By: Chris Rowe — July 20, 2021
Technical Tuesday - Be Bearish on Large-Caps - Here’s Why
If you’ve been following the market news, you might be feeling antsy.
Let me show you why you shouldn’t be.
In the short-term, expect downside but in the bigger picture/long-term, expect renewed strength.
Yesterday the Dow Jones Industrial Average fell more than 700 points and of course the mainstream financial media fell all over themselves trying to scare you.
Don’t fall for it!
The Wall Street Journal, NBC News and MarketWatch all had headlines calling yesterday’s 2% decline “The Worst Day of 2021.”
CNN blamed it on covid “Delta variant fears.”
Barron’s said the selloff was due to “global growth worries.”
Blah blah blah..
Here are a couple of things you should keep in mind.
Reasons for a decline might be interesting water-cooler conversation (Not that many people are standing by any water coolers lately in life.)
But “the reason” the market ever does what it does isn’t what’s important, for three reasons.
- Dips are normal and not worth panicking over
- We can get bearish and profit from downward moves, if we so choose.
- “Why” the market or a sector moves higher (or lower) doesn't change the way we invest.
At True Market Insiders we have the one play book: buy the strongest stocks in the strongest sectors and get bearish on the weakest.
And our method starts with seeing the market clearly as it pertains to the two pillars of our framework…
- Market internals (a.k.a. “Market breadth”), which tells us if the general stock market is under accumulation or even if a group of stocks, such as sectors, are under accumulation (if institutions are buying).
- Relative strength. Once we know which groups of stocks are under accumulation (or distribution) we then use relative strength to determine the likely velocity of a move we’ll see in any of those groups. (If all sectors are being accumulated, which ones will trade up 5% and which will trade up 50%?)
In last week’s Technical Tuesday (“Declines to Come and Strength to Follow”) I told you, “Be ready for a short-term sell-off.” I also told you large-cap stocks were the weakest.
I didn’t write that because my crystal ball told me to. And I certainly didn’t write it because of anything I heard on the news.
I wrote it because I was seeing two market set ups taking shape at once.
One was a short-term view (the market internals showed a short-term selloff in the cards)… And one was a longer-term view (relative strength is showing us that we’ll likely see lots of upwards price-strength, to follow).
To be clear, I’m not saying that the market won’t fall further. It probably will.
What I am saying -- what we always say -- is that you don’t want to pay too much attention to the noise and hype you see on the news.
And of course I’m saying to be prepared.
Let’s take the short-term picture -- the market internals.
We look at the breadth of the market and its sectors (or any group of stocks) to see if the big institutions are buying or selling, and (very important) if they’re buying or selling specific sectors.
Last week I showed you this image of the US Industry Bell Curve. (When you join our sector research platform, Sector Prophets Pro you get access to this and other premium tools.)
(Click any image to enlarge)
The red boxes are sectors under the control of the bears (or Supply) over the short term. The blue boxes are sectors under the control of the bulls (Demand) over the short term.
At the time just 10 sectors (out of 45) were in the hands of the bulls.
Compare that to the same indicator -- the Bell Curve -- from June 16, one month prior.
At that time bulls controlled 31 sectors -- 69% of the market. In other words, the institutions were buying those sectors.
It’s pretty obvious that by July 14 Supply had all but taken control of the market.
By Friday (July 16) the picture looked like this:
Only three sectors were controlled by the bulls. To be clear, this wasn’t a warning sign of things to come. The fact that you see all that red means that stocks were already in strong decline.
The next trading day -- yesterday -- the rest of the world was able to see the sell-off as the major market averages finally reflected the big market selloff that had been masked, up until that point.
And if we needed more confirmation of broad-based weakness, we got that on Thursday, July 16.
Our #1 indicator, the New York Stock Exchange Bullish Percent Index (NYSE BPI) reversed from a column of X’s to a Column of O’s. Until that reversal the chart had been sitting in an X-column for 122 days.
(If you’re unfamiliar with the NYSE BPI, don’t worry. I won’t talk about it here, but we have a free website devoted to changes in the status of this indicator. We update it after every important move.)
Let’s look at the long-term picture -- the relative strength setup.
We look at relative strength to understand which securities or groups of securities are seeing the most price strength.
Based on relative strength, last Tuesday we could see a nearly bullet-proof picture of a “risk on” market in the much bigger, long-term, picture.
At the asset class level, U.S. Equities (the stock market) was by far the strongest. That’s the first sign of a “risk-on” market. (To be clear, “risk-on” means there’s an appetite for risk and is a bullish term that means riskier assets - like stocks - are likely to perform well.)
The safer asset classes -- such as cash and fixed income -- were weak. This is also considered to be “risk-on”.
Then, when we zoom in and take a more specific look at what’s “under the hood”,within U.S. Equities, we see the riskiest of the 11 broad sectors -- Consumer Cyclicals and Energy -- were the strongest. The safer sectors -- Consumer Non-Cyclicals and Utilities -- were the weakest. Risk on.
When we take a look at the asset class that’s considered to be the safer asset class, relative strength studies show us that Fixed Income, in general, is in low-demand - not much interest in the asset class.
When we zoom in to the specific relative strength relationship within the Fixed Income asset class (we look at the sectors of Fixed Income), we see the riskiest bonds -- U.S. HIgh Yield, or “junk bonds” -- were strongest. The safest bonds -- Long Duration Treasuries -- were the weakest. Risk on.
(You can read more about all this in last week’s column.)
That picture has not changed since last week. And so what I told you last week still applies today. I said…
“[The relative strength picture] is telling us that even though supply is currently putting downward pressure on stocks, large institutional investors are favoring the higher risk areas of the stock market and of the global financial markets with respect to all asset classes.
And the latter is the bigger picture, the more reliable picture, the long-term picture.”
Remember, our golden rule for making money is “buy the strongest stocks in the strongest sectors and get bearish on the weakest.” And we could add to that “... or avoid the weakest.”
Right now within U.S. Equities, the weakest size and style are the large-caps, especially large- cap value stocks.
The large-caps that are most likely to see the biggest declines are the ones that haven’t been performing very well (most of them). In other words, don’t count on the strong performers (like Amazon, Microsoft, Apple) to lead the declines.
At a minimum you’d want to stay away from them. But you should also consider getting bearish on them.
You can short individual large-cap stocks if you want to (and if you have a margin account and experience shorting). But a far safer way to gain bearish exposure is to buy Put options on large-caps.
Look for ideas in the weaker sectors.
Using relative strength analysis, we can see that on a long-term basis, three of the weakest broad sectors are Healthcare, Utilities and Consumer Non-Cyclicals.
Within the broad Healthcare sector you’ll find sub-sectors like: Biomedics Genetics and the (narrow) Healthcare sector.
Inside Utilities we have narrow sectors such as Gas Utilities or Electric Utilities.
Consumer Non Cyclicals (also sometimes called Consumer Staples) are where you find things like your Food Beverages Soaps narrow industry group.
The easiest way to gain exposure to an entire group is with a sector ETF.
You can gain bearish exposure to the broad healthcare sector through Health Care Select Sector SPDR Fund (XLV).
The sector ETF that covers the broad Utilities space is Utilities Select Sector SPDR Fund (XLU).
The sector ETF for this one is The Consumer Staples Select Sector SPDR Fund (XLP).
People sell stocks when they think stocks are going to move lower. And stocks move lower when people sell stock.
As this scenario plays out we’re always going to hear bearish hype on the news.
But the best time to get bullish and buy is when everyone else thinks stocks are heading lower, and everyone is selling.
We’ll do what we always do -- ignore the news and watch the indicators.
I believe that before very long we’re going to see a buying opportunity that’ll make your mouth water.
Stay Cool, Be Patient and Trade Safely,
Founder, True Market Insiders