benefit everyone in that field.
NetApp wasn’t the market’s pick in the first wave of tech outperformance, but on a second bounce, with value increasingly scarce, it could catch up quite rapidly. That makes it an ideal candidate to buy on dips from here.
Disclaimer: The author intends to establish a long position in NetApp in the near future
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
Martin Tillier
Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.
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