The market has been on a wild ride that’s taken investors from fear to the fear of missing out emotions within days.
Tariffs and geopolitical events are wrapping the headlines daily, forcing investors to feel like stocks are inevitably doomed to fall, and they may be right.
But at the same time, stocks like Him’s & Her’s, Bigbear.ai, Palantir and other stocks that have shot to new all-time highs, luring investors into what feels like a game of chicken with stocks.
The fact is that the pattern we’re seeing plays out more often than investors remember.
Those situation where it feels like the market can’t go wrong, but indeed it’s already started going through the stages that will inevitably cause the market to incur a healthy 20% loss, what I like to refer to as a “Healthy Correction.
It’s something that investors should celebrate, and it may start as early as next week.
Think back about a month or two ago. The market was hitting its stride. The Nasdaq 100 and S&P 500 were heading to new all-time highs as investors celebrated the fact that the elections went off without a problem. Investors love certainty, and that’s what we got from the election results.
At the time, the Magnificent Seven stocks were helping the market to move to their highs. All Seven of the companies, except for NVIDIA (NVDA) were heading to new all-time highs in December.
To say that the market was being driven by the headliner names would be an understatement as breadth was positive and growing stronger. But something happened.
The normal “leaders” of the market started to pull back from their leadership in December.
Appler, Microsoft, Amazon.com and the rest of the Magnificent Seven started to slip into short-term bearish trends.
Nvidia was the final of the Magnificent Seven stocks to make the move lower when shares peaked in January. Since then, NVIDIA has dropped as much as 22% at its lows on January 31.
But at the same time, we suddenly had a group of more aggressive, smaller stocks that started to take the spotlight.
Companies like BigBear.ai, Him’s & Her’s, Carvana (CVNA), Palantir (PLTR), SoundHound (SOUN) all came charging in to take trader’s attention away from the flagging large cap tech performance.
And that’s the warning.
It’s a phenomenon that has repeated itself for decades. Call them Meme Stocks, Penny Stocks, whatever… they’re not the stocks that normal investors buy and hold, but that’s what happens.
Sentiment shifts to favor the faster moving volatility ladened stocks away from the core investments that serve as the foundation of the market’s performance. The market looks at the “shiny objects” as they search for return while the foundational stocks continue to suffer and move into a correction phase.
That’s where we are right now.
Investors are chasing returns as they try to squeeze the last bit of returns out of the market.
That almost always correlates with the beginning of a Healthy Correction, which while painful, will be good for the market and investors.
Healthy corrections in the stock market are a natural and necessary price adjustments that occur periodically in the market.
A "correction" is typically defined as a decline of 10% to 20% in the price of a stock or index from its most recent peak. These corrections can happen due to various reasons such as changes in economic indicators, shifts in investor sentiment, reactions to news events, or simply profit-taking after a strong rally.
Note that as of right now, at this moment in the market, we’ve got almost all those triggers in place.
The frequency of corrections can vary widely, but they are a normal part of market cycles.
Historically, corrections in the stock market are expected to occur about once a year on average. However, the exact timing and frequency can be influenced by broader economic conditions, market sentiment, and external shocks.
It's incredibly important to note that while corrections can cause short-term market volatility, they also provide opportunities for investors to enter the market at lower prices or to adjust their portfolios according to changing market conditions.
In other words, knowing that a healthy correction is about to start gives every investors an opportunity to prepare to make their portfolio better.
The market endured its last 10% decline in July and August of 2024.
Stocks reacted to shifts in the political polls as well as a disappointing earnings season. Investors sentiment was at its highs as optimism towards the elections and the economy were high. Inflation was in a strong downtrend and interest rates were holding steady.
Just weeks ago, we saw similar signs.
Sentiment, according to the CBOE Volatility Index ($VIX) remains as optimistic as it has been in the last year.
Last week, the AAII Sentiment poll index saw the percentage of bulls cross below the bears. In lay terms, this means that the number of individual investors that consider themselves bullish is dropping. That translates to a shift in sentiment that will take its toll on stocks over the next three to four weeks.
Finally, I always like to maintain a watch on the CNN Fear & Greed Index. This indicator does a fantastic job of summarizing investors sentiment towards stocks and is an effective tool in forecasting directional moves in the stock market.
As of today, the index is stuck in “Neutral” following a short drop into the “fear” territory last week.
The CNN Fear & Greed Index had been signaling “Greed” just ahead of the beginning of the drop in the Magnificent Seven stocks in December.
Today’s reading of Neutral is likely to switch back to “Fear” and then “Extreme Fear” next week following the phenomenon that I’ll got into next.
Those readings will accompany a wave of selling by institutional and retail investors that will likely trigger the “Healthy Correction” that will provide you with a better buying opportunity for stocks.
The calendar.
I went into it a little last week, but the time is here to brace your portfolio… Week Nine is here.
If you haven’t read my research on Week Nine, this is the short story.
Week nine is one of two weeks in the year that have a decidedly negative effect on the market.
The normal weekly return for the S&P 500 on any week over the last 20 years is +0.1%.
Week Nine averages -0.8% since 2000, putting it in the odd position of being one of the most bearish weeks of the year to hold stocks.
This information can also be used to prepare for the buying opportunity that stands on the other side of Week Nine.
From a technical perspective, the market is already deteriorating as investors have been selling the large cap technology stocks. The Nasdaq 100 has been held near its highs by an odd mix of stocks that do not include the large cap Magnificent Seven stocks.
Further breakdown in names like Microsoft (MSFT), Google (GOOG), Apple (APPL) and Amazon.com (AMZN) will trigger a wave of ETF selling that will pull the Nasdaq 100 and S&P 500 ETFs further into that healthy correction phase.
At this point, the “Flashy Five” will see their prices drop quickly as investors flee these Meme-like stocks for safer ground in the market. Don’t worry, these are some of the first stocks that you want to target for re-entry as the dust starts to settle from this correction.
We’ll see the CBOE Volatility Index peak above a reading of 22 and the CNN Fear & Greed Index dip all the way into “Extreme Fear” before the all-clear signal is sounded.
That will represent the time to go in to buy the dip on those Flashy Five and Magnificent Seven stocks.
Keep in mind that NVIDIA is set to announce their quarterly results during Week Nine. The timing of the earnings could be even more critical as any slight resemblance of am earnings miss or light outlook from NVIDIA would magnify the selling volume and price movement of the market.
