You know that quiet, slow feeling when you're getting to the top of the first hill of a roller coaster? It's the last few moments of quiet before things get exciting - and maybe a little scary.
There's a unique perspective I watch on the market that's telling me... we just had that moment.
Those of you that follow me know that I've been complaining about the fact that this market is missing the "risk on" trade. Those of you that aren't familiar with this concept will get it fairly simply with one of my "Ten Commandments of Trading".
Commandment IX states: "Stocks are driven higher by speculation, not fundamentals."
That's right; as much as we want to believe that fundamentals drive the market higher... they don't.
Speculation - the act of investing $1 because you expect to get back $1.01 or more - is what makes stocks go higher.
This bedrock truth is always on my mind, so I watch the small-cap Russell 2000 and how it's trading against the backdrop of the more widely watched S&P 500.
Here's what I see...
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Where, Oh Where Has the Risk Trade Gone?
Normally, small caps are the "home" of risk in the market. Because they're relatively more volatile, smaller stocks can attract speculators simply because the gains are often bigger. That's Commandment VII: "Volatility is a bull's best friend."
Lately, it's not looking good for a bullish summer.
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First, the small-cap sector has been lagging the broader S&P 500 since February. This is a sign that the speculators have moved away from buying stocks - not bullish. We need speculators - and the "upside volatility" they bring to fuel this market - in order to expect a truly strong bull run.
Otherwise, you get a "defensive rally," where investors dart from cover to cover like troops under fire, picking up dividend payers; that kind of rally is almost always doomed to slide into a bear market.
Also ominous: The activity in the iShares Russell 2000 Index ETF (NYSEArca: IWM) has suddenly gone quiet. The speculators looking to take advantage of big, fast small-cap gains are few and far between.
So, yes, it's like the roller coaster is sitting right at the top of that hill, almost still, for the moment right before the cars go down that first heart-grabbing drop.
The chart below displays the IWM shares with one of my favorite - and simplest - indictors to watch: the actual volatility of the index (standard deviation).
Over the last two years, we've seen four periods where the IWM ETF "went quiet," causing the volatility indicator to drop to its lows. This week, IWM has been seemingly stuck in what I refer to as a "squeeze play".
The squeeze play is represented by the IWM bouncing in a tight range between $155 and $156 for almost 10 trading days. This pent-up price activity is getting ready to break out, as indicated by the volatility gauge going flat on us over the last few days.
Bottom line here is that this squeeze play is going to end as volatility pops out of its hibernation (it's already starting to happen), which is likely to be the breaking point for this market.
This, combined with the S&P 500 slipping back below the 3,000 level, tells me that this market is about to turn into a seller's market.
Here's the Profitably Protective Way to Go
It's a creepy feeling, but there's no need to panic - here's how to hedge and stay safe while making some money on it...
Consider buying September at-the-money puts. IWM is trading at $154 right now, so an at-the-money put would be the IWM Sept. 20, 2019 $154 puts (IWM190920P00154000).
You don't necessarily have to buy options, either; the ProShares Short Russell 2000 ETF (NYSEArca: RWM) moves inverse to the IWM ETF, meaning a decline of 1% there means a gain of 1% for RWM.
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There are about 4,000 stocks traded daily on the U.S. markets - but only about 100 of them may be worth your time. Most people can't tell the difference... and this opens the door to tremendous opportunities for folks who DO know the secret. In fact, just by zeroing in on one tiny fraction of the market, you can pinpoint winners with 94% accuracy based on our testing. And as soon as the markets open Monday morning, we're going to release a brand-new recommendation from this top-100 list. Take a look now - before you miss it...
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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.