Market breadth lurched to 10-month lows this week. Very similar to what we saw as the 2022 bear market went into overdrive to the downside:
With both the Russell Microcaps and Russell 2000 leading this long-term bearish backdrop to the downside the past few months, the selling accelerated in other major indexes last week. As of late Friday afternoon, Mid-caps were next in line to break to new 52-week lows (seasonality, be damned):
By utilizing a weight of evidence approach, I was able to flag the deteriorating breadth in late August and visualize the move in the Russell 2000 to new lows. Since then, I have been almost entirely in cash, focused mostly on the short side.
In the very near-term, while we are very oversold and could soon see a furious multi-day rally begin at any moment, for those who are still relying on the seasonal calendar to save the day, I have bad news: its impossible to have a sustainable intermediate-term rally when there are only 26% of stocks on the NYSE technically healthy; until this indicator turns up in a decisive manner, all rallies should be viewed with extreme caution and suspicion:
No trick or treat under the hood in Nasdaq-land. With this indicator firmly entrenced in bear market territory, is there a scary end of the year coming? I think so...
Pivoting to the most important inflection point of the year – the generational bear market in long-term US bonds – hat tip to Tony Dwyer, who put out a phenomenal piece last week. In it, he gave an important history lesson: during each of the four recessions between ’68-’82, rates on the 10-year actually rose to new highs DURING the recession, not before it:
While rates have moved decisively higher and 5% is a logical spot for consolidation for the 10-Year, with odds favoring a Government Shutdown in a few weeks, are the bond vigilantes really done doling out fiscal recklessness lessons? I don’t think so. What do you think?
Moreover, with so much Treasury issuance forthcoming the next few quarters, the main pain point for the long end will continue to be the stark imbalance in supply relative to demand; there simply is not enough long-term buyers willing to commit to buying our long-term debt at these levels. Especially, with the strong PCE we had this week:
If I am Powell, I would be shaking my head in disgust after seeing the U. of Michigan forward inflation expectations inflect higher to 4.2%. Should higher inflationary expectations become embedded in the consumer mindset, this would be a huge blow to the Fed’s ability to successfully snuff out inflation anytime soon. The only way to kill inflation is with a recession. How many more Fed hikes will actually be needed to tame inflation? More than one I fear…
The current correction/nascent bear in various parts of the equity markets has been catalyzed by the move higher on the long-end, not by an earnings recession (although that should come next if the economy weakens further in the coming quarters).
Should the 10-year break above 5.20%-5.40% (1-in-3 odds) a parabolic blow-off in the 10-year toward 6% could come into play.
Any such move would be “Game, Set, Match” for equities:
Long-term bearish slant aside, I am currently not interested in shorting in the very near-term.
We are extremely oversold.
If this long-term bearish backdrop were to follow historical patterns, any cylical bear would, most likely, last for 8-9 months. So, odds heavily favor very tough sledding through the winter and more time for a # of tricky counter-trend rallies to materialize.
In a bear market, patience and discipline are paramount.
Bear market rallies are prone to torrid, salacious rallies that will test an investors discipline.These rallies can extend not only for days, but also, at times, for weeks and months. The hardest part is waiting for these rallies and then selling into them.
But that is the best formula for success in a bear market.
For the time being, the QQQs have been the only index remaining above their 200-day SMA.
What if Apple disappoints badly next week? Any break below the 200-day - $338.53ish - on the QQQs would catalyze further downside for the other indices. Things will get very messy on any such break:
As an inflection point sharp-shooting specialist, each earnings season always serves as the breeding ground for such new leaders to manifest themselves.
Dexcom, Inc. (DXCM) posted another strong beat. I really like the company’s execution and the material inflection in profitability:
Unfortunately, DXCM is part of a very weak group and its chart is in a strong down-trend. So, a pass.
Appfolio, Inc. (APPF) posted a phenonemal inflection quarter. Top-tier growth. If the market were right, I would have exited the week with a very high allocation in APPF. Discipline trumps conviction in a long-term bearish tape, however, so I did not pull the trigger in the name.
Mark my words though. APPF is poised for strong upside longer-term if they keep posting beats like this:
NerdWallet, Inc. (NRDS) piqued my attention this week with this beat:
Has NRDS logged a durable long-term bottom? Perhaps. One to work on in the meantime:
On the short side, are the cyber names going to be the next set of breakout failures like we saw in GOOGL? I believe so.
For those corrections which worsen and morph into a bear market, almost all leading stocks will succumb to the cluitches of the bear. Breakouts fail because in worsening backdrops – such as the current one – all stocks eventually become sources of cash for investors.
Palo Alto Networks, Inc. (PANW) looks very dangerous here. I plan to short on any close below its 150-day SMA at $225:
Is the top in for Cyber Ark Software Ltd. (CYBR)? The stock’s inability to break to new highs suggests lower prices are forthcoming. Watch out below on any break of $150, its 200-day SMA, and then, thereafter, $148:
TransUnion’s (TRU) materially guide down was the worst negative inflection I saw this week. The conference call was ripe with real time 411 on the state of the U.S. consumer. Has a mild consumer recession begun in the U.S.? This commentary seems to tilt the odds to this being the case:
After covering my short a bit early, I am looking to re-short on any rally to $46-$48 next week:
Were Align Technology, Inc. (ALGN) to rally back to the $200-$210 zone, I would short it there:
Costco Wholesale Corp. (COST) looks very toppy to me. I will short it on any close below its 150-day SMA in the coming weeks:
Financials (XLF) are poised to head to new lows.
Any final pull-up to $31.5-$32 early next week looks very shortable to me:
PepsiCo, Inc. (PEP) is in a very strong downtrend. A close below $158 is where I plan to press a quick short scalp:
Should a recession finally occur, its hard to see how even a top-tier language learning app would not see softness in its business in the coming quarters.
Duolingo, Inc. (DUOL) is a short should the stock close decisively below its highlighted 200-day SMA:
The current backdrop is rife with danger.
Should this correction morph into a classic cyclical bear, remember, the big downside occurs in short stretches. 1-2 big days in downdrafts account for a big part of losses in down-legs. The rest of the time the bear will frustrate all, even those playing the short side.
With earnings season climaxing the next two weeks, my attention remains focused on ferreting out the top inflections, both good and bad, and then generating alpha on such trades.
Because shorting is very difficult, however, it’s imperative to not overstay one’s welcome in those trades showing a profit. In and of itself, this is another reason why I trade so minimally in these backdrops.
In due time, all the bad news will be discounted and, eventually, stocks will begin to rally on bad news and a new bull market will emerge, seemingly out of nowhere.
Are you getting ready for that? I am.
That’s where my big money is made - on the other side of bad market corrections and long-term bearish tapes like this one. Viewed from this prism, I am expecting a big 2024. What about you – are you visualizing your next period of outperformance yet and putting in the work to make that positive manifestation a reality?
Important question to ponder, isn’t it?
A good weekend to all.
