A Shift in Market Character, But This Is Not a Bear Market

There is a small bounce in stocks early Friday morning following strong results and a positive response to earnings from Intel (INTC). Investors are still struggling to digest the ugly response to a good report from Alphabet (GOOGL), however, the Magnificent Seven (MAGS) is already up about 1% and the semiconductor sector (SMH) is trading flat.

A drop in oil is also giving things a boost. The Iran situation remains a mess but there is some hope that President Trump will not have to escalate the situation even further as he is threatening. This may actually be a bigger issue than earnings news as it will influence inflation and push the Fed to raise rates.

A Signal From the Momentum Crowd

The market action on Thursday was not only technically significant, but there is a change in character in the price action. Investor’s Business Daily dropped its suggested market exposure to just 20% to 40% and noted “The Nasdaq undercut its early June lows during Thursday’s session and finished at its lowest point since early May. Those are strong indications of ongoing weakness and a clear signal to further reduce your market exposure.”

The IBD approach to market timing focuses on momentum and is reactive rather than anticipatory. Market exposure is reduced as technical levels are breached and fewer stocks meet buy criteria. It stays defensive until there is some positive action and what is called a “confirmation day” where there is high volume follow-through to the upside.

This market-timing approach is designed to prevent high levels of exposure as a broad market decline gains momentum. It doesn’t always work, especially when there is a quick reversal after a blowout, but it does a good job of reflecting a major shift in the character of the market.

What Is Different This Time

There are two major differences occurring this time. The first is that this action is not a response to poor earnings or missed estimates. The selling in Alphabet is mostly a knee-jerk reaction to increased capital spending. There is a presumption that this spending is not going to produce substantial returns. There is little evidence of that but investors don’t like that cash flow is going to zero in the near term as this massive investment continues for years.

The hyperscalers are confident that their investments will pay off but they also have little choice if they want to stay competitive. Investors are skeptical and that is what produced the strong negative reaction.

The second issue that is at play is the strong rotational action. Money coming out of technology is not leaving the market. It is shifting into other areas. There are still many good values and growth in various sectors of the market such as health care, industrials, and energy.

This is far from classic bear market action. There isn’t any panic and there is no broad selling or a race for the safety of cash. The news flow that is causing this selling isn’t even that bad. It is just a readjustment because of the capex worries.

Strategy

I’ve been anticipating this sort of action for a while and have a good amount of cash available and a shopping list in place. I’ve been waiting for dislocations to gain some traction and that happened to some degree on Thursday. The issue now is finding some entry points in stocks that I favor. I’m moving incrementally and am mindful of upcoming earnings reports in many cases.

The market periodically needs these sorts of shakeups. They are healthy and create a new supply of opportunities. My best advice is to think opportunistically rather than be influenced by the negative views of most market commentators.

At the time of publication, Rev Shark had no positions in any securities mentioned.