Market Report: A Pullback That's Largely Driven By Tech And Growth Stocks

Summary

• Last week saw a wide divergence in the stock market.
• Sectors that exploded higher after March 2020 (e.g. tech, IPOs, growth stocks) saw sharp drawdowns while sectors that lagged significantly are catching up.
• Here are the top indicators and charts to pay attention to right now.

Last week saw a wide divergence in the stock market. Sectors that exploded higher after March 2020 (e.g. tech, IPOs, growth stocks) saw sharp drawdowns while sectors that lagged significantly (e.g. energy & finance) are catching up. In this Market Report I will highlight a few indicators that matter right now. But more importantly, I’ll discuss how we’re investing & trading in this environment because at the end of the day, the only thing that matters is how you’re positioned. Everything else is just noise.

Sentiment

Sentiment is not displaying excessive pessimism despite the recent selloff. Here’s the NASDAQ Daily Sentiment Index:

Now of course, sentiment doesn’t need to fall to extremely low readings for markets to bottom. Sentiment is mostly just a function of price. Markets bottomed last October on sentiment that wasn’t much lower than today.

Insider Buy/Sell

There’s been a slight uptick in corporate insider buying recently as stocks pullback. Past market bottoms saw a higher insider buy/sell ratio, so this could be a sign that the pullback/correction isn’t yet over.

Source: BullMarkets.co

Relative Gamma Exposure

Relative Gamma Exposure (Gamma Exposure divided by the S&P 500’s value) plunged to a record low.

Source: SqueezeMetrics

Historically, such low Relative Gamma Exposure was a bullish sign for stocks over the next 3 months:

USD rally

Stocks and the dollar have been inversely correlated over the past year, so it’s no surprise that the U.S. Dollar is rallying right now as stocks pullback. There’s been a slight uptick in large speculator positioning towards the Dollar. The dollar will rally higher if stocks fall further. This matters for funds like ours that invest in UK private assets.

Source: Bloomberg

Fund flows

The recent pullback in stocks has been accompanied by strong fund flows into S&P 500 ETFs. The last time this happened was in January 2018, when stocks fell further and VIX spiked.

Source: Bloomberg

Breadth divergence

Since the recent selloff is very sector specific, a large % of stocks are at 52 week highs AND 52 week lows:

Source: Bloomberg

This kind of split market breadth historically was not a good sign for stocks:

I pointed out important long term risks for the stock market. These risks do not matter over the next few months to 1 year, but will matter on a 2-5 year time frame.

Conclusion: how we’re investing and trading

The above indicators and charts point a confusing picture for markets. Some suggest that the bottom is here, whereas others suggest that there’s more room for stocks to fall. Here’s how we’re positioning our portfolio:

Long term portfolio

I don’t have a crystal ball. Stocks will either explode higher over the next 12 years or we’ll experience a major 15%+ correction. The buy-the-dip mentality is still very much alive and bubbles typically require more than 1 shakeout to end. This sounds like stating the obvious, but think about it for a moment. We have:

1. Rampant speculation and near-record valuations.
2. Insanely strong momentum where people now think that 10%-a-month gains are the norm!

The last time this confluence of excess risk-taking and powerful momentum happened was during the dot-com bubble. Only with 20/20 hindsight do we know that the bubble ended in 2000. In reality, the dot-com bubble could have ended in 1997, 1998, 1999, or 2000. Bubbles can end today, or can last longer than you expect.

While we won’t pretend to know what stocks will do over the next year, we do know 1 thing: long term risk is high. We do not invest in “lose-50%-or-win-100%” scenarios. As a result, our long term portfolio is not invested in public equities. Instead, this part of our portfolio is focused on attractive opportunities in private markets where we can earn double-digit returns with excellent downside protection.

In a normal scenario, the NASDAQ’s current pullback would be enough for us to start scaling in. Many growth and tech stocks are down significantly. HOWEVER, this is not a normal environment. Long term risk remains exceptionally high. This is either the start of a much larger decline or the end of a normal pullback/correction. Again, stating the obvious. But we do not participate in “lose-50%-or-win-100%” bets. I’ve seen growth stock investors down 20-30% while the S&P is down mid-single digits right now. If the S&P falls -15%, these growth investors will lose more than 50%.

Short term portfolio

Our short term portfolio focuses strictly on equities. The trend is neutral, so we are hedged. The specific trades we take are determined by our trading algorithms. But due to high long term risk in the stock market, we have decreased the allocation to our short term portfolio (equities) and increased the allocation to our long term portfolio (private markets).

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Comments

[jprizzuto]

so NOT true... "at the end of the day, the only thing that matters is how you’re positioned"

as every trader knows, at the end of the day, the absolutely ONLY thing that matters is whether you made money!!!

[Think Long Term]

I bet when the stimulus vote passes tomorrow in the House, we will see a ramp up job like no one has seen before....basically SPY index is flat for the year...you gotta think they are going to pump this over 400 tomorrow on a passing vote

[Chancetaker28]

@Think Long Term nope

[Kaliboo]

Tech and Growth equity shares have been like a yo-yo, going way down, then way up, except mostly it's doing 3 way down days for every way up day. The narrative about rising interest rates hurting these T&G businesses but almost nothing else is a canard in my view. That narrative is coordinated with the endlessly repeated "rotation" narrative in the financial media. It seems to be a ploy and conspiracy to drive prices down and cause huge volatility in T&G to create great buying opportunities for the co-conspirators . And it's working. The growth/disruption opportunity in T&G just doesn't hardly exist anywhere else unless politicians are forcing huge tax credits picking winners and losers as in the Green energy space. Today's strong bounce (so far) seems to bear this out.

[Daniel-san]

I've been reading that we're going to see a 10-15% correction for the last 11% down (much more for some stocks). I'm curious why articles like this one don't take into account the drop we've *already* experienced, and then clarify your proclamations about a drop. Otherwise, the "~15% correction" you've stated would actually be a "~26-30% correction" if we included the ~11% drop (NASDAQ, which is now officially in correction territory) that we have *already* seen.

[j. hughes]

@Fundamental Capital
You mirrored my investment strategy.
What little I have in stock is hedged and I am presently negotiating the purchase of rental properties in the ski industry. The season is ending and, during the lockdown, due to COVID, this past season has not been great. With the vaccines things should bick up and mortgages are still cheap. If rates go up, I have the cash.

[Kaliboo]

Nice article and graphics. Makes sense to me. Private debt equity sounds like a good place to wait this out. Thanks.