With the first quarter of 2017 in the books, it’s time to look toward Q2. So you know, my base case is that we will see volatility continue to perk up in the second quarter. With the market going through what could be a critical shift in posture (i.e, intermediate-term bullish to bearish), it is important to learn from the price action we saw in stocks and other asset classes in the first quarter.
The S&P 500 as represented by the SPDR S&P 500 ETF Trust (NYSEARCA:SPY) closed lower for Q1 and although the Nasdaq 100 as represented by the PowerShares QQQ Trust (ETF) (NASDAQ:QQQ) still ended in the green for Q1, the selling pressure from the past couple of weeks looks and feels somewhat different this time, compared to previous sell-offs.
- To scale out of long positions in the second half of January, we flipped short in late January/early February for a trade via the iShares Russell 2000 Index (ETF) (NYSEARCA:IWM) or the inverse ProShares Short Russell2000(ETF) (NYSEARCA:RWM).
- By the second week of February, our process signaled that stocks are now in a wide chop zone, where the best course of action was to take a step back and do less. This helped us avoid the choppy mess that chart chasers were involved in right through the end of March.
- While it looked like banking stocks could break out in the second half of March, we quickly respected the uncertainty and non-conformation thereof and went right back to market neutral, thus avoiding the latest drop in stocks over the past two weeks.
- Lastly, all quarter long, I reiterated almost daily to you that while large-cap tech stocks remain a market growth segment, there was increasing risk of a correlated profit taking move. This of course hit home over the past two weeks as mega-cap tech-related names forced institutional investors to clip some of their exposure to such names with basket trades, i.e., selling the theme not just some individual stocks.
The major questions I am pondering now as we head into the second quarter are:
1. Sell the rally mode? After years of buying the dip “mode”, stocks may finally be slowly switching into a sell the rally mindset. This is not yet an investment theme of ours, but it is definitely in development as we are at an important juncture in the market that must be monitored closely.
2. Looking for tactical buying opportunities — as much as large-cap tech has seen volatility of late and could indeed be giving us lower highs for the first time in ages, there will be tactical (bounce) buying opportunities for juicy gains.
3. Utility stocks — we have been bearish/underweight this part of the market since October 1, 2017. Although utilities are increasingly looking giddy to break higher, they remain range bound. We will be watching this closely.
In regards to point No. 1, note that while the strong up-trend in the Nasdaq 100 continues to hold all support lines, in my eyes, the risk of a better mean-reversion move lower into the $140s or even $130s in the PowerShares QQQ Trust (ETF) (NASDAQ:QQQ) is ultimately increasing.
The buy-the-dip mentality is deeply ingrained in most chart chasing traders these days and with institutional investors no longer willing to pay any price for some of these high flying stocks, the risk of making lower highs in this part of the market is increasing markedly in my eye.
Moving averages legend: red – 200 week, blue – 100 week, yellow – 50 week
In summary, the SPDR S&P 500 ETF Trust (NYSEARCA:SPY) closed the month of March and the first quarter right at the lower end of its 2016 up-trending channel and near its yellow 50-week moving average. The difference between the SPY and the QQQ is that so far, the S&P 500 has already made a lower high versus its January highs. While we have yet to see a lower low to confirm these lower highs, risk is certainly higher if only marked by the higher volatility range we have seen so far in 2018.
Moving averages legend: red – 200 week, blue – 100 week, yellow – 50 week
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