The market strives to be forward-looking. One can make the argument that it is currently discounting the potential of a second Covid wave or at the least, the realization that the virus might stay with us and impact every aspect of our lives for a lot longer than previously expected. This would explain the extreme strength in software, online retail, biotech, protective gear equipment, diagnostics test stocks last week. So many new all-time highs among those names. Even gold woke up from its nap last Friday. Clearly, the market is confident that the Fed will bail everyone out and it is trying to highlight the potential winners in a Covid world.
The indexes have the uncanny ability to erase two weeks gains in two days. Last week, we finally saw some deflation in the frothiness that had captured the market. Almost 99% of all stocks went down on Thursday. SPY dropped 6% testing its 200-day moving average. QQQ dropped 5% testing its 20-day EMA. Such big one-day drops often act as a wake-up call. The odds are that now the chasing is not going to be as mindless as in May but turning excessively bearish might be premature. Here’s why.
The price action in the past couple of months has created a buy the dip mentality which is likely to continue to support the indexes for the foreseeable future. This is not going to change easily. Even now, there are quite a few momentum stocks that are consolidating in a range and acting constructively. And yet, the trading environment has changed from a clear uptrend into choppy which requires a lot more nimbleness and careful tactical allocation.
In March, people were talking about another Great Depression. Three months later, we are talking about new all-time highs and Nasdaq 10k. Other than Central Banks pumping liquidity into the system, no one can really explain why the market is going higher. It just is. What if rising prices turn into self-fulfilling prophecies and they actually help companies become stronger businesses? This is how reflexivity works.
Last week brought another round of sector rotations – the U.S. Dollar and Treasuries dove, the leaders in software and biotech took a break, while the so-called old-economy sectors shined and had a spectacular short squeeze. There’s some element of complacency in the market right now but the market can remain frothy longer than short-sellers can remain solvent. Don’t chase blindly extended stocks but be ready to welcome dips as buying opportunities.