The small-cap Russell 2k (IWM) tested its multi-month range lows last Monday and it bounced again. The large-cap, QQQ, and SPY also recovered from vulnerable positions below their 50-day moving averages. The participation in the rally was widespread – from reopening stocks like airlines, casinos, hotels, cruise lines, and beaten-down sectors like biotech and ARKK to momentum leaders like semiconductors.
The range-bound market environment remains intact. You don’t want to get too bearish when the main indexes are down several days in a row in a range market as was the case last Monday. You also don’t want to get overly bullish when the indexes are up several days in a row in the same environment.
The last and the first week of the year typically feature big short-term moves in beaten-down former momentum names. I will be watching for opportunities in those. We already saw stocks like BROS and MARA perking up on Friday.
What really happened last week from a big picture perspective – anything high-growth and cyclical that had shown even remote relative strength finally caved in – the mega caps QQQ, semiconductors SMH, homebuilders XHB, financials XLF. It might seem dramatic to talk about a market correction with the S&P500 so close to its all-time highs and still above its 50-day moving average but there has been some serious damage under the surface. Many of last year’s momentum leaders are down 40-50% from their highs. There is a new group of stocks getting hit every week while the most-oversold sectors are having big 1-2-day short-covering rallies. All of this has created extreme volatility and choppiness which require all traders to be extra nimble or just step aside a wait it out.
The Fed wants to accelerate tapering and plans to raise interest rates three times next year in order to fight inflation. Initially, the market read this as complacency and underreaction. All stocks had a major rally on Wednesday afternoon. Most were given back on the following day. Friday was a quadruple option expirations day and we had some major mean reversions. The worst-hit groups in the past few weeks had a sizable bounce – biotech and high-growth, high-multiples software stocks. In the meantime, financials, homebuilders, mega-caps, and semis showed relative weakness. At least this market is not boring and riddled with high correlations.
SPY, QQQ, and SMH are now looking vulnerable to further downside if they lose their lows from Friday. The odds are that we will see more choppiness next week.
The large caps are holding above their big gap from last Tuesday and acting relatively constructively. Both QQQ and SPY have consolidated near a potential pivot. Going above last week’s highs would be a buying signal. I would not trust those potential breakouts for anything more than a quick scalp because there is simply too much weakness among individual stocks.
In the meantime, the divergences continue. While defensive sectors like consumer staples (XLP), healthcare (XLV), and some semiconductors are perking up, small caps and many software/internet stocks are under pressure. The recipe to surviving in this tape (meaning limiting drawdowns and if possible, growing our accounts) is to trade smaller and be selectively active, only focus on the best setups, and be willing to play both sides of the market.