When a Bear Market Becomes Capitulation

Bear Market

Cash remains your best friend. Momentum is red. I hope you’ve been paying attention because I’ve been beating this message hard since January, especially since early April

This market is the worst I’ve seen since March 2020 and rivals December 2018 in terms of volatility and the lack of buyers. The NASDAQ 100 shed another 2.7% today, and SARK (the short fund that targets Cathie Wood’s stocks) added nearly 10%. 

What’s insane to me: The VIX is still at only 33. If we move to 40, I’m not sure what will be left in this market. Valuation compression has accelerated. 

Everything I’ve been warning about to start the year has come to fruition. So I’m not beating my chest. I’m saying, very matter-of-factly, that we are in a bear market, and we want to prepare for the other side of the “2022 financial crisis.” How do we trade in a Bear Market?

So Goes Apple

On October 20, 2021, I wrote in Haven Investment Letter that Apple Inc. (AAPL) is the single most crucial stock trading today. It sits in more than 300 exchange-traded funds (ETFs). It is owned by pension funds, hedge funds, and pretty much every retail investor, whether they know it. 

If you own the SPY Trust, you own Apple. If you trade the Nasdaq 100 (QQQ), you own Apple. And if you have a pension or a college fund, I’d be shocked if Apple isn’t in the portfolio. 

As I noted: “So goes Apple, so goes the U.S. market.”

Apple and Tesla have been the two stocks hedge funds and institutions cling to. Everyone – and I mean – everyone holds the bullish case for both stocks. But when the market begins to break – and the capitulation kicks in, neither are safe. 

Today, Apple’s 5% drop should be the final wake-up call to the market. We’ve been about to enter a bear market for Apple stock since the start of the year, and the safety for Apple isn’t at $140… it’s at $100 per share.

I am looking at June 17, 2022, $120 put on Apple as a trade because it is so ugly that it’s worth the $1.25 bet. If Apple and Tesla go, the Nasdaq and the S&P 500 could channel down another 10% to 15%. There’s no safety in this market… except cash – which IS A POSITION.

We move to cash and target inverse funds and puts when momentum is negative. When momentum turns positive, we close the shorts and ride the capital wave moving back into the market. We’re nowhere close to calling that bottom.

Playing in Bear Market

In a bear market, which we’re in, whether people want to argue about it, you have to change your strategy a bit. I’ve outlined in recent issues the community banking strategy championed by Tim Melvin… and the liquidation strategy that gives us companies like US Steel (X) and Hurco (HURC). 

Fundamentals matter. So, you want companies with solid balance sheets, excellent cash flow, solid assets in real estate and tangible goods, and low valuation multiples. Instead of buying stocks at current levels, you want to look at the cheap ones and have liquid options chains. 

You can sell cash secured puts or credit spreads on some of these companies well. Then, if they hit the strike price, you buy an outstanding stock at a great price, and you know that they are real businesses. 

The list below consists of stocks with strong-yet-cheap cash flow, sound balance sheets, and trade under their liquidation value. Plus, they trade at attractive EV-EBIT (enterprise value over earnings before interest and tax), attracting a private equity buyer. 

Don’t buy these stocks all at once. Instead, buy a few shares, and if the market charges lower, pick up a few more shares. Then, buy in tranches and eat like a bird.

If momentum does bounce back, I expect these will be the places where a lot of institutional capital will flow. People will be very skittish about trying to buy anything at extreme price-to-sales ratios. 

Now is the time to start to plan. Build your cash, build your cash, build your cash. Then, when the buying begins and we are liquid, it will set you up to find incredible deals with 50%, 75%, and 100% upside in the next two years. These opportunities only come around every few years.

Garrett Baldwin
Garrett Baldwin
Garrett Baldwin joined Godesburg Financial Publishing as Chief U.S. Markets Analyst in early 2021. A Johns Hopkins-trained Economist, he’s worked with hedge funds, venture capital firms, angel investors, and economic advisors to the U.S. government. Baldwin specializes in market anomalies and alternative investments. He’s written extensively on momentum, value, insider buying, and other unique strategies that provide investors that elusive edge.
Garrett Baldwin
Garrett Baldwin
Garrett Baldwin joined Godesburg Financial Publishing as Chief U.S. Markets Analyst in early 2021. A Johns Hopkins-trained Economist, he’s worked with hedge funds, venture capital firms, angel investors, and economic advisors to the U.S. government. Baldwin specializes in market anomalies and alternative investments. He’s written extensively on momentum, value, insider buying, and other unique strategies that provide investors that elusive edge.

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