This article was written exclusively for Investing.com
Stock markets around the world, including the S&P 500, are dropping as COVID cases rise across Europe and the US. Meanwhile, hopes of a US stimulus is all but fading. That is resulting in some options traders placing big bets that the stock markets will continue to fall after the election.
One has to wonder where the next bull narrative—to keep stocks moving higher—will come from. Earnings may not save the stock market this time around. In some cases, blow out earning reports haven’t helped to lift shares. Perhaps after all these months of stocks rising, valuations may even be starting to matter.
The recent weakness and sudden change in tone could be why, on Oct. 27 the open interest levels for the mini-SPX Index put options at the 300 strike price increased by approximately 18,200 contracts for expiration on Feb. 19. The mini-SPX Index trade at 1/10 the S&P 500 index value, based on the options trade, would imply that the S&P 500 index is trading at 3,000 or lower by expiration. The data shows the puts were bought for around $8.80 per contract.
Meanwhile, there have been some bearish bets building on the NASDAQ QQQ's. For example, the open interest levels for the Nov. 20 $265 puts increased by about 17,000 contracts on Oct.29.
Chart Courtesy of Investing.com
The bearishness appears to be coming in the face of some companies reporting robust results. Shopify (NYSE:SHOP) is one company that reported much better than expected results on Oct. 29. But it did not provide any guidance for the fourth quarter due to the uncertain environment. It resulted in the stock falling by nearly 5% the same day. Its stock has had a tremendous run in 2020, with the shares more than doubling. But that also sent its valuation skyward, currently trading at 268 times 2022 earnings estimates and over 25 times 2022 sales estimates.
Even shares of Advanced Micro Devices (NASDAQ:AMD) have fallen dramatically, despite reporting a better than expected quarter. It also outlined better than expected forward guidance.
AMD announced a widely applauded acquisition of Xilinx (NASDAQ:XLNX) for $35 billion in an all-stock deal. Still, its shares are down over 4% on the week. But then again, AMD finds itself in a similar spot as Shopify, trading at a lofty 32.5 times 2022 earnings estimates and nearly 6.6 times 2022 sales estimates, which are both very high for a semiconductor stock.
Even strong results and guidance from Amazon (NASDAQ:AMZN) and ahead of expectation results from Facebook (NASDAQ:FB) didn’t help to lift the stocks on Thursday afternoon. Both traded flat to their closing prices.
It seems entirely possible that valuations are beginning to matter once again. Then the S&P 500 index could have further to fall before bottoming out, especially if the liquidity that has driven asset prices higher stop in its tracks.
Currently, Refinitiv estimates that the S&P 500 will have earnings of roughly $161.56 in 2021. That means that the Index is currently trading with a one-year forward PE multiple of 20.6. Which is historically a high multiple for the index. It tends to average around 16 to 17. Then it might take the S&P 500, falling to approximately 2,750 before being fairly valued again.
It could very well be that the dynamics of the market are beginning to shift. Especially with a high degree of economic uncertainty as the pandemic continues to circulate and lead to shutdowns in parts of Europe. A stimulus deal may now be on hold, with an additional layer of uncertainty, until after the inauguration in January, resulting in a challenging period ahead.