Frothy Momentum Ends Abruptly but Technical Conditions Remain Positive

Frothy Momentum Ends Abruptly but Technical Conditions Remain Positive

The indices suffered their biggest loss in months on Thursday with technology stocks and the Nasdaq leading the fall with a drop of 5%. There was selling across the board but it was the momentum names that have led the indices to new all-time highs that bore the brunt of the damage.

The pullback was unusually abrupt as it occurred the day after the Nasdaq and many of its components hit new all-time highs. It is unusual for big downtrends to begin in that manner. There normally is some churning and uncertainty before a pullback gains momentum, but there has been quite a bit of rotational action under the surface already as Apple (AAPL) , Tesla (TSLA) and other technology names have screamed higher.

Typically in a selloff of this sort the downside volume would be 90% or more. In this case, it was far less extreme, which illustrates that it was mainly the most overbought stocks that were correcting. The rebalancing of the Dow Jones Industrial Average on Monday coupled with the splits of Apple and Tesla had created some unusual buying pressure that finally came to an abrupt end. There was no real justification for the move and the market finally reacted.

The big question now is whether this action is the start of a major top or just another bout of sudden selling that will be quickly shrugged off. Since March the indices have had a number of big one-day selloffs that quickly reversed. On June 11, the S&P 500 dropped 5.89%. There were bounces over the next few days and new support levels formed and led to a complete recovery by the end of July.

Downside follow-through has not occurred since the market bottomed in March, but is it different this time? Perhaps.

However, there are a number of positives still at work that may make this difficult for the bears. First and foremost is that the liquidity that has been driving this market has not suddenly disappeared. There has been a flood of capital looking for a place to go and much of it has been chasing a small group of big-cap stocks. There have been numerous stories about how narrow the market has been since the FATMAAN names have been running.

Will the money coming out of the very extended big-caps rotate into far less extended names that are still relatively good values? It is tough for secondary stocks to outperform when leadership is correcting, but there have been some hints of it lately as money has rotated from growth to value.

This market needs to broaden and move beyond the FATMAAN names if it is going to continue to run. If the selling in technology broadens it is going to be difficult, but due to the level of liquidity out there we should expect to see some bottom-fishing occur fairly fast.

We have monthly jobs news coming up that will create another reaction, but that news has not had much lasting impact in recent months. The dip buyers are anxious to buy, but the gap-up open is frustrating some plans.

My game plan is to start looking to do some bottom fishing fairly fast. The secondary names that have shown good relative strength will be the primary target.

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