Hi friends,
Another week has come and gone, and a hot summer is approaching. Stock market action is equally torrid – there is lacklustre sideways action and lack of conviction in both price and volume almost anywhere except in low-quality issues, broken ex-leaders from 2020, and some strong action in micro-cap market fleas.
Unchanged from the last couple of months, the market is 98% driven by over-bullish sentiment in AI-exposed mega-cap stocks (the mega-8), a large wave of bear market short-covering that is near the end of its unwinding, and renewed blind ETF purchasing since the arbitrary 20% mark in SP500 has been made.
But ponder what’s leading this market – while the cap-weighted SPX is up strongly, the equal-weight index (RSP) is meandering sideways. Roughly 32% of the S&P500’s impressive rally is driven by 2% of its stocks. Is this what a “strong market” truly is?
Social media “experts” are more and more pushing technical setups of stocks with high overhead supply and bad price-volume action – and as good as all are pushing the same names. Such “overcrowded” stocks have the nasty habit of whipsawing heavily, and rolling over with almost annoying frequency. Various metrics of sentiment are signaling euphoria of amateur and even professional market participants, the VIX is near historic lows, and the bull/bear newsletter ratio is showing that 3x more writers push the bull narrative.
This would be all nice and tidy if this market was driven by new high-quality issues, tons of stocks made new Highs on a daily level, and capital was flowing broadly into the market. But virtually none of these can be seen, and such a thin market led by old played-over stocks and flagrant piling into safe-bet blue-chips cannot lead anywhere but chaos … eventually that is, because euphoria can carry on for a very long time. Be prepared that this could stay such a weak market for a while.
Earnings season is coming in soon, and the concomitant liquidity might be a catalyzer in both directions.
Air-pocket in mid-/small-/microcaps
Volatility has once again risen, as a sudden gap last Thursday appeared across everything but the crowded mega-cap stocks (e.g. see below the mid-/small-cap Russell 2000 index IWM). This was followed by another meek rally on Friday.
Very typical action of such a thin, precarious market.
“Chop” has been the mantra of the broad market at the moment, and more risk-on equities from the small- and mid-cap arena have been going nowhere but sideways since over a year:
Money remains rotating into defensives & cyclicals
The stock market has sure earned its label as a “mosaic” these last few months (or perhaps as a game of musical chairs?) Money has been rotating in and out of specific cyclical groups, from transports, industrials, electronics, construction, healthcare, homebuilders, food and consumer staples.
This has been going back and forth, in a common theme of parking money in high-earnings stability stocks by those that do not quite believe this over-complacent blue-chip bonanza that is unraveling in the popular NASDAQ-100, NASDAQ Composite and S&P500.
Specifically, healthcare defensives (e.g. LLY, CAH, MCK, ABC), transports and homebuilders have been strong the last few weeks. While healthcare defensives rallying is textbook bear market behavior, transports and homebuilders popping up is a good signal, potentially showing bettering for the long-term. But then again, they’re just not enough to call this a broad rally. To boot, these sector drifts are not led by strong high-quality issues, rather by sluggish action of the industry titans with almost total lack of more dynamic leading stocks. Lastly, almost all of them have failed to reverse the long-term side-ways chop/down-trend and refuse to follow the “in AI we trust” tech mega-caps (e.g. transports DJT below).
Leading stocks lacklustre
Although there are a few interesting prospects of stocks holding up well (e.g. ACLS, SMCI, RMBS), few of them are truly fresh ideas and none of them shows price-volume action that is, so far, conducive to risking a whole lot of capital in this market. There are also a couple of more thinly-traded stocks lifted up by AI sentiment (e.g. SYM, OPRA) that have appeared on my radar. These may yet develop into something stronger and actionable, but as a group they are just not enough to declare this a strong market. Until I start seeing 20-30 stocks like the above-mentioned ones, forming strong trends and constructive digestions, I will not be inclined to risk my hard-earned money in this environment.
Conclusion
Every environment will offer some opportunities. Otherwise the vast majority of speculators wouldn’t be lulled constantly into dipping their toes (or outright cannonballing) into such markets. However, most environments do not offer low-risk opportunities, and we always have to keep in mind that hindsight is 20/20. Yes, a stock like OPRA may look impressive. But when you truly look at how many a stock you would have had to probe into with low-quality and high-risk entry points to get in, how many losses and whipsaws you’d have to have taken, at the bottom line you would be still near breakeven … if you’re lucky that is.
Markets are good when very many strong opportunities show up, almost more than you can handle, and when the odds of success in such stocks are high. Both those factors are currently absent, which is enough for me to know to not put my hand in the fire, a fire that looks so alluring to many amateurs and impulse-driven professionals to play with.