2019 Stock Market: 2007 or 2010?

The recent bounce in the stock market has been nice, but it tells us very little about whether it will continue…or roll over and make new lows. The biggest problem is that the recent rally is nothing more than what we usually see at the beginning of a bear market, so nobody can say that the worst is behind us..That said, we readily admit that the recent action does NOT mean the stock market will DEFINITELY roll-back over into a important bear market.  It’s just that bear markets ALWAYS see the kind of bounce we’ve seen recently…in the MIDDLE of the decline…and long before we reach the final low….and thus investors need to be careful over the coming days and weeks.

In fact, the action we are experiencing right now is almost exactly what we saw in late 2007 and early 2008!  Back then, we experienced EXACTLY what we’ve seen over the past few months.  After a fabulous bull market…and after a “double-top”…the S&P saw a strong decline of 18.3%.  This was followed by a bounce of 12% (a 50% retracement of the sharp decline)…..The problem is that this action was then followed by a severe decline to lower-lows…and a horrible bear market.

This time around, we’ve seen a similar “double-top”…followed by a very similar initial decline (of 19.8% this time)…and then a sharp bounce which also retraced about 50% of its initial decline…just like it did in early 2008.  (On top of this, the 4th quarter initial (sharp) decline had two very-short-term bounces of 6%-8% before it bottomed just below bear market territory…which is exactly what we saw back in 2007 as well.  How weird is that???)

Oddly enough, the bear market of 2000-2003 got ALSO got off to a very similar start.  It’s initial sell-off was 16.8%…followed by a 8.6% bounce (or a 45% retracement of the initial decline)…but then rolled back over into a horrible bear market.  (The initial decline only had one bounce back in 2000…instead of two (like it did in 2007 & now), but the moves are still eerily similar.)  

Having said all this, we can ALSO sight with examples of times when this kind of action was NOT followed by a bear market…and instead of rolling back over, the stock market was able to bounce-back in a more sustainable fashion…and avoid a bear market.  

In 2010, a 16% initial decline was followed by a 10% bounce (50% retracement)…only to fall to a “higher-low”.  That “higher-low” was followed by a nice “higher-high”…and the stock market was off to the races.  We saw a very similar situation in 2011…when a 19% decline was followed by a 61.8% retracement…then another “higher-low/higher-high sequence” and the market was again off to the races.

What we are trying to say is that the recent bounce…as impressive as it has been…tells us VERY LITTLE about what is going to happen next.  IT CAN GO EITHER WAY!!!.….Therefore, we’re going to have to wait to see what happens over the next few weeks to see which way things are going to go this time around.…(We want to reiterate that the next few WEEKS will be key, not just the next few days.  The next 1-2% move won’t tell us much…but the next 5%-7% move should.)

We still worry that it will resolve itself the the downside.  During the examples we sighted about what took place in 2010 & 2011 (when the markets bounced back), we had an historically accommodative Fed…but now we’re looking at a Fed who will be providing less liquidity to the system than they have in the past.  Therefore we think the odds are high that the stock market will roll-back over and move into a bear market this time.  (However, we are NOT looking for the kind of “horrible” 50% bear we saw in 2000-2002 and 2007-2009.)……..The good news is that if we’re wrong, we should know within the next few weeks.

Housing Stocks Getting Ripe for a Bounce

We’re getting more evidence today that the housing stocks have become “washed-out”…and that a lot of bad news has already been priced into the group!  This does not mean that the group has seen a bottom that will hold for years to come, but it does seem to be telling us that the group has become quite ripe for a “tradable” rally.

Let’s face it, the news on the housing front has been absolutely HORRIBLE over the past 3 weeks.  The earnings out of D.R. Horton (DHI)and KB Homes (KBH)were terrible…and this morning’s NAHB Housing Market survey was the biggest one-month decline since 2014 (and took it to its lowest level in more than 2 years)!  HOWEVER, the ITB home builders ETF has actually RALLIED slightly trading slightly over the past 3 weeks…and it’s actually FLAT today (despite a 2% decline in the broad stock market)…..Experience tells us that when a group does not decline further after getting more bad news (especially when it has been as bad as it has for the housing stocks in recent weeks), the group has become “washed-out”.

We think this is particularly true for the housing stocks right now.  As we mentioned in late October, the ITB had already become EXTREMELY over-sold after its 35% decline over the previous 9 months…based on both its daily AND weekly RSI charts.

Not only has the group become quite oversold, but sentiment on the group has turned decidedly negative over the past few weeks…with several Wall Street firms turning negative over the past three weeks.  We’re not sure where these people have been over the last 10 months (while interest rates were rising and the sector was falling 35%), but we turned negative on the group in February…..No, we did not top-tick the housing group, but the ITB has fallen more than 20% since we turned bearish on the homebuilders.

Again, we are NOT saying that the group has bottomed for this cycle.  We’re just saying that its oversold and over-hated condition…combined with its pretty good action in the face of VERY negative news over the past few weeks…tells us that the group is very ripe for a “tradable” rally (one that lasts a few weeks, not just a few days).  This should be especially true if the broad market can finally bounce in a more sustainable way.

No market moves in a straight line…and we just think that those who want to sell these names will get a better chance to do it at higher prices in the coming weeks. (Also, we would not short the group down here for tickets to The Masters…or anything else!!!!)…..Even in the worst bear market in the housing group in a generation (that bottomed in early 2009) saw SEVEN rallies of more than 10%!!!!!  In fact, four of them were between +20% and +55%!!!

There is no question that the fundamental picture stinks for the group…and we’ll get a few more data points on this group over the next two days…so we could/should get some more negative news rather quickly.  However (and to repeat), when a group acts positively in the face of a lot of negative news, it’s almost always a sign that the short/intermediate-term picture for the stocks is more positive than most people think!!!!….(As we’ve all heard a zillion times in the past, there is sometimes a big difference between a company/group…and the stocks of those companies/groups.)

Are Housing Stocks Getting Ripe for a Bounce?

We turned negative on the housing stocks back in February…after long-term interest rates broke out to the upside (above it’s key 2.6% resistance level)…which was followed by a very feeble bounce in the ITB home construction ETF compared to the broad market.  Don’t get us wrong, we’re not trying to claim that we turned negative right at the January top, but the ITB has fallen more than 20% since we turned bearish on the group (while the S&P is actually up about 1% since then…even after its recent decline).

However, we’re starting to see some indications that the group could/should finally see a meaningful bounce…..Again, it has been a rough year for the group, but until recently, a lot of that of its poor performance was simply on a relative basis (in the spring & summer months).  The ITB did not continue to decline in a meaningful way after the February lows, it just began to “drip” lower in a downward sloping trend-channel.  However, since the broad market continued to rally, the group’s performance continued to be very poor on a relative basis.  (So the group’s performance wasn’t good, but it SEEMED worse than it was due to the continued rally in the broad market.)

More recently, however, as interest rates broke-out above another key resistance level (the 3% level), the housing stocks saw another significant down-draft.  Over the past month, the ITB has fallen 17 out of 19 trading days (and one of those two down days saw a rally of only 5 cents!!!).  The decline has take it down another 15% (in less than a month)…and it now stands more than 30% below its January highs! 

When a stock or an ETF (or even an index) falls 17 out of 19 days, it’s usually reaching a point where the sellers get tired…and the shorts get crowded.  (We have to admit, however, the most recent short interest readings on most of the stocks in the ITB are not very high.  PHM and TOL were relatively high when the last reading came out two weeks ago, but not at crazy levels…and few of the other names had high short-interest.  The readings should all be higher after the further sharp decline in the group, but it’s hard to say that we’ll be the kind of readings that will lead to a massive short-covering rally.)

However, just because the upcoming bounce might not be a massive one…does not mean it won’t be a meaningful one.  When you combine this “straight-line” decline over the past 4 weeks…with the oversold condition of the ITB is starting to see in its RSI charts…it leads us to think that the group is getting ready for a bounce….To be more specific on the RSI charts for the ITB…it’s daily (14 day) RSI has fallen to 16 today…and its weekly RSI has fallen to 25.5.  This is the most extreme readings on both of these RSI charts since their mid-2011 lows (when they reached 12.3 on the daily chart and 22.8 on the weekly chart).  Therefore, their oversold readings are getting quite extreme…and thus the group should be getting ripe for a short-term bounce.

ANOTHER reason why we think the group could bounce right here is because the ITB is testing its 200 week moving average (that week MA, not day MA).  That line provided excellent support for the ITB back in 2016…when it bounced off that line on two different occasions.………It might break below this line eventually…especially if interest rates continue to move higher over time.  However, we think it will probably see a successful test of this key moving average on its first try.

We’d have more confidence on this call if the short interest was higher…but with the broad market getting somewhat washed-out on a near-term basis (for reasons we mentioned in our “Morning Comment” this morning)…a bounce in the S&P could/should finally give the housing stocks some relief.

(We will get the updated readings on the short-interest for these individual names tonight.  With the ITB down more than 9% since the last reading…just two weeks ago…it’s a pretty good bet that the shorts have grown.  In fact, we almost waited to see them tonight before we made this call.  However, given our belief that the broad market is oversold and due for a pop…we think the housing stocks should bounce as well.  So we didn’t want to wait for those numbers.  If those short-interest reading do indeed increase by a lot, it should be something that will allow the group to see an even bigger bounce than we’re thinking right now.)

In other words, the whole thing could feed on itself.  The broad market could help the housing stocks bounce back…but because they are more oversold than the broad market, the ITB could/should rally in a more meaningful way.  If THAT happens, it could actually give the broad market a boost as well…and thus they just might feed on one another.

With mortgages rates rising, we are not calling for the beginning of a major bull market in the housing stocks.  We’re just saying that could/should see a sharp bounce over the coming weeks.  Either way, we would NOT want to be short the housing stocks right now!!!

Yes, the tech stocks are THE key group in the stock market right now, but the housing stocks could be a very important group to watch over the next couple of weeks as well.  

Near-term Federal Reserve Pain Will Equal Long-Term Gains.

People (including the President) should not be blaming the Federal Reserve for the recent swoon in the U.S. stock market.  Yes, higher interest rates are part of the reason for the decline, but so are the rising tensions with China (which the President himself has created).  Either way, what the Fed and President are doing NEEDS to be done….even if it has a negative impact on the stock market!  Therefore, people need to stop playing the “blame game” and they also need realize that just because certain actions by the Fed or the President cause the stock market to go down, it does not mean they are mistakes!

Who says that the stock market HAS to go up 100% of the time???  Pull-backs and corrections (and even bear markets) are normal AND healthy.  Sometimes things are done that cause the markets to correct…but occasionally those things are actually the right things to do!!!  

Again, the recent actions by both the Fed and the President have caused the stock market to pull-back.  Let’s take the Fed first.  Ten years ago, they lowered rates to “abnormally” low levels in order to help asset prices rise.  Their (stated) goal was to create a situation where rising asset prices would help keep the financial system from collapsing…..Now that things have stabilized in the U.S., one could argue that they need to raise rates back up to the “normal” level (the “neutral” level).  That neutral level is probably higher than the perma-bulls realize.  Also, as rates are “normalized”, it will probably have the opposite effect on stocks (at least to some degree) than it did when these rates were pushed to “abnormally” low levels.   Again, now that things ave stabilized in the U.S….and the U.S. economy is strong…it can be argued that the Federal Reserve NEEDS to raise interest rates back to the level where they would normally stand given today’s strong level of economic growth.  (In other words, normalize them back to the neutral level.)…..This should be done, some would argue, EVEN if it hurts the stock market and/or other asset prices. 

Similarly, one could argue that President Trump is doing exactly the right thing with China (in terms of trade).  Most everyone on both sides of the political isle agree that China has been cheating for a long time on trade.  Therefore, President Trump NEEDS to stay strong in his negotiations…in order to level the playing field with China (at least some-what).  Again, some would argue that this should be done EVEN if it hurts the stock market.

Ok, we’ve used the terms, “it can be argued” and “one could argue” several times.  We’d just like to say that we agree with these arguments.  The stock market has rallied more than 330% since the crisis and 40% since Election Day 2016…and the U.S. economy is strong.  Therefore, this is the right time to implement these tough decisions.  Just because these moves might cause the stock market to go down 10%, 15% or (God forbid) 20% over the next year or so…DOES NOT mean they are a “mistake”!!!!!!  Sometimes actions need to be taken that will cause some pain over the short-term…so that the situation will be better over the longer-term.  Doing these things when the economy and markets are strong is the best time to do them!

In our opinion, the economy would have rolled over in a major way in the first five or six years after the credit crisis of 2008.  In other words, the stock market moved away from being a leading indicator for the economy when the Fed and other global central banks began influencing the markets via QE.  (It became a tool to help the economy…instead of an indicator for the economy.)

Now that the system has stabilized (at least in the U.S.) the steroids can be removed.  This, in turn, will cause the stock market to decline (at least some-what).  That’s okay…because once the stock market reaches a “neutral” level vs. the underlying earnings/growth, just like the U.S. economy has in recent years.

It comes down to a simple question.  Why don’t people realize that if the Fed is going to “normalize” interest rates back to their “neutral” level, it will force the stock market to “normalize” back to its own “neutral” level as well!  (Stocks have been trading at a higher-than-neutral level for years…just like interest rates have been trading below neutral for years.  If one is going to revert back to its historic norms, so is the other one.)

We HAVE to go back to a situation where the stock market is a reflection of what is going on in the economy…instead of one where the economy is a reflection of what is going on in the stock market (which has been the case for almost a decade)……..This is what Fed Chairman Powell is trying to accomplish in our opinion.  It’s NOT a mistake.  Just because it could/should cause some pain over the near-term does not make it a mistake…especially since it will help things over the longer-term.


The Presidential Election Cycle for Stocks Won’t Work This Time.

“Calendar issues” are frequently sighted when pundits are talking about the stock market.  “Sell in May & go away” and the “January effect” are ones that are well known on Wall Street and beyond.  We also hear about individual months being the best and/or worst months of the year for the stock market…and we even somethings hear about how the Friday’s before long weekends tend to be bullish days for the makret.  

The problem is that although many of these old sayings can frequently be accurate, there are plenty of times when they break-down.  For instance, those who “sold in May” the past two years have been very disappointed…as the S&P 500 Index rallied 8% from May to November last year…and it has rallied over 10% since May 1st this year!

We’d like to focus on two other “calendar proclivities”.  First is the fact that the 4th quarter of the year tends to be a bullish one for the stock market and the second one is the well known “Presidential Election Cycle”.  The first one is quite bullish, but we do not believe the second one is as bullish as many pundits are trying to portray right now.

On the first issue, and as the chart below shows, we have seen a gain in the stock market in eight of the last nine years in Q4…with only 2012 giving us a very slight decline of just 1%.  (The market did see a 7% decline mid-quarter that year, but it finished with only a mild decline.)  The average return in the 4th quarter has been 6.2% over those nine years (and +7.1% if you include only the years that had gains).  We’d also note that in the five years leading up to the 2007 top, the market rallied every single year in the 4th quarter (with an average gain of +7.1%).  So no matter how you slice it, the 4th quarter is usually a very good one for the stock market.

The only consolation for the bears is that the S&P declined 3.82% in the 4th quarter of 2007…which was the start of a brutal 56% bear market into the 2009 lows. (Another similarity is that the top in late 2007 was a “double top”…and that’s what we’d see today if the stock market was to begin to roll-over in an important way over the next few weeks.)…..However, unless the market is at the cusp of a bear market, history tells us that the 4th quarter this year tends to be a good one.

The second issue is the Presidential Election Cycle and this one says that the third year of a President’s term tends to be the best of the 4-year cycle.  It’s interesting, this issue is the one “calendar issue” that has a much better foundation underneath it.  In other words, there are solid reasons supporting this cycle…and thus it is one that should be followed more closely.  However, this time around the reasons that usually make the Presidential Election cycle so compelling…are not in place this time around.  In fact, the exact opposite conditions exist today.
The reasons the election cycle usually works is that when a new President comes into office, they tend to use their mandate (which they always claim they have) to pass new policies.  The thing is, the new economic-based policies from the new president are usually “back-end” loaded.  So they “kick-in” over the last two years of their term.  This well-timed improvement in the economy & stock market helps them get re-elected for a second term.  (For incumbent presidents, they want the same thing…because they don’t want their policies to get reversed by the other party after they leave office.  So they again set up their economic policies so they kick-in in the last two years of their second term as well.  That way, the economy is humming when the nominee from their own party runs for office.)
The propensity to follow this scenario has kept the “cycle” working very well over the years.  History tells us that the 3rd year of that cycle (which is just 3 months away this time around) is the best one for the stock market.  Looking at the statistics going all the way back to 1928, the 3rd year has an average rally of over 12.7%.  The average for the other years are as follows:  The 1st year is 5.26%, 2nd year is 7.29% and the & 4th year is 5.55%…..So you can see that not only is the 3rd year the best year, but the last two years of the cycle are better than the first two years (+18.25% vs. +12.55%).
This time around, however, President Trump “front-end” loaded his policies…especially in terms of deregulation and the tax cuts.  Therefore, the first two years of the Presidential cycle this time around are giving us much better gains.  Instead of the average gain of just over 12% for the first two years, it has rallied 30% this time (+37% if you start on Election Day, 2016)!  In other words, we’ve already received the economic boost we usually get in the second two years from a new president…and thus we’ve already gotten the rally we usually get from their new policies!  
Therefore, we believe that the odds we’ll see a stronger stock market in the second half of the Presidential cycle this time around are much smaller than they usually are.  This is especially true given that the effects from these “front-end loaded” policies begin to fade a bit…and the Fed continues to be less and less accommodative.  
Of course, nothing is guaranteed on either of these issues.  Just because the stock market usually rallies nicely in the 4th quarter, it does not mean it will again this year.  Let’s face it, if we start to hear a lot companies lower guidance due to the tariff issue (or anything else), it will not be good for a continued rally in Q4.  
Similarly, just because Trump administration has front-end loaded is economic policies, it does not mean that something else will take the reins and lead the stock market higher in 2019 and 2020.  However, we think it is important to point out that there is a big difference between what has gone on over the first two years of he Trump administration and what has take place with previous Presidents.
What we’re trying to say is that there is a reason why the presidential cycle works as well as it does.  Unlike some other “calendar issues”, this one does not involve a coincidence and too many pundits are missing the fact that the Presidential Cycle has been turned upside down during Trump’s Presidency.  Therefore, since the “set-up” has been reversed in this cycle, the odds are much higher than most people realize that the difference between stock market’s action in the first half of the presidential cycle and the second half of that cycle will also be reversed .

Is Silver Finally Getting Poised To Fly?

We’ve all heard a lot of people try to catch a falling knife by calling a low in gold in recent weeks/months….and they’ve all been cut-up pretty good in their attempts. We have not attempted to do that…as our work has not pointed to a compelling low for the yellow metal.

HOWEVER, we ARE seeing some indications that SILVER could be close to an important bottom.  First of all, Relative Strength Index (RSI) for silver’s weekly chart reached its most oversold level since 2013 (just before it began a 37% rally).  Second, bullishness for futures traders in the Daily Sentiment Index fell to just 8% earlier this week.  (We’ve seen bullishness drop a bit lower than that over the years, but whenever it gets into the single digits it usually says that at least a short-term bounce is imminent.)

Finally, the Commitment of Traders data (COT) shows that the “positioning” in silver is back down to the record net short positions we saw for the dumb money speculators (the “specs”) back in early April…so a lot of people are on one side (the short side) of the boat on silver.  (We’d also note that the smart money…the “commercials”…now have record net long positions!!!).

Of course, none of this guarantees that silver will see a significant long-term (or even intermediate-term) bottom.  (Let’s face it, the last time silver got this oversold back in April, it was only followed by a 6% bounce…and then the commodity rolled back over and made new lows.)

However, silver is also close to testing a VERY important support level (its lows from late 2015 and early 2016).  Therefore, with so many people on one side of the boat in silver, if (repeat, IF) it can bounce significantly off those 2016/16 lows, it could finally see a rally that lasts for several months (if not longer).   

Facebook’s Stock Is Testing a Key Support Level

As we wait for the stock market to open this morning, a lot of today’s focus will be on the testimony (from several people) in Washington DC.  The one that we’ll be focused (at least for the markets) will be the testimony of FaceBook COO Sheryl Sandberg.  She is a very smart and polished executive, so there is every reason to think that she will come across quite well in her testimony………This will be important…because the stock of FaceBook (FB) stands at a VERY important technical juncture.

We all know about the more than 20%+ decline FB saw back in July after they reported their earnings.  Yes, it did bounce 7% off those lows, but since it only retraced 1/3 of its decline, the bounce was not as impressive as some tried to portray.  More importantly, the stock has since rolled over…and yesterday’s poor action (after a downgrade by Moffett) took it down to its “reaction lows” from July…….In other words, the stock has seen a key “lower-high” (which was a MUCH lower-high)…and if this is followed by a key “lower-low” below those July lows, it’s going to be quite negative on a technical basis.  (Chart attached below.)

We’d also note that a break below the July lows will be particularly concerning because experience tells us that whenever a stock falls 20% or more over just 1-3 days, it usually involves some “forced selling” (margin calls, etc).  These kinds of severe declines over just a few days usually leads the stock to get “washed out”.  This, in turn, usually signals a bottom for the stock that lasts for a long time (6 months or more).

However, sometimes a stock will not see a multi-month bounce.  Sometimes it rolls back over and takes out those panic lows rather quickly.  When that happens, that tends to tell investors that another shoe is going to drop…and both momentum AND fundamental investors get very nervous.  This frequently leads them to throw in the towel and sell….and look for much lower levels to move back into the stock.

This is why we believe that the July lows ($170-$171) is a VERY important level for FB…and any “meaningful” break below those July lows (a small break will not be enough) could/should lead to another significant leg lower in the stock.  (2nd chart below.)

As always, we HAVE to wait to see if the stock breaks this level or not before we send a red warning flag up the flag pole!!!!  If FB can hold this important support level, the stock will be fine!!!…and Ms. Sandberg is the perfect person to defend the stock at this key juncture.  However, if FB breaks below that level (either now…or after any initial pop after her testimony), it will indeed raise a red flag in our minds.  Therefore, the action in FB over the next week or two is going to be very, very, very important.  (Click the link below to see our comments from a CNBC interview on this subject.)


Ignore the European Bank Stocks at Your Own Peril!

A lot has been made of how the U.S. stock market has been able to shake-off negative news in the market place in recent months…and “climb the wall of worry” to new all time highs.  However, not all markets around the globe have been strong…highlighted by the bear market in emerging markets (and China in particular).  That said, there is one other area that is also in bear market territory, but it is not getting the attention it deserves…and therefore, it could become the issue that finally catches the bulls off guard as we move into the frequently scary time for the markets (September & October).

As long as the list is on the above-mentioned negative news, the list on the bullish side of the ledger has become just as long.  U.S. economic growth remains strong, U.S. earnings are fabulous, consumer confidence is near all-time highs, key economically sensitive groups (like the transports and the retailers/consumer discretionary stocks) are making new highs, almost all of the major stock averages have hit new record highs, etc.

Therefore, the negative issues that people (including ourselves) have been harping on for months now are being more than offset by the positive ones…and thus there are a lot of reasons to think the rally will continue going forward.

As we stated above, however, there is one other issue that could cause some compelling problems in the not-too-distant future.  (It’s also a key reason why we believe that continuing to shift to a more defensive posture in one’s portfolio is a good idea right now…especially since so many defensive groups and stocks continue to act so well.)

Again, the issue we’re referring to is the action in the European banks.  We have been harping on this issue for a long time now, but we’re surprised how little attention it is getting around the Street.  The STOXX Europe 600 Banks Index is down over 20% from its January highs and has NOT BOUNCED AT ALL recently…even though most other global stock markets have been able to see some recent strength.  (Heck, even the EEM emerging markets ETF…which was also down 20% from its January highs recently…has seen a 6% bounce over the past two weeks!!!)

Even though the recent “holiday” seemed to take the problems Turkey is seeing off the table for many investors, the issues they’re facing are far from solved.  Similarly, Italy’s credit problems are also far from solved.  Even today’s news that they’re requesting help from the ECB has not helped Italy’s spreads to tighten up…or their 10yr yield to fall.  (We’d also note that the Italian bank stock index is down more than 28% from its April highs.)

It’s funny, a lot of pundits frequently point out (correctly) that it’s the issue that nobody sees coming that’s the one that finally knocks a bull market off its kilter.  However, sometimes it’s the issue that was staring everybody in the face…but was ignored…that does the damage.

Is AMD Too Over-Bought to Help the Semis Further?

The semiconductor stocks have been a key leader for the tech group and the broad market since the 2016 election, but it has been lagging a bit lately.  This is not a major concern yet because the group saw a short period under-performance during the spring-time…only to bounce-back strongly.  However, on a technical basis, the SOX semiconductor index has formed an “symmetrical triangle”, so whichever way it breaks out of this pattern should be important over the coming days and weeks.

One thing that could hurt the index is Advanced Micro Devices (AMD).  That might sound like a very strange assertion…given the fact that the stock has rallied so VERY strongly over the past 4-5 months.  It has rallied a whopping 168%…but it has now become very over-bought.  In fact, its weekly RSI chart has moved above 85…which is more extreme that it reached at the early 2000 highs!!!

That’s not to say that a reading above 85 is unheard of.  It reached a similar extreme in early 2006…but we cannot take much solace in that because that extreme reading in 2006 was followed by a major decline (of more than 50%).  In fact, almost every reading above 80 on the weekly RSI over the past 20 years has led to a substantial decline in AMD, so we think the stock has gotten way ahead of itself and should be due for a short-term pull-back.  (We’re certainly not calling for another 50% decline, but since the stock has already fallen 6% below its midday highs already today, it’s not too much of a stretch to think that a compelling pull-back will begin soon…if it hasn’t already begun.)

Moving back to the broader SOX semiconductor index, we do need to point out that the correlation between the SOX and AMD is not anywhere near as strong as the SOX has been with other semiconductor stocks over the years, so any pull-back in AMD does not insure that the SOX will not be able to break its symmetrical triangle pattern to the upside.  However, any decline in the this particular stocks might mean we’ll have to wait a little while before the semis can help engineer another leg higher for the broad tech group.

If the FAANGs Fall Further, the Broad Market Will Feel the Pain.

If the FAANG stocks (and other big cap momentum names) continue to decline, it will have a much bigger impact on the broader stock market than it has so far.  The simple reason for this is that as the leverage that has built up in these momentum names will have to be unwound (again, if these stocks continue to fall).  That, in turn, will spill over into the rest of the stock market…just like it always does.  This does not mean the market will crash…or that it will even fall into bull market territory, but leverage creates powerful moves…and it works in both directions.

One of the big problems we continue to hear from those who study the stock market today is that they concentrate too much on “extremism”.  Either the stock market is going to go to the moon…or it’s going to crash. There doesn’t seem to be any room for anything in the middle for many of these pundits.  Despite the fact that the last two bear markets took the S&P 500 Index down by 50%, history tells us that “something in the middle” is exactly what we usually get when the stock market goes through a painful period.

This is why we don’t care when these pundits try to say that this is not 1999 all over again. They are correct when they say this, but they also seem to imply that since it is not 1999 once again, then the stock market cannot go down a lot if these stocks roll-over.  The only thing it really means is that the stock market will probably not fall 50%.  However, it could still see a deep correction or even a bear market.

The recent action in the FAANG stocks might not be the beginning of a sustained decline in those leadership stocks, but whenever a sustained decline DOES take place, it will almost certainly be negative for the broader stock market.

We all know that margin debt remains at/near all-time highs (and much higher than it was in 2007). Given that Facebook (FB) was up over 700% over the past 5 years (at its recent high), Amazon (AMZN) is + 620% over that time frame, Apple (AAPL) +250%, Netflix (NFLX) +1,200% and Alphabet (GOOGL) +230%…it’s not a big stretch to think that a lot of leverage has been built-up into those stocks over the past five years.

One only has to look at the action in FB over the last few trading day!!! FB did not have a valuation that was anywhere near bubble proportions…and yet it has fallen a whopping 21% in just three trading days!!!!! This was not a situation that faced companies like Enron or Bear Stearns…so we would argue that the main reason it fell SO far, SO fast…and has not bounced at all since that initial sell-off…is due to “forced selling” (margin calls, etc). (Don’t get us wrong, there’s no question that FB’s news was negative, but we would argue that only “forced selling” would account for the kind of extreme move we’ve seen over the past few trading days.  In other words, the negative news knocked the stock down, but “forced selling” played a roll in keeping it down.)

The problem is that history tells us when you get broad based “forced selling” (which would come to fruition if more of these momentum names roll over…and if FB, NFLX, TWTR, etc. fall further), the buyers disappear in those names…and thus the “forced sellers” have to start selling other stocks/assets to meet their margins calls.  Thus “forced selling” almost always spreads far beyond the stocks that were initially impacted.

This doesn’t mean that the FB cannot bounce…or that it has to fall further from current levels. It also does not mean that the big rally in the FAANGs (and other momentum names) has definitely come to an end. However it DOES give you an idea of what will happen when the bull market in these names does indeed end.

You don’t have to go very far back into the past to see what “forced selling” can do to the broad market.  Earlier this year the very crowded and highly leveraged “short volatility” trade needed to be unwound. That development caused a quick/sharp downdraft in the broad stock market…which was a decline that has yet to be fully retraced by the DJIA or the S&P 500 Indexes.

So what are we trying to say here? Well, even though the decline in these momentum names so far has only taken the S&P down 1.5% and the Nasdaq 4.2%, we believe that if it continues over time, it WILL have a negative impact on the broad stock market…..The key word in that last sentence is “if”. It is not a lock that these momentum names will continue to decline right now. However, it does show that a significant and sustained correction in the momentum names WILL have a negative impact on the broad market…whenever it does come (whether now…or in the future some time)…….Leverage is a VERY powerful force…and it works in both directions!!!!

That’s the BAD NEWSand it’s why we continue to suggest that investors should be adjusting their portfolios to a more defensive posture (which is working well since the defensive names have been rallying nicely over the past two months). They should also be raising a little bit of cash…which leads us to the GOOD NEWS.

The GOOD NEWS is that whenever “forced selling” takes place, it creates unbelievable opportunities for investors (because the baby gets thrown out with the bathwater). If investors have some cash on the sidelines, they will be able to take advantage of that kind of situation. Those who are fully invested will not.