The Technicals Setting Up For Potential Flush Out

Inside Stocklabs we have mean reversion algorithms that measures greed and fear across all asset classes and stocks and measures the returns of them after achieving extreme levels. We are presently OVERSOLD on the 12 month algorithms; but the data is mixed.

First I want you to see the level of the OS at 1.56. The oversold levels change with markets. For example, during a bad bear market, the OS will be deep, as low as 0.9; but during great bull runs it could be shallow, above 1.6.

If you look back to 2022, during the down 32% year for markets, the OS was at 1.35.

Here is the backtest data for this signal over 5 years. Although the returns are all positive, you can clearly see it starts to pick up in earnest after the 5th trading day.

This dreary technical pattern screams danger and because of that, caution should be exercised. By that I mean raising some cash, hedging via puts or inverse ETFs, waiting it out until some green candles appear.

Yes markets ultimately trade higher and yes this rout isn’t rooted in anything substantial; but it is happening and the seasonality of it happening is worthy of note.

For example: the $SMH is already down 11.7% for September. How does that compare to previous bad Septembers? Lucky for you, I have the data.

Note that all of the other years when the $SMH lost double digits it was in bear market years: 2022, 2008, 2000, 2001, 2002.

Clearly, this sell off is extreme in the context of historical declines and we all know the semis were very overvalued. But overvalued or not, these sort of declines are normally not sustainable lest paired with bad news. Well, where is that bad news? My sense is, this squall will end soon and markets will jump sharply, so try to stay in the game and manage your risk until we get the turn.

Quick thoughts since I am super busy right now and won’t be able to pen a closing blog.

Today’s rout should not be taken with a grain of salt and you should not believe just because we knifed lower this week we’ll rally next.

The $SMH is off nearly 12% for September, and the month just got started. As such, I liquidated many so called “long term” positions to raise cash.

Because of the technical breakdown, any substantive rally will be sold or there will be sellers present to make it difficult without news.

The range of losses for the $SMH during September has gone up to down 32% on several occasions and it is not atypical to see it lower by 13%. That said, we are either at the early stages of a market rout or the mean reversion will kick in sometime soon.

Gun to head feeling: we trade lower early next week and bounce around Wednesday.

At first glance it looked like the perfect jobs report, not too hot or cold, suggestive of a Fed 25bps cut. And then the downward revisions came in and then the breakdown of migrant v native employment and boy is that something to look at.

To be honest, I don’t even know how to react to numbers like that. A loss of 1.3m jobs for Americans in August and not a peep? Who is warning? We haven’t seen anything out there to make these numbers make sense.

It looked like markets wanted to rally, with futures climbing over 150 off the lows. But now we are steaming lower, amidst a frozen bond market and bullish commodity tape. Make it make sense.

At the present, I’m 105% long, taking some hits, down 65bps.

The weakness is once again centered in semis and small caps. You can toss away the smalls because who really cares. And then we are left with one: $NVDA. Markets do this all the time: using a nation like China or a stock like $AAPL or in this case $NVDA has lynchpins to the overall health of the economy. If you remember back in 2015 when Trump was discussing tariffs on China, that seemed like the very worst idea in the world, for traders.

And then he did it and nothing happened.

We are now in the era of $NVDA, and this too shall pass. There will be a new era in the future based around the cult of a leader or a concept or a company and markets will jostle between the great many changes that are both real and perceived.

Ultimately, the S&P is +16% for the year and if the year ended now, that would be viewed as a fine year. It isn’t all good and it isn’t all bad, like most things. The market is nuanced and manifests itself across asset classes based on assumptions

Right now we are assuming the semis are cooked. Are they?

Let me preface this blog by stating I am 100% long and bullish. I am bullish for various reasons, in spite of the recent technical carnage that has caused traders so much anguish in this little squall. It might seem like a significant moment but this too shall pass and become nothing but a faint memory in the grande scheme of things.

Reasons to be bullish:

1. Election year
2. Nothing bearish has actually occurred recently
3. Earnings have been good.

Reasons to be bearish:

1. Seasonality
2. Valuations on tech is at historically high levels
3.Technical patterns might indicate a worsening is looming

What do I mean by the last statement? I mean a head and shoulders formation on the $QQQ now.

It’s not the cleanest pattern but it’s there. But it’s not the pattern of the head and shoulders that is important but the psychology. It goes something like this: Oh gee isn’t this great. The dip was bought and we are heading to new highs. We are at new highs and we hope to go higher. We have cracked lower, quite sharply, and I hope we bounce, else all is lost, apparently. We V shaped higher and might be barreling towards new highs again.

Lastly, oh no we are cracking lower again. Maybe I should take some recent gains off the table in the event we “retest recent lows”.

Price action is always driven by core fundamentals in the long term. But there are peaks and valleys along the way and those are dictated by greed and fear, the relationship between people and their money.

We measure the fear and greed in Stocklabs using algorithms and they’re called mean reversion signals. When technical levels reach a certain point there is a catalog of history to reference to see how that relationship held up in the past. We track the performance in what is called “back testing. ” Presently we have oversold signals in the $SMH and $QQQ and the data is strong, suggestive that in previous occasions at these technical levels, people bought stocks. Naturally, every time is different and past results are not indicative of the future. But like the saying goes “history often rhymes” or something akin to that.

Let’s see how this plays out.

I know the market looks terrible and futures are sharply lower this morning; but isn’t this a little maudlin? Are we so predictable that we’d crash September again only to recover in October and then sail into 2025?

Boring.

This is an election year and although Harris is talking about taxing unrealized gains; that’s never going to happen. The way I see it, $NVDA just posted great numbers. People panicked about OPEC increasing supply but that’s going to get delayed, according to today’s report. We have some mean reversion signals flagging inside Stocklabs and frankly I see no reason to all of a sudden believe that it’s over.

It’s been over for some time now yet market continue to make new highs. Don’t get me wrong: I’m receptive to a bear raid and might even end up shorting today. But if we’re talking beginning of a long protracted move lower, I’d have to argue against it, even though my heart and soul would really prefer it.

One last thing: I’m malleable to the market winds and I say that not to couch my current feeeeelings but to state a reality about me.

If you notice the site looks different it’s because I finally nuked all of the other distractions on the site, blogs not updated in years taking up space. It’s just me and you now, at least for the moment.

I’m here stuck in Boston with barely any internet connection at my daughter’s apartment, building furniture just purchased from Ikea because Mrs Fly once had fond memories going there when we were in our 20s. I keep telling her “ikea is shit” and would prefer buying an already made dresser and bed for $10,000 before having to build another one — yet here I am amidst market tumult and me with 20,000 pieces of cheaply made cardboard and instructions in Swedish attempting to piece together a room.

FML

I have barely any insight into today’s tape other than the obvious: semis and much of tech crashed lower and defensive stocks were solid. Yields dropped and commodities were destroyed. This type of action spells economic slowdown or recession; but we’ve seen this sort of action before and have it be a temporary glitch en route to higher prices.

I did what I could today, trading inverse ETFs various times for profit and definitely reduced my losses but still shed 224bps. Many traders must feel shoehorned after recovering the past two weeks only to be destroyed on the first trading day of September, a month rife with cataclysm.

Much of the worry is in regards to the price action at $NVDA. We already know the fundamentals are good, so now it’s simply a matter of people and confidence.

Ultimately you spoiled brats have to accept that markets will trade down on occasion and lest you’re willing to turnover your portfolios daily or entirely hedge at the first sign of weakness, you’re bound to have days when drawing down is inevitable.

The concern now is whether today was a one off plunge lower or the beginning of something greater. We shall see soon.

I’ll be out of pocket most of tomorrow and flying back to NC in the evening.

Statistically, September is the worst trading month of the year and we’re starting with a plunge this morning, with semis off by 3%, oil hammered for 3.4% and most risk areas of the tape lower.

September corrections are so cliche at this point you’d think it would eventually lose its luster and offer some contrarian signal. But alas…

The weakness in crude isn’t new and the growth in Chinese EV’s isn’t helping with the supply and demand aspects of the commodity. I’d argue that copper had been behaving better but even that is lower by 3% this morning.

The only question I keep asking myself today is “is this plunge legit or just another morning head fake?”