Buying Tech Stocks in Times of Market Volatility

Certain behaviors give away inexperienced investors in much the same way a poker player gives off tells. For example, we’ll often hear readers talk about how a certain price point is “a great buy” for a particular stock. Trying to call the bottom for any given stock is pointless. A February 14th article on Seeking Alpha talked about an “attractive valuation” for Palantir (PLTR). That Valentine’s Day recommendation didn’t show much love to investors as PLTR sold off sharply when the company reported earnings, followed by a massive dump by ARK Invest. Whoever wrote the following Seeking Alpha article must be chowing down on a healthy plate of crow right now.

Credit: Seeking Alpha

Pundits on Seeking Alpha and other platforms often give Foolish advice in the form of clickbait articles that focus on short-term speculation. It’s a surefire way to erode your wealth.

Avoiding Red Flags

Another mistake investors make is paying too much attention to the rollercoaster trading activity of active fund managers like ARK Invest. Imagine commanding tens of billions of dollars in capital and trying to decide what trading decisions to make in the face of extreme criticism. Many of the factors relating to ARK’s decision-making process are opaque, though they do share with investors some of the reasons for their trades. For example, their large sales of Palantir stock recently could be – at least partially – attributed to this short research note they published on the topic.

Short research note ARK Invest published about Palantir
Credit: ARK Invest

The comment about “a significant deceleration in growth in the larger government division” is exactly what we warned about last April. We do not invest in companies that are over-reliant on a small number of customers, especially if they happen to be the U.S. government. Then just days ago, a senior Citigroup analyst was on CNBC talking about how Palantir’s SPAC strategy appears nefarious, something we talked about last August. We’re not just raising these points because we love tooting our own horns (we do), we’re also pointing out how important it is to pay close attention to red flags, especially when all the voices around you are bullish. Be fearful when others are greedy, and vice versa.

Be Greedy When Others Are Fearful

As risk-averse investors, Warren Buffett is probably the market guru we admire the most, and one of his oft-quoted bits of wisdom is to be greedy when others are fearful. One way to measure fear is by looking at volatility which can be measured by the Cboe Volatility Index (VIX) which can be charted over time like any asset.

One way to measure fear is by looking at volatility which can be measured by the Cboe Volatility Index (VIX) which can be charted over time like any asset.
Credit: Google

In the above chart, there are two spikes. The one on the left is the financial crisis of 2008, and the one on the right is the market’s reaction to the Rona. We can also see that recently volatility has been increasing as geopolitical events increase risk in global markets. This is probably the most objective way to measure fear in the markets, and it tells us that people aren’t truly fearful right now.

Calling a Bottom

Trying to figure out when a stock has “hit the bottom” is another mistake all investors inevitably make. Sometimes the bottom takes a while to arrive. A good example of this would be Invitae (NVTA). You might recall ARK Invest talking about what a bargain Invitae was when the market tanked in March of 2020 and shares traded around $10 a pop. Two years later and they’re trading even lower than that. If even professional money managers can’t call a bottom, why would your average retail investor think they have a chance?

We’re presently holding shares of Invitae which we were buying slowly over time using dollar-cost-averaging. We stopped buying shares after committing the total amount of capital we allocated to the position. It continued to fall and now sits at more than 60% below our cost basis. Since our thesis hasn’t changed that we’re aware of, there’s little else to do but wait. We’ll likely check in with the company soon so that investors thinking about establishing a position, or adding to an existing position, can see how the company has been progressing since we last looked at them in June 2020.

If you’re only buying quality companies, you won’t have to worry about trying to catch falling knives. The intrinsic value of a business provides some support level in the form of mergers and acquisitions that can happen when stock prices plummet. That’s the idea anyway, but you can never tell how low things will go.

When The Market Corrects

There are any number of ways to measure a “bear market” or a “correction,” but it only takes common sense to gauge just how bad the markets are getting punished at any given time. Just look at the five-year chart of the Nasdaq and you’ll see the current “correction” hasn’t really been very meaningful.

Look at the five-year chart of the Nasdaq and you'll see the current "correction" hasn't really been very meaningful.
Credit: Yahoo Finance

The red arrow above shows the March 2020 reaction of the market to the emergence of COVID-19 which was short-lived.

Tech stocks could fall to the levels they were at just prior to COVID-19 which would mean a drop of about 33% from today’s levels. Of course, a fall to pre-pandemic levels would assume that this global pandemic had no impact on the world economy which isn’t true. The trillion-dollar travel industry was decimated, not to mention we’re still seeing supply chain problems emerge as the bullwhip effect takes hold. In fact, one could easily argue that a proper correction would fall below pre-pandemic levels for growth stocks given they’ve been on an absolute tear for the last decade.

You might argue that the economic value added over the past several years managed to offset the impacts of the pandemic, but the net effect should have been a flat line, not a growth of +50% based on today’s levels.

Buying Tech Stocks in 2022

We currently have dry powder that accounts for about 17% of our total tech stock portfolio value. That cash remains inside our tech portfolio and could potentially be added to by liquidating our two tech ETF positions (something we’ve already decided to do) which would give us a cash position of around 22.5%. As we talked about late last year, size matters for tech stocks, and we don’t want to increase our overweighting for small stocks if we can help it.

Nanalyze Tech Portfolio Size Breakdown
Credit: Nanalyze

In the face of increasing geopolitical risk, we’re not inclined to believe that now is the time to buy because everyone is fearful. The VIX index tells us that true fear isn’t affecting the markets yet, while a cursory look at the Nasdaq index performance tells us that a correction has hardly taken place. Our strategy for 2022 will be to make selective purchases for assets that have fallen significantly below our cost basis. As an act of caution, we won’t buy any stock unless it’s fallen 30% or more below our cost basis. We also won’t overcommit capital to any single position. It’s all part of our living tech investing methodology that adapts to the times.

As for buying new stocks, that’s also something we’re approaching with trepidation. We’re presently holding our target number of positions (36) and could potentially increase that number by four until we reach our hard stop (40). Corporate events such as acquisitions could also free up some slots. What we’d like to do is identify gaps in our coverage where we’re lacking exposure (electric vehicles for example) then identify suitable candidates for investment. That way when the cow manure truly hits the spinning blades, we can add names we really want to be holding.

Lastly, we want to touch on paper losses. The February version of the Nanalyze Disruptive Technology Report shows red across the board in our own tech stock portfolio. Seeing all that red is difficult for some to stomach, and that’s why you should only allocate a percentage of assets under management to tech that matches your tolerance for risk. For us, that number has historically ranged between 22% to 17% where it sits today.

Nanalyze Asset Class Allocation as of Feb 2022.
Credit: Nanalyze

Having a diversified basket of asset classes means you’ll usually always have something to celebrate when your tech portfolio is hitting the skids.

Conclusion

During bull markets, everyone’s a successful stock pundit with a large following. It’s during bear markets when risk-averse investors start to be taken more seriously. Since 95% of professional investment managers can’t beat a broad market benchmark, don’t think a couple Saturday afternoons of due diligence will put you in the 5% that can. Savvy investors like Buffett only invest in companies they understand using simple rules-based strategies that keep human emotion from getting in the way – like buy when others are fearful, but don’t try to time the market.

Tech investing is extremely risky. Minimize your risk with our stock research, investment tools, and portfolios, and find out which tech stocks you should avoid. Become a Nanalyze Premium member and find out today!

2 thoughts on “Buying Tech Stocks in Times of Market Volatility
  1. hi guys, thanks for the fantastic article, your thoughts are always very interesting. I love your risk-averse approach especially in a portfolio that invests in disruptive technologies. But I can’t understand if, in addition to an in-depth analysis of a company’s growth potential, you also take multiples into consideration, trying to understand if the company is extremely over-valued at the time of purchase? Value investing also makes sense among growth tech stocks, I say this also seeing that most of the companies you have bought are losing value (capitalization), and are approaching more “reasonable” values. Regards, Guido Frigieri Italy – Maranello

    1. Thank you for the feedback Guido! We use a simple valuation ratio to compare valuations which focuses on revenues vs. market cap. Along with that is an established cutoff which we don’t invest above which we’ve defined in the below article:

      https://nanalyze.com/2021/06/simple-valuation-ratio-tech-stocks/

      Now that tech stocks are getting decimated, we could switch that up and say “we only buy stocks with a simple valuation ratio of less than X.” However, since most of our portfolio is constructed already, it’s much easier to measure the drop in valuation by how much below our cost basis any given stock is. Provided revenue growth is still there, then this would make sense to do.

      The idea of proceeding with caution in the face of increased volatility means we’re not going to be adding to positions unless they’re meaningfully below what we purchased them at – say 30% below our cost basis or more.

      For investors who are looking at establishing positions today, we’ve identified quality companies that are certainly trading at a bargain relative to what they were trading at before. But again, we can’t be tempted to “call a bottom” given that we have no idea what direction the market might take. Having 22.5% cash means we have dry powder so we’re glad if stocks continue to fall because we’re adding quality on sale. If they go up, we’re happy as well.

      Hope this makes sense in regard to your comments. Nice to see you hail from the land of Bistecca alla Fiorentina. Is there anything better?

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