IBD Says Go to Cash. I’m Looking for Rotation.
Investor’s Business Daily cut its suggested exposure to 0% to 20%. The indexes are weak, but money is moving into the stocks that were left behind.
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Oil prices are down nearly 3% early Monday as renewed diplomatic efforts to end the U.S.-Iran conflict ease supply concerns. Indexes have some early bounce action, and lower oil prices are lifting sentiment. Overseas markets are weak after the poor U.S. action on Friday.
IBD Goes Further
After the close Friday, Investor’s Business Daily cut its recommended market exposure to 0% to 20%. Its reasoning is that the indexes are suffering broad losses, the Nasdaq has fallen close to its 200-day moving average and the S&P 500 has dropped below its 50-day. It advises investors to cut exposure in a measured way, selling their weakest holdings first, and to build a watchlist for when the next uptrend takes hold.
On Oct. 22, IBD cut exposure to 20% to 40%, and I wrote that its approach has a blind spot in a market like this one. The IBD method uses the indexes to time how much money to have in the market. That has worked poorly lately because so many stocks haven’t moved with the indexes.
The last month shows how far apart they’ve been. On Oct. 6, the Invesco QQQ Trust (QQQ), the SPDR S&P 500 ETF Trust (SPY) and the Nasdaq all hit new all-time highs. The next day, about 72% of the stocks tracked by Finviz were below their 50-day moving average and 63% were below their 200-day, the kind of numbers you expect in a bear market. The indexes said strength.
On Oct. 22, the day of IBD’s earlier cut, the Nasdaq had its worst day since June, yet the Invesco S&P 500 Equal Weight ETF (RSP) gained 0.86% and breadth was close to even. The indexes said weakness.
For months, the strength in the indexes was narrow, driven by a small group of big-cap tech names. Momentum trading worked in that group, but the indexes failed to show that much of the market was wallowing in a bear market. Now we have the opposite. Money is rotating into the lagging names, and the weak indexes are hiding it. Rather than rotate into that strength, the IBD approach is to go to cash.
The reasoning is that weak indexes will keep strong momentum from building in nearly all stocks. Maybe. But this has been an odd market for a long time. I think the combination of seasonality, the midterm elections and global economic conditions is likely to drive strong rotation while the AI sector sorts itself out.
Pockets of strength are worth more attention in a market like this, not less. We will see this week how that evolves.
Can the AI Group Find Its Footing?
The big event tonight is Apple’s (AAPL) earnings report, and many secondary and smaller companies report over the next two weeks. Much of the worry about AI has already been discounted. The group is unlikely to reverse and go straight up, but there is a good chance it chops around and finds support. Amazon (AMZN) has already recovered most of its post-earnings loss, and that is an early sign that the selling went too far.
The Election and Jobs
The election uncertainty is also weighing on the market, and once it is out of the way, the market will be able to adjust. The most likely outcome is gridlock, and that has historically been a positive for stocks. When neither party can push through its agenda, investors have fewer policy surprises to worry about.
The other big event this week is the October jobs report on Friday, and it will be particularly important. September’s report showed only 29,000 jobs added, yet the Fed is still widely expected to raise rates in December because of inflation. Another weak number would make that a harder decision. A strong one would make a hike more likely.
Game Plan
My game plan is to stay focused on rotation and the charts. Biotechnology is a good example of how the rotation is playing out. The group has bounced after the brutal selling caused by big funds degrossing earlier this month.
I have a long list of earnings reports to watch over the next two weeks, and I’ll be looking for new winners to emerge.
At the time of publication, Rev Shark was long AMZN.
