Today, we’re going to talk about whether or not the stock market is going to crash in May 2021. Because for the past few weeks, the market has gone down depending on what index you’re looking at.
So today we’re going to deep dive into this. Is the market going to crash? What is happening with cryptocurrency? What would happen to your portfolio if the market crashes, and how can you protect yourself from this?
What you see looking at the Nasdaq, over the past three days, it has been gone down. Selling seems to have been accelerated so far today.
The NDX is for today, at the time of this writing on May 13th 2021, still up a little bit, but is the market going to crash? How can you protect yourself, and what will happen to our wheel positions if the market is crashing?
That’s what we’re going to talk about today. And I thought in order to do this, it would be fun to do this with another expert, my head coach, Mark Hodge.
What’s Happening In The Markets?
Markus Heitkoetter: So the Dow Jones has been making new all-time highs for quite some time right now, but then two days ago, and yesterday, it plummeted down. It was the worst day since January or something like this?
Mark Hodge: I believe so.
Markus Heitkoetter: But the Dow is only part of the picture. I think what most people are concerned about are these growth stocks. The Nasdaq had quite a significant drop, and people who are invested in, for example, TSLA, SQ, or in any of these growth stocks, have seen these growth stocks have taken a beating over the past few weeks.
Mark Hodge: Right now, this is what’s known as sector rotation. Sector rotation is when everything is going great, interest rates are low, people are bullish, people are willing to put their money in more aggressive stocks for future growth.
Stocks that you would imagine have higher future earnings and have the potential to grow faster, even though they might not be even showing profits right now. So that’s where the money is going.
Now, when you talk about inflation concerns and you talk about higher interest rates, that’s when people get more cautious, and that’s where the blue chips, or the value stocks, become more attractive because people are worried about future profits getting eaten up by higher costs and higher interest rates with these growth stocks.
That’s why the Nasdaq stocks and tech stocks are taking a bit of a hit, but as you mentioned, the Dow was sitting at record highs just last week.
Markus Heitkoetter: I just want to put it in perspective a little bit. According to a weekly chart of the Nasdaq, with the drop that we had yesterday, we are down 8.4%. So around eight and a half percent. This is something that we saw also in March.
In March the markets went down by 12.5%, and we have almost forgotten this now. First of all, a true correction in the market is defined as 10% or more. So at 8.4% we’re not even there yet, but let’s take a look at a few other drops that we had earlier this year here.
There was another 12% drop, a 14% drop, and then, of course, last year, this is where everybody got super spooked during the Covid drop, right? This is when the Nasdaq actually dropped 30 percent.
But I mean, things like this happen in the markets all the time. It is absolutely normal. So will we, right now, see a 30 percent drop? Even if we do, so what?
If we were to look even further back, we would see these retracements happening all the time. July 2019, we also had a 9% drop in the Nasdaq. Before that going back to April/May in 2019, we had a drop of 12%.
Towards the end of 2018, it’s so long ago, we almost don’t remember anymore, but we actually had to drop off of almost 24%.
We have these healthy drops all the time and they need to happen, right Mark?
Mark Hodge: Exactly, and I mean, that’s a good point, Markus. It’s healthy for the market to pull back, to retrace, and it does create a buying opportunity. So a 10 percent retracement or correction is normal. Now a 20% drop is a bigger deal.
The 30% drop that we saw with the pandemic, that was a big deal. You know, that’s where people are getting fearful and they’re pulling money out of the market, but right now, people aren’t pulling money out of the market.
Money might be going into blue chips and then people might be seeing a buying opportunity in tech, but it’s definitely not the same thing, at least at this point.
Where Does The Money Go?
Markus Heitkoetter: You know what, Mark? Let’s actually talk about “buy the dip,” what it means and why it exists.
First of all, money doesn’t disappear. You see, after we see a run up, or even when the markets are making new all time highs, traders who bought at this point are eventually going to sell at some point and take profits.
Now, what happens when you’re taking profits? Money is being deposited into your account. The key question is, what do you do now with this cash? That’s where we have kind of the Holy Trinity, where we have, on the one hand, money market accounts.
This could be like CDs or something like this where we are earning interest rates. So this is one way where you can put money in it. Mark, what is the interest that you are getting, 0.1% or 0.15%?
Mark Hodge: Not much, say just say zero.
Markus Heitkoetter: Then of course, you have the stock market that you can invest in. So the stock market is another way where you can put money in, and then finally, you also have real estate. So this is where we have this holy trinity. So money is not just sitting in cash because I mean, cash is trash, right?
You might have heard about this, and since right now in the money market accounts, you’re not getting any interest, this is why a lot of money is right now flowing into the stock market.
But then at some point you are taking profits. When you’re taking profits, what do you do now? The real estate market is super hot. I mean, Mark, we talked about it the other day. I mean, houses are going on the market, and within a day or two, they’re being snapped up.
So it is clearly right now a seller’s market, and in a seller’s market, you don’t want to be a buyer. I invest in real estate, and right now I don’t want to be a buyer.
Mark, you had an example of something that happened in your neighborhood, right?
Mark Hodge: Yeah, in Sacramento. It was, I think about a month ago, I believe it was 122 offers on just the normal three bedroom, two bathroom house in one weekend with multiple offers over the asking price.
I want to say they haven’t turned down a $500,000 offer because they wanted to extend the whole process. But anyway, real estate, it’s crazy right now. Markus, I mean, you were looking at even buying a resort.
Markus Heitkoetter: You can’t buy a resort right now if you wanted to. I mean, I’m trying to buy an apartment complex, and you can’t, I mean, it’s crazy the prices they’re asking for them.
The other thing that is interesting is that the stock market and the real estate market, both historically just go one way, and that’s up.
Now, what about interest rates? Interest rates on the other hand, they fluctuate and they stay in a range. Remember the time when we had 10% interest rates? Nine% was this in the 90s? Mark, do you remember?
Mark Hodge: I believe it was before the 90s. I think it was more the 80s. It’s been a while.
Markus Heitkoetter: So it has been quite a while, and right now there’s not much money in cash. So it is fluctuating between the stock market and the real estate market, and it is not really that interesting right now.
If you were to look at a monthly chart of the Nasdaq, one thing that you see in the stock market is it’s constantly going up. Now, in between there are a lot of little dips, and those are absolutely healthy. Those are happening when there’s profit taking.
What Causes The Market To Crash?
This is why in the long run it has paid off to invest in stocks long term. So why, besides the profit taking, do we have these dips? Why could the market crash and why could we possibly see a market crash now in May?
There’s two reasons why markets go down:
Number one, there is just simply some profit taking. If a market is getting too hot, then profit needs to be taken out of the market.
Now, number two is uncertainty. Traders don’t like uncertainty, and right now, we do have some uncertainty going on.
Let’s talk about the economic calendar. Last week, we had pretty bad news from the stock market. The unemployment rate actually jumped up from 5.8% to 6.1%.
That’s not good for the economy because when people talk about how is the economy doing, the one key indicator, Mark, is jobs. Right? When you say in an economy that is doing good, unemployment is low.
Last year when we had the pandemic starting, it was just going out like crazy, the unemployment rate and it was going down, down, down, but now it is going up. So one thing that traders are concerned about when it comes to the market is unemployment.
The other thing, Mark, and this is what has been spooking the investors this week is inflation. So inflation is the next spooky thing. And inflation, the Fed has a target of 2%. What does it mean year over year? We are OK with prices going up by 2%. Now Mark, let me ask you, how does the Fed control inflation?
Mark Hodge: With interest rates.
Markus Heitkoetter: Right, Interest rates. So what the Fed does is if inflation gets high, is they start raising interest rates and therefore inflation usually goes down again.
This is the tricky part, because we need interest rates low because low interest rates are leading to jobs. How do low interest rates lead to more jobs?
You see, this is why we are talking about this today. I think it is super important that you understand a little bit of what’s behind the market so that you don’t panic when you see the market going down for two days in a row, and dropping maybe 8% in a week or two.
How do low interest rates create more jobs? Well, first of all, lower interest rates allow companies to borrow money cheaply for expansion.
So today, everything is pretty much in the green. You see up at the top, all of these stocks are these so-called growth stocks. Down below are where you have the value stocks. Also, growth stocks are usually in the Nasdaq, while value stocks are more in the Dow.
So especially these growth stocks, how do you grow a company? By borrowing money. And as long as interest rates are low, it is easy to borrow money and to grow to have healthy profit margins.
Now, if interest rates starts rising, this is increasing your costs, and when the costs are increasing, it means that profits are decreasing. This is the point and this is what it all boils down to. So it’s Interesting for you to see how this all ties together.
What Do We Do When The Market Goes Down?
Now the question is “what do we do when the market is going down like this?” I mean, Mark, we have several trading strategies, and one of the trading strategies that we would really like to trade is The Wheel strategy.
So what do you do when it is going down?
Mark Hodge: One of the benefits to the market falling is that when the market is dropping or there’s uncertainty in the market, then that means that options are getting more expensive.
So options are derivative and they are based on stock prices, and when the market is just kind of going up, things are complacent. Nobody’s worried about options. Prices are cheaper, but when there’s uncertainty, they expand, they get bigger, which means that we get to collect more premium.
So, I mean, that’s what we are doing this week. We are selling options on some stocks that we liked and that took advantage of the opportunity, took advantage of the drop.
Markus Heitkoetter: Absolutely. So a few puts that we sold is, for example, AAPL. We sold the 119 put, and this was just perfect. We got a lot of premium for it on the way down.
This is one of the trades that we did. Another trade that we took was Boeing, (BA). Boeing also a good trade as Boeing comes down, and especially over the past few days as we had the dip. This is when we can make a lot of money selling options.
We sold the strike price of 217.5. So if Boeing stays above $217.50, we just keep the premium. Otherwise we are getting assigned.
Then we have LVS. LVS is actually one of the stocks where we were assigned, we bought it at $58. Right now it is trading at $56.17, and we were able here now to sell calls. So this is what we did earlier this week. We sold a call with the strike price of 59, and we were able to buy this back today.
If you know how to play the markets, it is actually a good thing when the markets are going down because this is when you can pick up some really nice stocks.
We also picked up SNAP and again, Snapchat was going down, therefore we picked up the put. We sold this with the strike price of 47 expiring tomorrow (March 14th, 2021). Right now, it is trading at $51. This is great.
And then we also had SQ is pretty interesting because it really seems to be bound to bitcoin here and BTC right now is tanking.
Mark Hodge: Yeah, this one does some exposure to Bitcoin. I think it was like one hundred and fifty million or something like that, I mean not the one point five billion that Tesla bought, but they have some bitcoin exposure. So the lows today that were established with SQ were lockstep, same move that Bitcoin saw.
Markus Heitkoetter: Yeah, absolutely. So this is where trading The Wheel strategy when the market is going down, as it is right now, when others are taking profits and selling. This is when we go on a shopping spree. This is what we have been doing this week.
We just sold puts this week. Then based on what the stock price does, you might or might not get assigned. If you do get assigned then you are selling calls.
Markus Heitkoetter: I mean, this is just a strategy that we like to trade. It’s not for everybody. Because while you have these stocks, you can experience a drawdown in your account so you can have a huge unrealized loss.
For example, RIDE is a stock that I was wrong about. I sold the 21.50 and this is where I got assigned. RIDE keeps going down. So right now (March 13th) it is trading at a little bit less than $7. Now I was able to lower my cost basis to $15.23.
I actually was able to collect premium of more than $9,000, which is lowering my cost basis to a break even of around $14.30, but as you can see I’m still underwater water.
What you need during these times, it’s of course nicer when you have the index because the index is bouncing back fairly quick. Again, you see how many weeks does it take after a draw down before it bounces? One, two, three, four?
When we had this huge, massive drop because of Covid, it took us 11 to 12 weeks. That’s only three months here. Often see this also in stocks.
The question is, should we be concerned about a crash?
First of all, having a retracement here? This is not even a correction. Having a retracement of 8% is nothing. I mean, unless we start seeing something like we had 10 or 15 percent or 12 percent or 12 percent, or if you are going back in time, if you are going before the covid drop where we had, what, 24%?
This is when we are selling puts and by doing so we are getting paid for selling points and as the market bounces back up, we are buying it back. And if we are in a stock, we start selling calls.
So having a down market mark, for me that’s not scary. It’s a matter of can you deal with it? And yes, as a trader, you need to have a stomach for this. I mean, it is not for everybody, right?
I mean, this is where we are going back to the Holy Trinity. If this is not for you, these fluctuations, then consider money market accounts. I mean, right now, you’re not making a lot of money there, but this is where you can’t lose money. Well, you kind of do because of inflation.