I have a confession to make: The markets are fun, even during an absolutely crazy week like we just had.
I mean, look at everything that's actually driving this market: trade talks, new tariffs, earnings, geopolitical tensions with Iran and North Korea, the usual D.C. shenanigans, Uber's IPO... and the list goes on.
For those of us that like to solve puzzles and play strategy games, this gets to be real fun!
But we've got to get down to business. There is a significant risk I'm looking at, lurking out there.
That's the bad news, and it ain't all that bad. The good news is I'm clocking it, so we won't be taken by surprise - and if we follow my recommendations, we'll even come out comfortably ahead...
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The Odds of a Bigger Dip Just Got Much Higher
I'm looking at the possibility of what I call a "self-fulfilling correction." Let me tell you what that's about.
Around two weeks ago, as stocks approached their September 2018 highs, we started to hear a lot of analysts talk about the potential for a "double top."
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This is formed when a stock or the market hits the same highs and is unable to trade higher. The results are usually a retreat from that high, and the market tries to fight its way up another day.
That's exactly what we faced a few weeks ago as the market slowed its progress to 2,950, but then the "poo" hit the fan - or should I say, the tweets hit the Internet. All of the variables that I mentioned above started to hit the market like a Golden Gloves boxer, pounding away at their opponent in the corner.
One after another, we saw the market hit with a rapid-fire succession of punches. Now we're down more than 4%, on one knee trying to catch a breath while the referee is giving the standing eight count - otherwise known as the "protection count."
On Wednesday, Thursday, and especially Friday, we saw bouts of buying - buying big, in fact - as some institutions with billions in the market jumped in to buy a few "value" issues, but that was far from the strength needed to get off the mat.
Wednesday and Thursday saw flashes of buying late in the afternoon as some of the institutions - you know, the guys that have billions to put in the market - dipped their toes in to buy a few "values."
This is far from the strength that we need to get this fighter off the mat.
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So, what's the damage? From a technical perspective, it's pretty extensive.
- The S&P 500 has gone in a hurry from all-time highs to challenging its 50-day moving average. This critical trendline has been holding support and identifying a bull market run since January.
- The Chicago Board Options Exchange Volatility Index - simply referred to as the VIX, or Fear Index - is now trading in the 20 range, in what is normally gauged as a short-term correction pattern.
- The Russell 2000 ETF is breaking below its 50- and 200-day moving averages at the same time. This tells us that traders are becoming more risk-averse. This isn't good for a quick recovery, as the market needs risk-takers to step in and buy to reverse the selling pressure.
- Market breadth has declined dramatically as the percent of companies trading above their 50-day moving averages has fallen below 50%. This means that fewer companies are trading in bullish trends.
The list can go on (and does on my screen), but let's look at what to look forward to over the next week...
We know trade talks wrapped Friday - amid buying, in fact - with no deal, while new tariffs on Chinese goods went into effect at 12:01 a.m. Friday. Yesterday morning, China announced retaliatory tariffs on around $60 billion worth of United States goods, starting June 1. And wouldn't you know it, the Dow dropped 500 points yesterday morning.
On the other hand, we're looking at 295 earnings reports coming out this week. Depending on how those break, we could see pressure ease on stocks, though I'm not expecting any wildcard rallies. Retail companies figure prominently this week, which will make for some juicy trade opportunities for my paid-up subscribers following along.
Let's look quickly at the smartest moves to make and approaches to take this week...
Here's What to Do
This dip has me in "spring cleaning" mode, and I don't mean my closets. I'm going through and shutting down unprofitable long positions - no point waiting for them to turn around, and in fact, those open "wait it out"-type positions can expose you to losses in a market like this.
That frees up precious capital to jump on fast-moving opportunities - most likely they'll be of a short nature, but there will probably be some long-side profits to be had, too.
The weakest sectors - ripe for puts and, if you're adventurous, shorting - are, as I mentioned, small caps, as measured by the iShares Russell 2000 ETF (NYSEArca: IWM). I've also got my subscribers making moves on weakness in the SPDR S&P 500 Pharmaceuticals ETF (NYSEArca: XPH), another weak performer.
On the strong, long side, I'm liking the chances for a move higher in the SPDR S&P 500 Retail ETF (NYSEArca: XRT) as the sector benefits from all the earnings activity this week.
Stay safe and profitable out there.
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About the Author
Chris Johnson (“CJ”), a seasoned equity and options analyst with nearly 30 years of experience, is celebrated for his quantitative expertise in quantifying investors’ sentiment to navigate Wall Street with a deeply rooted technical and contrarian trading style.