Month: May 2022

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We finally saw the bear market bounce many were waiting for. It started with a bullish momentum divergence the previous Friday and it followed with a widespread buying after the Fed minutes were released on Wednesday. The minutes didn’t say anything new – most board members are for multiple 50bps increases in interest rates and yet the stock market bounced hard. Something has shifted in sentiment and all of a sudden we saw positive market reactions to bad earnings reports. It’s anyone’s guess how long it is going to last. We will dance until the music is playing. The next major technical resistance levels are 420-430 for SPY, 320-330 for QQQ, 80 for the biotech ETF – XBI, 190-200 for the small caps Russell 2k (IWM).

The current earnings season is coming to a conclusion. The latest themes:

1. The resetting of expectations continues with full force, especially in the tech sector. Companies are either missing estimates, guiding lower, or both. The silver lining is they have managed to lower the market expectations so it’ll be easier to surprise in the future.
2. The impact of Inflation is not distributed evenly as of now. While Walmart and Target said that costs have gone up more than expected and their customers have changed their purchasing habits due to higher inflation, Nordstrom and Williams-Sonoma pointed out that their clients are not having those issues yet. It only makes sense. Higher inflation typically hits first people with less income. 
3. The most heavily shorted stocks are missing estimates, gapping lower, and then squeezing higher. We saw that in companies from various sectors – USPS, DKS, BROS, etc. This is a normal part of the market structure. Every share that has ever been sold short will have to be bought back at some point. High short interest can be a source of solid future demand. What better time to proactively cover a short position than after a prolonged downtrend followed by a big gap down on weak earnings? Granted, many of them will probably set up again on the short side in the near future.

In the meantime, anything related to energy continues to be among the price leaders. Oil &  gas stocks went up about 20% across the board last week as natural gas hit 12-year highs. Lithium stocks have also been on fire as it is needed in the clean-energy space – LTHM, ALB, LAC, SQM.

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That bear market bounce didn’t last long. SPY and QQQ rallied to their previous low where they found resistance. Then, they continued down and finished at new 52-week lows. The silver lining is that many stocks and ETFs did not make new 52-week lows alongside the indexes which is a bullish breadth divergence. This is not a reason to buy blindly; just a signal that selling is starting to weaken.

In a bear market, eventually, all stocks get hit. We saw a glimpse of that last week when even consumer staples like Costco went down more than 15% on weak earnings reports from competitors Walmart and Target. Everyone’s favorite Big-Tech stocks have also been under heavy pressure as they have become a source of liquidity for many – AAPL, GOOGL, MSFT, AMZN, NVDA, and TSLA are down 25-50% from their 52-week highs.

The issue with prolonged downtrends is that they can become self-fulfilling prophecies to a certain degree. Companies without a positive cash flow have to raise more money to survive which means diluting current shareholders. Younger tech companies that compete for talent with Big Tech, have to give their employees more stocks and options to keep them from leaving – which means again diluting current shareholders. In a way, lower prices bring more supply from both the companies and shareholders who want out. This is why most rips don’t last long during downtrends. There’s too much overhead supply.

The good news is that the market is cyclical and no trend lasts forever. Out of every bear market and economic situation, there is always a new set of winners that will set up and go on to make 5-100x returns. This one won’t be any different. 

In the meantime, it pays to remain nimble (focused on really short-term trades) and with a high cash position. 

Here’s how I think the three stages of a market bottom are formed:

Stage 1 – Bullish breadth divergences – the main indexes will make new 52-week lows but many stocks and ETFs won’t. This is not a reason to buy. Just a sign that selling might be getting weaker.

Stage 2 – Heavy-volume wide-spread buying – the majority of stocks and main indexes go up 5-10%+ on 3-5x their average daily volume.

Stage 3 – More and more long setups start to show up and breakouts are following through. If this does not happen, Stage 2 is likely to be just a bear market bounce and new lows are likely to follow.

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One of the major characteristics of bear markets is very high correlations between stocks regardless of their current or expected fundamentals. We saw that last week when in the first half most stocks sold off together and in the second half they rallied – again together. 

During market corrections, some religiously look for stocks that show relative strength. The premise is simple – if a stock tries to break out to a new 52-week high while the general market is selling off, it is likely to be a future momentum leader. We have seen this time and time again. One of the most recent examples is Cloudflare (NET). Between February 20 and March 5th, 2020, NET rallied to new all-time highs. At the same time, SPY dropped 15%. At the time, I wrote that NET is likely to be a future leader. Guess what happened in the next few weeks. The market accelerated lower bringing down everything with it. In a few short weeks, NET went from a new all-time high to new all-time lows. When the market calmed down and started to climb, NET quickly made new all-time highs and it went up 10x from there.

Keep a watch list of growth stocks that hold well and even try to make new highs when the market is in a correction but keep in mind that those growth stocks are not very likely to make big sustained moves until the market starts to climb.

We are in the midst of a bear market bounce. It could last only a few days or a few weeks. Any such climb would be a climb of a wall of worry. After a few months of selling, most market participants are not thinking about buying dips blindly and are not trusting the rallies. It will take a long time for this sentiment to change which means that excessive volatility and frequent reversals are still here to stay for the time being.

Try my subscription service which includes a private Twitter feed with option and stock ideas, emails with concise market commentary and actionable swing, intraday, and position trade ideas, the Momentum 40 list of market leaders, and much more. See some of the recent testimonials.

PERFORMANCE

Here’s a Google spreadsheet tracking all closed options and stock ideas shared on my private Twitter stream and emails for subscribers.

Check out my free weekly email to get an idea of the content I share with members.

Disclaimer: Everything I share is for educational and informational purposes only and it should not be considered financial advice.