Breakout Buyers Caught in Classic Bull Trap
The problem with traps is that they don’t seem like traps until it’s too late.
You've reached your free article limit
You've read 0 of 1 free Pro articles.
It was an ugly day on Wednesday. Breadth finished at around 25% positive and it stayed under 30% all day. This was broad, steady selling from the open, and the dip buyers never tried very hard. The primary trigger was higher interest rates, with the 20+ Year Treasury Bond Fund (TLT) dropping back near all-time lows and the United States Oil Fund (USO) jumping 3.2%. Hopes that a hawkish Fed could be safely ignored were dashed. Small caps fell 1.75%, and after a strong Tuesday the biotechs gave it all back and more, with the SPDR Biotech ETF (XBI) down around 4%.
Classic Trap
Just a few days ago investors were celebrating the breakout in the Magnificent Seven (MAGS), Investor’s Business Daily went to maximum exposure at 80% to 100%, and the bulls were complaining about writers who kept pointing at poor breadth and a narrow market. That was Monday. Two days later, the narrow market we were told not to worry about is exactly what took us down.
This was a classic trap, and the trouble with a trap is that it does not feel like one while it is setting up. A record close in the Nasdaq and a maximum-exposure signal felt like confirmation that the coast was clear. Underneath it, five times as many stocks were making new lows as new highs, more than half the market was below its 200-day, and the only two prior days that looked like Monday were 1929 and 1999. The setup was there in plain sight, masked by an index at a new high.
This is one of the main points I have been making all year. The index is not the market. When the two disagree this sharply, the index is the one lying, and Wednesday is what it looks like when the market underneath finally pulls the index back to reality.
Seasonality Had its Say
I wrote on Wednesday morning that I was concerned we had not escaped the pull of negative seasonality, and the trading day sure felt like the answer. This is the historically weak stretch, the week after September expiration, and it arrived on schedule with a hawkish Fed and rising oil to give it some bite.
The rate problem is the problem. The market spent last week convincing itself the hawkish Fed was already discounted, and this week the Fed speakers and the bond market reminded everyone it is not. TLT back at the lows and oil jumping again is the exact combination that has driven every hard down day this stretch, and neither one is resolving.
Game Plan
The 4% drop in biotech the day after I added to a couple of names stings, but small incremental buying and small positions are the point. You take that hit and it doesn’t hurt quite as much when you still have plenty of cash to put to work. Anyone who backed up the truck on Tuesday’s biotech pop is having a much worse Wednesday.
What I am watching for now is the character of the selling. Wednesday was steady and broad, with no bounce, suggesting the market is still searching for a low rather than finding one. The bounce I want to buy comes with a washout, a flush that finally scares out the last holders, and then a reversal that holds. We did not get that on Wednesday. We got grinding. Until the selling either exhausts itself or capitulates, there is nothing here to chase, and plenty of reason to let it come to me.
I have written quite often that bad markets don’t scare you out they wear you out. This was scary action, but it takes time to wear out the bulls.
Have a good evening. I’ll see you tomorrow.
At the time of publication, DePorre had no positions in any securities mentioned.
