What I Learned From This Crucial Chart Over The Weekend…

Amber Hestla's picture

Tuesday, April 16, 2019 - 2:30pm

by Amber Hestla

Today, I want to share one of the most important charts I reviewed this weekend. 

It's a daily chart of Lyft (NASDAQ: LYFT). And yes, it includes relatively little information. But the story that small amount of information tells is big. 

That's because, just 10 days after the first trade, the stock fell as much as 20% below its offering price.

Take a look...

LYFT chart

As Lyft was falling, its rival Uber announced plans to begin trading at a valuation of $90 billion to $100 billion. That seems steep for a company that's yet to earn a profit on operations, but it's well below the $120 billion the company expected to be valued at as recently as November. 

These two stories indicate that investors are wary about the rush of initial public offerings (IPOs), which can be a sign of a market top, as I wrote about a few weeks ago. 

You might remember that I shared research from the paper "Using IPOs to Identify Sector Opportunities" by Kevin Lapham that showed IPOs can point to tops in sectors. Lyft, Uber, and other IPOs are being classified as "tech stocks," and that indicates it's time to closely follow the NASADQ 100 Index. This is a tech-heavy index and could be adversely affected by the rush of IPOs. 

At the simplest level, IPOs are a transfer of money. Early investors are selling shares to investors in the public market. This is important because funds are limited. 

To buy shares of a hot IPO, investors often sell other stocks. For example, an investor might sell shares of IBM to raise funds to buy Lyft. This is true for individuals and institutional investors alike, because all investors are constrained by the amount of money available for investments. 

Institutional investors are also constrained by investment policy statements that allocate percentages of the portfolio to different sectors. That might mean a large-cap investor tracking the market allocates 21.3% of the portfolio to the information technology sector, which is the weight of the sector in the S&P 500. 

They'll try to beat the market by overweighting individual stocks in the sector they believe will be the biggest winners and underweighting stocks they believe will underperform. 

These actions should show up in the NASDAQ 100 Index. New stocks will not be in the index, so investors holding their allocation to tech stocks steady are likely to sell stocks in the NASDAQ 100 to raise funds to buy newly issued IPOs. 

For now, the Index remains bullish, as the chart below shows. My Profit Amplifier Momentum (PAM) indicator is shown at the bottom. The Nasdaq's 20-day moving average (MA) is also shown in the top panel as the solid blue line. Right now, both of those indicators are bullish.

PAM chart

​I'm tracking the 20-day MA as an early warning of trouble in the market. This indicator caught the downturn at the end of the last year, but there are frequent whipsaw trades to look out for. Whipsaws occur when the price moves back and forth, above and below the MA rather than trending. They lead to small gains or losses and are frustrating. Whipsaws are one reason it can be difficult to trade based solely on MAs. 

To address that problem, I've added PAM to the bottom of the chart. This indicator will spot shifts in momentum and the combination of the two indicators should provide a signal when the IPO market is pushing the stock market into a bear market. 

This is, of course, just one indicator to watch. It's also important to follow how traders react to earnings announcements. We had a few reports last week, and 45 companies in the S&P 500 or NASDAQ 100 are reporting next week. 

Among the most important reports to watch will be Netflix, which is scheduled to report after the close on Tuesday. Over the past five years, the stock has declined an average of 4.3% in the week after the announcement. 

NFLX is overvalued with a price-to-earnings ratio of about 130 and the stock is already under pressure and fell more than 4% on Friday after Disney a new streaming video service that will compete against Netflix's service. Although the stock accounts for just 1.9% of the NASDAQ 100, the reaction to that earnings report could tell us a great deal about market sentiment and the market's future trend. That could be the most important news to watch this week.

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Amber Hestla does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.