Currently we’re seeing an ever-increasing number of preliminary warning signs for the markets.
The big smart money is already lightening up their positions. You can see that when companies announce very good results but the stocks get hit by lots of selling. That is because large amounts of shares can only be sold when there is demand for the stocks, such as good earnings announcements.
This typically happens when money managers, such as hedge funds, are selling lots of shares. This is always a preliminary signal. It is called “distribution.”
For the past couple of months, we have cautioned in our research services for serious traders and investors about distribution and how investors should expect a choppy summer market. A choppy market is always a good clue that “distribution” is underway.
For those who have disregarded our words of caution, and perhaps are leveraged, ask yourself what you would do if your stock plunges 20%-30% or more? Would you sell before major damage is done, or decide to ride through the valley? Would you stick with that decision?
Make the decision now, not when it happens. Don’t ever say “I will watch it.”
Another warning sign has been the narrowness of the market rise, which has sent several indices to new record highs. Over the past few months it has continued to narrow with fewer sectors and stocks participating. Analyst Fred Hickey says that so far this year, “the top 10 stocks in the S&P 500 have accounted for more than 76% of the index's gain.”
In our view, this is confirmation that the markets are within a few months of a strong decline. It could be shocking to the majority of market participants. The ultimate confirmation came less than 2 months ago when the most prominent bear on Wall Street threw in the towel and turned bullish.
The chart below shows that the equal weight S&P 500 (SPEW, blue line) made its top this year in late March. We would not be surprised if that was the actual bull market top for the majority of stocks.
Meanwhile the top 50 S&P 500 stocks ETF (XLG, candlesticks) and the mega-cap FANG tech stocks (FNGS, red line) have soared since their mid-April bottoms.
Over the past 5 weeks the SPEW has been flat while all the bulls focused on AI, which sent the XLG and FNGS higher in June. When the generals (big-cap AI stocks) lead, and the soldiers (SPEW) don’t follow, the generals will eventually be in big trouble.
The small cap stocks, as reflected in the Russell 2000 index, have been very weak this year because it reflects the broader market, not the dozen or so big cap stocks that have been manipulated upward. The ETF for that index, IWM, is still below the high of last December.
We believe there are lots of shorts in small caps, which perhaps gives the HFT outfits an opportunity to squeeze the shorts and move the small cap stocks up for a short time. See the 2-day chart below:
However, we would NOT consider that sector a longer-term investment opportunity.
CONCLUSION: The organized illusion is that the stock market has risen strongly this year. As we wrote, it was only a handful of stocks that had big gains, with the several thousand others being flat or declining. Why is this happening? We have our theory, which we will discuss in our upcoming Wellington Letter.
We expect a very volatile post-summer market, through the rest of the year, especially around election time. Therefore, it would be prudent for any serious investor to start preparing their portfolios right now, ahead of the turmoil.
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