Here are some excerpts from two subsections of the most recent Weekly Strategy Session, which I published earlier today. Keep in mind, this is just a small portion of the full Session, which contains tons of actionable trading ideas, specific price levels to watch on the major indices, educational material, and broad market context in the form of thorough current relevant issue coverage.
1. When Leaders Start to Lag in a Bull Market
…the weekly chart indicates the (XLU) ETF is back down to its rising 10-week moving average. The utilities may stabilize here next week, but there has been some damage done to a market leader, without question.
And now you can see on the S&P 500 Index weekly chart, first below, that stocks pushed to new highs, despite the weakness in the utilities. Also note on the second chart, below, that price on the weekly chart for the Nasdaq Composite Index has punctured its upper Bollinger Band (the S&P is essentially right at the top of its own upper weekly and monthly chart Bollinger Band, as is the Nasdaq puncturing its upper monthly Band, as well).
Generally speaking, when you see a major index puncture its weekly and/or monthly chart upper Bollinger Band it indicates a rather rare and overbought condition. We are not dramatically overbought here, however. And it is certainly not direct evidence of a looming market top.
But it does reinforce the notion of not getting lulled into complacency with trades, as Bollinger Bands are useful indicators for measuring relative tops and bottoms, if only for a respite before the trend resumes.
The reason why the broad market was able to continue its uptrend last week while a leading sector was harshly punished is because of the power of rotation. Indeed, we saw consumer discretionary stocks, financials, and materials all benefit from capital inflows. In lieu of fleeing equities as an entire asset class, capital remained within equity markets and rotated from leading sectors down to lagging or lesser-extended ones.
One week, however, does not a bonafide rotation make.
Headed into this week therefore, the suggested strategy is to key off several prominent stocks in the above sectors which are now at critical junctures.
(continued)
3. Animal Spirits Surge: Signs of a Maturing Bull
In addition to rotation, another hallmark of a maturing bull market is that speculation in higher beta, beaten-down stocks and sectors begins to run rampant. Furthermore, many heavily-shorted issues find themselves in the spotlight, featuring breathtaking short squeezes higher. Last week, we saw a notable uptick in both of those characteristics, with speculation running rampant in historically very high beta and extraordinary beaten-down China and solar stocks, like BIDU DANG TSL, sprinting higher into Friday’s close. Beyond that, GMCR TSLA and SODA stole many a headline with their vicious post-earnings short squeezes higher.
While bears will argue this type of speculation amounts to euphoric froth in the market and a sign of an imminent major top, keep in mind that timing a significant inflection point remains uniquely difficult, tops even more than bottoms. Moreover, the speculative fervor can continue for a while before it abruptly stops. Think of it as a game of musical chairs, with hot money-seeking traders following extreme short-term momentum in these high beta stocks and sectors. We want to acknowledge it and look for our spots to participate without over-expsoing ourselves to getting badly trapped when the music stops (or tops).
The reason why we see this uptick in speculation into lagging, volatile, and riskier issues is two-fold. First, many leading sectors become too extended and rich to not see some profit-taking, such as utilities and consumer staples. So, in a bull market some of that capital will seek to rotate down to beaten-down names. Next, a maturing rally becomes more selective in terms of the amount and nature of healthy, energetic breakouts in some of the larger cap, more marquee stocks. However, traders are still feeling increasingly bullish given the overall market action and improved sentiment. Therefore, they tend to congregate in that which is working well, particularly those high beta stocks offering the potential for fast, sizable gains.
Even as larger cap growth stocks like CMG LNKD VCLK see slowing upside price momentum or outright head-fakes higher and reversals lower, traders seeking immediate action were gratified in the high beta China, solar, and even some terribly beaten-up steel stocks.
With this in mind, the suggested strategy is to put in the work to identify other potential beneficiaries from the increase in speculation, without drifting too far away from your discipline. In other words, we want to be nimble enough to adjust to–and profit from–the signs of virile “animal spirits” in the market without leaving ourselves vulnerable to making undisciplined mistakes.
The best way to go about executing that strategy is to isolate those high beta stocks in the beaten-down sectors in play which are not yet too extended, and which are also sporting constructive technicals on their own merits. This is consistent with a focused and disciplined process, and often guards against emotionally chasing up volatile stocks in overall downtrends. While they are fun and exuberant on the way up, they are assuredly damaging to both capital and confidence on the inevitable ride down.
In sum, these signs of a maturing bull need not mean an imminent market top is upon us. However, we must acknowledge the increase in speculation taking place and seek to find opportunities without becoming too willing to buy any stock in any sector simply because it appears it may benefit from this change in market character.
4. Following Through
Given that specific strategy, the following three ideas are long setups…
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