It is not a market of stocks. It is a market of three sectors. The market benchmarks had their worst week in 2013, but if you were invested only in consumer staples, utilities and biotech, you wouldn’t even know that there was a correction. $XLP, $XLU and $IBB finished at new all-time highs.
Let’s look objectively at the current market situation:
- Correlation is rising. On down days, almost everything is down. On up days, almost everything is up.
- Volatility is rising, which is natural for earnings season
- High volatility and correlation are typically not a sign of a healthy market
- Small caps and high growth names took quite a beating in the past month. Russell 2000 and the St50 lost 3% just this past week. They typically lead on the way up and on the way down;
- Distribution days are piling up. Distribution is basically transfer of ownership, from strong hands that are locking in well deserved profits to weak hands that are chasing. There were two other cases of concentrated distribution in the benchmarks earlier this year and both times, it was resolved higher. This time the pullback tastes different and has left a lot more damage.
- Seasonality is on the side of the bears. Three weeks ago I joked that the new “Sell in May and go away” is “Sell in April and go to Consumer Staple”. Little did I know how correct this statement will turn out to be.
- Selloffs in widely held gold and Apple are never isolated and usually cause a chain reaction forced liquidation and a lot more selling. This is one of the reasons why momentum stocks took it on the chin this past week.
- Highly-shorted stocks like $TSLA (43% of the float is short) are outperforming big time. This is one of the things that happen when people are forced to cut risk and decrease market exposure. They cover high-conviction shorts.
All in all, the odds are that we will see some further turbulence in the following couple months. What is important to highlight here is that the market could look very different depending on the time frame you use to look at it. If you zoom out and look at a monthly chart of the small caps index ($IWM) for example, you could certainly make the argument than even additional 5% correction from here won’t break the long-term trend. The same is true for the S & P 500 and the Nasdaq Composite. How does one proceed in such situation? A 5% correction in an index, could mean 20% correction in one of your holdings. It is naïve and irresponsible, to assume that each of the past leaders will bounce back and recover. Some will. Some won’t. Our priority, first and foremost, should be to manage risk, which means cutting losses before they leave too big of a mark on our capital and confidence.
The silver lining of pullbacks is that they highlight the potential future leaders. So far, the relative strength has been concentrated in biotech, which tend to live in their own world, and consumer stocks. Stocks like $ALKS $ACOR $GPS $TSLA $GWRE $TSCO $EL $SPNC etc.
Don’t forget, it is earnings season. Over the next couple weeks, hundreds of companies will report, providing a glimpse into the state of their business and industry. The best performing stocks in any given earnings season are the ones that surprise the most. Some new trends will be started this earnings season and new leaders will emerge.
You can easily follow any or all of the stocks in the ST50 on StockTwits by clicking here.
Have A Great Weekend!