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Is a Market Correction Imminent?

Is a Market Correction Imminent?

Posted On July 14, 2021 2:50 pm
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Stocks, or specifically the headline indices such as the S&P 500 (SPY) and Nasdaq 100 (QQQ) keep powering higher, once again hitting new highs today.  This comes despite last Thursday’s dive (when they fell over 1%, gasp!) where many felt the first warning shot across the bull’s bow.

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I understand today’s circumstances are quite unique due to the incredible liquidity injected by the Fed and Congress’s monetary stimulus.  Money is indeed sloshing around looking for a home. Oh, and have you seen home prices?! 

I also understand that the economy’s coming out of a self-induced, artificial recession as a response to Covid with the timetable and recovery magnitude being equally eye-popping. 

Talk about “V” bottoms; the SPY recovered the initial 25% March 2020 decline by June — meaning it gained 50% in a mere three months. 

Since then, its climb has been both relentless, and freakishly uniform.  The trend up can be drawn by a straight edge ruler along with the 50-day moving average.   

SPY 50 DAY MOVING AVERAGE

From the May to November period, one could explain the disparity between the indices performance and the incredible turmoil beneath the surface as a result of fast and furious rotation between sectors; growth vs. value, reopening vs. stay-at-home, and commodities with pricing power vs. those that cannot pass along input costs. 

 I big concern of mine is that market breadth has deteriorated over the past few weeks — we’re back to the FANG+M (Facebook (FB), Amazon (AMZN), Alphabet (GOOGL) Netflix (NFLX),  and Microsoft (MSFT) have been doing all the heavy lifting in the market cap-weighted indices. 

If we look at the equal market weighting, we see a clear divergence; breadth weakening even as the index climbs highs.

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spy nyse chart

If the soldier can’t follow or get behind the generals (AMZN, GOOGL, MSFT), the market might find itself in a precarious and fragile state.  One vulnerable, and honestly quite due, for a 10% or more correction. 

The Sentiment Trader chart below shows when the Nasdaq had made new highs with 50% less of the components trading below their 50-day moving average.  We’re here again, and the aftermath nearly results in a significant sell-off. 

sentiment trader stock chart nasdaq

Maybe I’m being overly cautious, but the Options360 portfolio has reduced exposure to individual names through adjustments to reduce cost basis. 

I also established bearish positions in Salesforce (CRM) and broad market hedge using a ratio spread in QQQ

I’ll keep things close to the vest and see how it all plays out as the deluge of earnings starts next week.  This should bring opportunity. But first, order it to keep your head above water. 

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About author

Steve Smith
Steve Smith

Steve Smith have been involved in all facets of the investment industry in a variety of roles ranging from speculator, educator, manager and advisor. This has taken him from the trading floors of Chicago to hedge funds on Wall Street to the world online. From 1987 to 1996, he served as a market maker at the Chicago Board of Options Exchange (CBOE) and Chicago Board of Trade (CBOT). From 1997 to 2007, he was a Senior Columnist and Managing Editor for TheStreet.com, handling their Option Alert and Short Report newsletters. The Option Alert was awarded the MIN “best business newsletter” in 2006. From 2009 to 2013, Smith was a Senior Columnist and Managing Editor for Minyanville’s OptionSmith newsletter, as well as a Risk Manager Consultant for New Vernon Capital LLC. Smith acted as an advisor to build models and option strategies to reduce portfolio exposure and enhance returns for the four main funds. Since 2015, he has worked for Adam Mesh Trading Group. There, he has managed Options360 and Earning 360, been co-leader of Option Academy, and contributed to The Option Specialist website.

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