Stocks Are Fighting an Uphill Battle

Editor’s Note: Due to technical issues, Sam was unable to provide today’s market outlook. Serge Berger is filling in for today.

It remains my base case that after 12 months of seeing volatility in everything from commodities to currencies to interest rates, equities will not be able to remain unscathed forever.

Eventually, this cross-asset volatility will ultimately find its way into equities.

To wit, we have already seen an uptick in volatility in late June and into July, but the combination of a last-minute save of Greece and the July options expiration rally quickly brought stocks back to par for the year.

You aren’t aware of the year-to-date monthly options expiration pop and drop, you say? Allow me to point you to the below chart of the Dow Jones Industrial Average.

Options Expiration
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Note that every options expiration week this year saw a run-up into the options expiration Friday of that month, which subsequently marked a near-term top in the market. Rigged? Maybe so, but it is what it is, and being aware of this type of stuff goes a long way.

Also note that last week, the Dow Jones made another marginal lower high — the second one since May …

It has been well documented how lousy market breadth was in last week’s rally. One way to see this is by looking at the number of S&P 500 stocks trading above their respective 200-day simple moving averages. Note that last week, the stocks trading above their 200-day SMAs made another lower high after topping out early in the year. After a six-year cyclical bull market, breadth is bound to slow.

And here we are.

SPX 200-day SMA
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This does not mean we dump and short the market, but we must keep this big picture in the back of our minds so we don’t try to fight the structural underpinnings of the market for more than a trade.

Small-cap stocks, as represented by the Russell 2000, in a ratio against the S&P 500’s large caps showed relative strength in May, but they began lagging by mid-June as the ratio bumped into lateral resistance.

In other words, know that small caps tend to lead large caps, so the underperformance of the Russell 2000 doesn’t bode well for the bulls.

Russell 2000 vs. S&P 500
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Lastly, note that last week’s rally in stocks was largely led by large-cap technology and financial stocks. On the below chart, the blue and green lines represent the technology and financial sectors, respectively. But note that the industrial sector (red line) diverged lower, and considering that financials and some large-cap stocks tend to be late cyclical in nature, industrials are likely pointing in the truer direction.

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In summary, chasing the broader stock market higher continues to be a low-probability strategy that will be met with more selling and ultimately a better 10%-20% washout in coming months before a better rally into year-end can unfold.

As I type this up, Amazon (AMZN) beat earnings estimates, and the stock is trading up roughly 20%. (You can’t make this stuff up.)

Once these big tech stocks are done reporting earnings and traders are done chasing them higher, yet another leg of the market will be taken out and a better mean-reversion trade in the S&P 500 toward the 1,900 area can begin to unfold.

Though probably not in a straight line.

Successful trading and investing starts with a plan. Download Serge’s essential trading plan, The Essence of Swing Trading e-book. As of this writing, he did not hold a position in any of the aforementioned securities.

Today’s Trading Landscape

To see a list of the companies reporting earnings today, click here.

For a list of this week’s economic reports due out, click here.

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