Ivanhoff Capital

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Small caps had a huge week. Russell 2000 (IWM) gained 5%. It is back above its 50 and 200-day moving averages and near the technically important 160 level. Will it stay in a range or it will break free. This is the big question.

What is different about this rally is that it has been led by lagging sectors – financials, retail, etc. In the meantime, many momentum stocks took a sizeable haircut. When I say momentum stocks, I don’t refer just to software which has been in disarray for a few weeks now. Even stocks like CMG, CME, V, and MA took a hit – granted their pullbacks are just minor blips when viewed from a 10,000 foot view but nevertheless, they have shown notable relative weakness in a strong market.

To sum things up – it seems someone flipped a switch and we saw an algo-related move from momentum to laggards.The weakest performers of the past year went up 20-30% while the strongest lost as much.

I don’t know if I am looking at the wrong stocks (and I am basically looking at all of them), but I see more bearish than bullish setups which is weird with the major indexes near all-time highs. If this is the beginning of a new leg higher, we should be seeing more stocks breaking out to new 52-week highs from proper bases. Maybe this time is different? By all means, either the indexes will catch up with the momentum stocks or the momentum stocks will catch up with the indexes.

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The charts on Momentum Monday are powered by MarketSmith

SPY and QQQ are finally back above their 50-day moving average. This means that the breakouts that failed in the range-bound market in August are now more likely to work. TWTR is a good example. It was stuck between 40 and 43 for six weeks and now it has finally cleared its range.

What astounds me about this rally is lack of leadership. SPY is less than 2% of its all-time highs and there are very few stocks that we can highlight as leaders. The software and cloud names which have been leading for two years are still under tremendous pressure.

Typically new leaders emerge after a correction but the recent decline was not large enough to justify as a correction. This means that the so-called old leaders were supposed to bounce and be among the outperformers of this rally. Many of them have already experienced 20-40% drawdown, so if this rally has more legs, they should be bouncing. 

Some might say that software is in the toilet bowl because of over-stretched valuations. This is a strong argument but if people care about valuations, this rally is not going to last long. In other words, the indexes are still one tweet away from a reversal. While we are going to take some shots on the long sides, we are not going to jump with both feet.

P.S. Check out my trading books. They are super practical, packed with actionable information that can be put to use right away:

Swing Trading with options – How to Trade Big Trends for Big Profits

Top 10 Trading Setups – How to find them, how to trade them, how to make money with them.

The 5 Secrets To Highly Profitable Swing Trading

The charts on Momentum Monday are powered by MarketSmith

Do corrections end when even the last standing momentum leaders break down or do they accelerate? This is the big question for September.

The market is not in love with software stocks anymore. Many of them sold off after decent earnings reports – the same reports would have led to a gap up and new all-time highs just a few months ago. Many of the software names are back below their 50-day moving average. Some are even below their 200-day moving average. This is in stark contrast with what we saw during the last correction in May when most software names build new bases above their 50-day moving average. Those rotations are a normal part of the game. No trend lasts forever and apparently valuations are starting to matter now.

Is it possible that this is just one long consolidation after monstrous moves in the past couple of years? Anything is possible. If the earnings and sales keep growing with the same space, some of those names will resume their upward trajectory. This is often how big trends behave – in phase one, growth stocks can triple and quadruple simply based on expectations about strong future earnings. In phase two, earnings catch up with expectations or expectations catch up with earnings and the stocks have a major pullback. 

The main indexes are still trading in a range. It is funny how in a range-bound market the best entries are when the indexes are down several days in a row and everyone is afraid to buy new stocks and the best exits are when the indexes are up several days in a row and everyone is eager to put more money to work. It is the nature of the market – it often acts in a counter-intuitive way to most people’s psychology.

P.S. Check out some of my best trading books. They are super practical, packed with actionable information that can be put to use right away:

Swing Trading with options – How to Trade Big Trends for Big Profits

Top 10 Trading Setups – How to find them, how to trade them, how to make money with them.

The 5 Secrets To Highly Profitable Swing Trading