This is meant to be a level-headed plan to help your portfolio remain healthy through a high probability pullback. Use it wisely.
The Nasdaq 100 is on the cusp of triggering a short-term bearish signal that hasn’t happened in nearly two years. That trigger may result in a fast 10-20% decline in the market as stocks make their way through an already volatile time of the year.
I’ll break down the action of my own Magnificent Seven Momentum Index along with the implications and a few strategies to help you weather the potential storm.
Let’s get into this….
We’ve moved into the most volatile month of the year, September, with the Magnificent Seven stocks already hobbling from a weak August performance.
This is by far the most important small group of stocks that can make or break the market’s confidence. Therefore, any weakness in the group is reason for investors to take notice and act with caution.
I always tell investors, new and experienced, that 90% of the market’s directional moves are dictated by price action and investor sentiment. This is especially true when the fundamental picture becomes less clear for investors.
Over the last two months, we’ve seen exactly that, the fundamental picture of the market has become more hazy.
Sure, investors are expecting a rate cut in less than a week and that should slow some of the market’s recent selling pressure. But the last two months have brought some uncertainty.
Simply put, the fundamentals for the market are anything but clear, the exact style of market that I suggest you start watching the sentiment and technical indicators of the market, they’re in charge of where this market is headed over the next 1-2 months.
It’s not great.
We headed right into the worst seasonal performance month of the year with everyone acting giddy about the most important earnings report to hit the tape in the last month, NVIDIA.
NVIDIA’s earnings report was a classic example of how sentiment and technical will override fundamentals.
Fundamentally, the report was great. An earnings per share beat along with revenue that beat analyst expectations. The company even raised their expectations for next quarter.
But there was a problem.
Investors had already priced the stock for performance. The shares had seen an unusually extreme amount of optimism ahead of the earnings report. That was the problem.
From a technical standpoint, the stock had rallied to its highs ahead of the report, a level that had provided resistance just a month later. The stock was set up for another round of selling based on that resistance, which is exactly what happened after the report hit the tape.
NVIDIA’s situation extrapolates out to the rest of the market.
I August, investors got ahead of themselves with bullishness optimism.
Readings of the CBOE Volatility Index (the “VIX”), known as the market’s “Fear Gauge”, dopped back to their lows, suggesting that investors were emboldened by the Fed’s pending rate cuts and the ongoing strength in the Magnificent Seven stocks.
That’s changed.
This morning’s read on inflation all but locked in a 0.25% cut instead of the 0.5% that investors were secretly hoping for.
And the performance of the Magnificent Seven? It’s not looking so “magnificent”.
I track the technical health of the Magnificent Seven stocks as a group. Call it the “Magnificent Seven Momentum”. They’re that important.
That momentum has dropped to levels that have a history of causing problems.
As of today, that “indicator” is in negative territory as we’re seeing the “trend” turn unfriendly for the Magnificent Seven.
Historically, negative readings of this momentum indicator foretell negative performance for the Nasdaq 100 (QQQ). It makes sense, if the Magnificent Seven cough, the rest of the market catches a cold.
As of now, the weakness is temporary, but we’re not far from this situation landing the markets in a critical situation.
Currently, we’re within ten days of the momentum readings hitting -6. This is a critical reading for the “indicator” as it tells us that six of the Magnificent Seven companies have fallen into short-term bearish trends.
That influence on the Nasdaq 100 has a track record of disappointing performance as shown in the table below.
In four instances over the last five years, the momentum indicator has hit readings below -6.
On average, the performance of the Nasdaq 100 ten days after each signals was -6.2%. 20-day, the equivalent of one month’s trading, the QQQ turned in an average of -2.3. That’s against the “at-any-time average” of +1.3%.
The returns worsen as time goes on with the three-month returns (60 trading days) resulting in an average of -10.3% against typical 3 month returns for the QQQ of +3.8%.
The next two weeks will be critical.
Current readings of this momentum indicator sit at -2, but daily readings have been dropping sharply. This means that the index is likely to accelerate to the downside over the next two weeks, resulting in a bearish signal for the Nasdaq 100 (QQQ).
If you’re looking for a sign, keep an eye on the Nasdaq 100 $450 mark as your lead. A break below this price will accompany a declining reading of the Magnificent Seven Momentum Index towards that -6 signal reading.
As if September – and the beginning of October – volatility wasn’t enough, the negative momentum among the Magnificent Seven stocks will add pressure to the market.
The Fed will likely give some relief next week, but just like NVIDIA’s earnings… that interest rate cut has already been priced into the market. We can expect the effect to be very short-lived.
Protection is the name of the game for the next 3-4 week. Plan for the worst and hope for the best, that’s the plan here.
Plan for the Nasdaq 100 to lose another 12% to land at round-numbered support of $400.
If you’re happy with “white knuckling” it through another 12% decline then do nothing. Get cash ready to deploy and know what stocks or ETFs you want to buy at what prices.
I’ll share a few of my ideas on Friday right here.
… is a strong defense.
Those looking to hedge the potential 12% decline should check one of two hedging strategies.
The ProShares UltraShort QQQ ETN (QID) is an alternative for hedging a portfolio. Shares appreciate 2% for every 1% decline in the Nasdaq 100.
The QID shares are currently trading at $42.50 with a target of $50 (16%+ return).
Alternatively, those of you with the education and experience trading options may want to consider a hedge using puts on the QQQ. This is the approach I favor.
For example, the November 15, 2024, QQQ $450 puts are trading for $1,656 per contract.
With a target of $400, those puts would be valued at a minimum of $5,000 per contract on intrinsic value alone.
This contract along with the November 15, 2024, QQQ $445 puts have seen a lot of trading volume over the last week, indication that options traders are preparing for a selloff event to affect the market, specifically the QQQ.
As always, set target to close these positions out at preset profit targets and don’t get greedy. Remember that hedges are short-term protection positions, not “quick money” attempts to make once-in-a-lifetime gains.
