Have you ever been at a party where you just didn't like the food on offer? I know this sounds a little weird, but stick with me for a minute...
Back to that party - the conversation is okay, and maybe there are opportunities that may make the party worth hanging in there for... but you can't get the food out of your head. Nothing there is to your liking. And as far as I'm concerned, if there's one thing that can spoil a party, it's bad food.
So what do you do? You leave, of course.
Well, right now, the market's throwing a party with really cruddy food.
Whether it's the samplers of trade war rhetoric, the finger sandwiches of horrifying technical damage, or the open bar serving fresh yield curve inversion cocktails, none of it is appetizing right now.
Let's take a look at what's happening out there, whether we can expect the bulls to come back, or whether the bears will have the run of the place.
Either way, the trend is your friend, and there's plenty of money to be made...
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The Definitive Trend Is Down for Now
The market hit the skids with mounting losses all month long. The reason and rationale is simple - a loss of 6-7% depending on which index you check.
The good news is that a "healthy" correction has been needed, as the bull market is getting long in the tooth. The bad news is that the day-to-day activity is starting to look more like a shift in the trend instead of a quick sell-off that flushes some of the frothy excess optimism from the market.
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Look, all the talk about tariffs with Mexico that sent the markets lurching lower could very well be a White House negotiating tactic - I don't know. I don't care.
What's important is the market doesn't do well at handicapping uncertainty, which is exactly what these announcements are. Instead, traders factor in the worst case and then unwind that expectation when the situation is resolved. This means that we should expect a continuation of this volatility, which is currently driving us toward a true market correction.
I've been squawking about the risk-on trade being "off" for a few months now, as the small-cap sector has been leading the broader indexes lower. Typically, this dynamic slows things down, but the continued trade rhetoric between China and the United States (and others) is really beginning to wear investors out.
Traders are reacting to the market's volatility by clearly setting up for further declines. Volume of puts is beginning to outpace calls, and the VIX is telling us that that they're paying up for those puts. Unfortunately, the trend is unfriendly in this area, as the VIX is solidifying its trend higher.
Let's take a quick look at those important technicals...
The Damage to the Market Is Fairly Extensive
- The S&P 500 broke below the 2,800 level on Tuesday and challenged its 200-day moving average. Both of these technical lines in the sand are trying to build some support, but at this point, traders are selling into any strength.
- The Transportation Index broke below 10,000 last week and stayed there. This puts the transports beyond a 10% correction from the April highs. Why does this matter? The Dow Theory is widely watched and states that when the Dow Transports make a new relative low, the Dow Industrials tend to follow suit.
- Fear, as gauged by the CBOE Volatility Index (VIX), has yet to hit a relative extreme, topping 19 yesterday morning. That means that we're in for additional selling before a tradable bottom is placed.
- As I said, small caps and other speculative (read: optimistic) areas of the market continue to lead lower, telling us that the "risk on" trade is non-existent. We need to see speculators start to dip their toes into the market to help spark a new bull market rally.
Where does that leave us? It's pretty simple: D-E-F-E-N-S-E.
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Put your portfolio in a defensive posture with put options on stocks lurching lower. That will allow you make some profits while everyone else is asking what the hell happened to the market.
For instance, in my services right now, we've got a slightly negative bias to our portfolio holdings, as we've got three puts and two calls. We'll trim the calls as needed and continue to add puts based on continued decay of the technical trends.
My Best in Breed sector analysis model continues to give some great bearish signals that are focused on the transportation, healthcare, biotechnology, and other areas of the market - including a growing number of technology names. We'll leverage that information to turn this market's trend in our favor over the next week.
Frankly, though, I'm excited about a directional move, as stocks have been happy to trade within a range for a while. Do I wish that the trend was higher? Yes.
But having said that, I'm excited to have the tools to trade a real bearish trend if this market continues to wane.
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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.