Monday's headline generated crash produced an oversold climax to five weeks of declines.
Last weekend everything was ugly. The markets were accelerating lower and the headlines were worsening. Everyone was slowly moving to the sidelines and the shorts were doubling up on every new headline. The Nasdaq crashed on Monday on worries about new regulations on Facebook and Google. The worries had been around for weeks but news broke confirming the potential probes. Shares in the mega cap techs all plunged in conjunction with those companies. If you dump tech ETFs because of exposure to a few big caps then all the stocks in those ETFs decline.
The tech dumping produced was not nearly as bad as you would have expected on a 2% decline. There were still some buyers with 56 new highs on the Nasdaq. While it looked bleak on the surface there was some underlying strength. The A/D line was actually positive 1,561 advancers to 1,464 decliners. Yes, you read that right. The Nasdaq was down 2% and advancers still held the lead.
When Chairman Powell said Tuesday morning that the Fed was willing to cut rates, it produced a monster short squeeze in a market that was oversold and already had investors buying the dip. The resulting short squeeze was a textbook example. The market exploded higher and never looked back as additional Fed heads added their voices to the mix.
Last week the A/D line was right at a two-month low and today it is a new high. What a difference a week makes. There was no wobble or deterioration in the trend on Friday. Advancers were 3:1 over decliners and a three-day high. For me, what this means is that the remaining shorts were running scared into the close and were forced to cover before the weekend. Given the resolution to the Mexican tariff problem that was the right decision.
There was a marked contrast between the A/D line on the S&P and the Nasdaq. The tech index posted a 6% rebound from Monday's lows BUT the A/D line barely improved. The difference between the two charts is remarkable. The reason is due to the generals leading and the troops lagging. The A/D on the Nasdaq on Wednesday/Thursday was 3:2 decliners over advancers despite the index making positive gains. The big cap techs were rebounding but the smaller stocks were mostly declining. On Friday that reversed with advancers 2:1 over decliners. It was a rocky week for the tech stocks despite the 6% rebound.
The small cap A/D line was similar to the Nasdaq. The small cap sector was not nearly as positive as the big caps. Decliners out paced advancers on Wed/Thr by the same 3:2 margin but Friday was strong with a 3:1 advancers over decliners. Clearly nobody wanted to go home short.
Google was the biggest drag on the Nasdaq with the 80 point plunge on Monday. Apple was the biggest help with the $20 rebound from Monday's lows. The correlation breakdown since the end of April has been remarkable.
The correlation between the Nasdaq and the Semiconductor Index is back in lock step after deviating significantly in April. The semiconductor crash has ended and the rebound in oversold chip stocks helped to lift the Nasdaq.
Unfortunately, the deviation is expanding between the small caps and big caps. The small caps led the market lower since the beginning of May. Last week the big caps led the small caps higher, but it was a battle. Note the lack of a pause on the blue line and the stutter step on the black line. This is our challenge for next week. If the small caps roll over without a clear catalyst, they could continue to drag the overall market lower.
The Dow triple top formation remains intact and the rebound stalled at what could be called a mini H&S formation. If the index does not continue higher from here it would be a technical breakdown on multiple patterns.
The percentage of Nasdaq stocks above their 200-day average rose slightly to 39.25%. This shows that the techs stocks are not longer-term overbought. This four-day rally was barely a blip on this chart. They are short-term overbought, but that pressure can be relieved in just a couple of days. Longer term most tech stocks are still undervalued on a technical basis. We can't determine a fundamental basis from a chart.
On a relative basis the same chart for the S&P shows a much stronger pattern with 63.5% of stocks trading over the 200-day. Big caps held their strength while the tech troops retreated into the woods.
The VIX faded but held over 16 and that is higher than you would have expected given four days of strong gains. The answer is the lingering expectations for Mexican tariffs on Friday. It should decline sharply on Monday now that the Mexican conflict has been settled.
While we should open higher on Monday, I would not chase the rally. We are short-term overbought and due for a pause. This week is likely to be choppy followed by some gains on Mon/Tue ahead of the FOMC meeting. There is nothing to be gained by trying to navigate this chop until after we see a bout of decent profit taking. Be patient there is always another day to trade.
Enter passively and exit aggressively!
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