| | The Market's In a Period of Transition - Here's What's Next
by Brandon Chapman, CMT | If you caught President Trump's interview with Maria Bartiromo over the weekend, he was asked specifically about the risks of recession. His reply: "There is a period of transition because what we're doing is very big." | It's interesting that some talking heads are pointing their collective finger at an administration that's been in power for less than two months and casting the blame for an "impending" recession. | The Atlanta Fed now is predicting a negative GDP print for the current quarter. The estimate has contracted quickly from nearly 4% at the end of January to -2.4% as of the most recent estimate. | | It sure looks like Trump's policies are sinking the U.S. into recession… | …until you begin to factor in the impact of gold imports to the U.S. accounting for a rather significant percentage of the decline. | What does this really mean? It means that measures like GDP have never been a reliable measure for economic growth. At best, it's a coincident indicator, but typically the recessionary revisions come after the economy enters recession. | What is the takeaway from this? Trump's words should mean something for investors. His administration is pursuing major policy changes that are aimed at transitioning from a debt-based economy that runs massive trade imbalances to a more saving/investment/production-based economy. | That is not an easy transition, but necessary, in my view. If you're still playing from the COVID-era playbook of massive monetary expansion, you're likely looking in the wrong place. One of my major theses this year is that the Magnificent Seven stocks will likely underperform. At this point, it's playing out that way. | Here's the Bottom Line | The playbook needs to change, but it's not a time to be fearful. I laid out the plan for hedging risk and taking profits on February 18, 2024, because of a market signal that pointed to a 5% to 10% correction. I've been walking through how to roll the puts and VIX volatility spread and closing the call spreads we sold to help pay for the protection. | If you're hedged, you're ok in the current environment. But what's next? This is a time, hedged or not, where you need to think about your current allocation. Are you chasing momentum names for the quick move? Or are you looking for value and areas of capital rotation? | The transition we're experiencing will require more than just chasing performance and buying after the move has happened. This is a market, maybe like 2000, where the MOMO tech names got hammered, but there were consistent pockets of strength. | An example of that strength was the performance of mid-cap companies. | The current environment may not be a sudden collapse of the entire system, but rather pockets of volatility and rotation to different parts of the market. The current rotation is defensive, but we may see a little risk-on rotation as oversold stocks look to bounce this week. | First Mover Setup | A little change today from my usual discussion of option prints. Today is about setting up the week for opportunities. We may see additional pain before any gain and I'm watching the SKE W Index closely to see if it can come down to the 115-120 range. The only problem is that we may need to see a wash-out type of day. | What is a wash-out day marking potential capitulation? Skew in the lower range is one indication, but a 90% day is another. A 90% day is when 90% of the NYSE stocks are down on 90% of the volume. | DECN/ADVN: Ratio of declining to advancing stocks on the NYSE | | | | DVOL/UVOL: Ratio of NYSE down volume to up volume | | | | | Looking at these ratios, a value greater than 9 would mean that 9x more stocks are declining than advancing on 9x more volume. Values greater than this level is a good indication of market capitulation. | In this kind of setup, the market tends to go back to what has worked previously. In this case, you'll likely see a bounce in Magnificent Seven names. At that point, looking to stocks like Amazon.com Inc (AMZN), Microsoft Corp (MSFT) and Apple Inc (AAPL) could be a good short-term play off to support a swing trade. If the volatility pushes high enough and skew falls enough, a short put vertical could give a reasonable reward with a higher probability. |
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