- Stocks have made a modest recovery from their mid-June lows but sold off Tuesday.
- Evercore’s Julian Emanuel says bear market rallies “occur regularly” and suggests how to trade them.
- He also suggests taking a calculated bet on QQQ, the Nasdaq 100 ETF.
The stock market’s recent bounce smacked into a ceiling on Tuesday as tech stocks fell, and fell hard. But there’s reason to think the rebound will continue, according to Evercore.
“Consumer, small business and investor sentiment is at or near all-time lows – all of which have proven to be contrarian indicators for stocks in years past,” wrote Julian Emanuel, who runs the firm’s equity, derivatives and quantitative strategy and portfolio strategy teams.
He said that while
rallies can end abruptly, they’re generally large enough and last long enough for investors to make real money. And the deeper the bear market downturn is, the larger the rallies tend to be.
“The” average “bounce for these rallies from extreme decline is 17.6% and the average length of the rally across all observations is 28 trading days,” based on bear market rallies of 5% over five-day spans or 10% over any length of time, Emanuel wrote in a recent note. “Tradable Bear Market rallies such as those seen throughout the 1970s occur regularly.”
Emanuel suggests two tactics for investors to use in a bear market bounce. First, he suggests taking advantage of overwhelming tech stock bearishness by taking a long position on the best-known Nasdaq 100 ETF.
“We also recommend going long a QQQ (Invesco NDX 100 Trust) January 315C / 345C / 240P” call spread collar “(buy call spread, sell downside put),” he said.
Emanuel explained that the strike price for that short put is 41% below the all-time high for QQQ, and he says it’s not likely it’s going to fall that far. To complete a 41.3% decline from its November high, the Nasdaq 100 would have to fall another 16% from today’s levels to about 9,728.
Second, he says that the way to invest today is to add high-cash-flow stocks that have underperformed the S&P 500 since the index peaked at the start of this year – but which, critically, have not made new lows in June, which is a sign of early strength that could underline a recovery. The high free cash flows mean the stocks offer better returns while maintaining additional stability in a turbulent market.
Emanuel zeroed in on 18 companies that have high short interest compared to their own recent history. If those stocks rally, investors will have to start covering their short positions, which could contribute to bigger rallies.
Those 18 stocks are listed below, ranked from lowest to highest based on how much they’ve declined since their pandemic highs as of June 28th.