Broken Stocks Lead a Bounce as Small Caps Lag
The most beaten-up names enjoyed a reprieve, but don’t be too trusting.
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A strong open was sold hard early on Monday, but the selling did not last long. Buyers stepped up and the market spent the rest of the session moving back toward the highs. Despite the recovery, breadth was just 51% positive as small caps lagged most of the day.
The biggest movers were the broken technology names like Palantir Technologies (PLTR), storage stocks, and the Roundhill Magnificent Seven ETF (MAGS). The Magnificent Seven gained an impressive 3% which helped to give the market a holiday feel in front of the July 4 holiday.
Wrong Names Lead the Bounce
The names that drove the rebound are the same ones that got punished last week. PLTR, the storage group, and the Magnificent Seven names led the move higher off the Monday morning lows. That is the bounce setup I wrote about on Monday morning. Positioning gets squared away after a rough stretch, the most beaten-down names attract dip buyers, and the technical action looks better than the underlying setup justifies.
The character of the bounce confirms what I have been writing for two weeks. The action is in the names that have been broken rather than in the leadership groups that have been working. Biotech slowed a bit but added another 1.3% on Monday as the rotation winners digest some gains.
The new money is chasing the traditional AI names instead of building positions in the rotation themes that have been working. That is the wrong move and it will get punished if the underlying issues with the chip pricing and the Fed setup do not change.
Index Strength Without Breadth
Breadth at just 51% positive on a session where the major indexes closed near the highs is a sign that we can’t trust index strength. Strong sessions usually have breadth above 60%. Narrow participation means the buying is concentrated in a small number of big caps that are beaten down names rather than spread across the market.
Small caps lagging through the day reinforces that view. The Russell 2000 has been the rotation winner in recent weeks and the underperformance on Monday suggests the new money is going to large-cap broken names rather than to the smaller rate-sensitive groups that benefit from a less hawkish Fed. That is positioning rather than thesis change. The Fed setup has not changed since last week and the May PCE data confirmed the hawkish trajectory.
Strategy
My defensive posture stays where it has been. Cash levels still around 45%. Heavy in biotechnology but trimming the names that have run hard. Not adding to the AI names despite the bounce because the issues that drove the selloff are still in place. Watching the next groups to take the bid as the rotation continues.
The bounce in PLTR and the Magnificent Seven is the kind of action that can extend for a few days and then fail. The right response is to use the strength to lighten remaining exposure to broken names rather than to chase the recovery. The names that work in this kind of market are the ones with their own catalysts and relative strength, not the ones that are recovering from oversold conditions.
Quarter-end flows on Tuesday could produce some additional noise as institutions square positions for the books. The holiday mood into the July 4 holiday Friday still applies. Q2 earnings start in roughly two weeks and that is the next catalyst that can meaningfully move the indexes. Between now and then the path of least resistance is sideways to choppy with rotation continuing to be where the opportunity lies.
Have a good evening. I’ll see you tomorrow.
At the time of publication, DePorre had no positions in any securities mentioned.
