Lower Oil Doesn’t Help a Market in Need of Rest

After four straight days of strong gains, Wednesday turned into a quieter session that gave the market a chance to rest and reset. The S&P 500, Nasdaq Composite and Invesco QQQ Trust (QQQ) finished close to flat. The Dow Jones Industrial Average (DIA) eked out small gains while the iShares Russell 2000 ETF (IWM) gave back a little. The Magnificent Seven (MAGS) played some catch-up after lagging earlier in the week.

A flat-to-mixed close after several constructive sessions is the kind of action that lets the rotation catch its breath without breaking the positive momentum. Nothing was confirmed on Wednesday, but nothing was undone either.

Iran Picture Got Harder

The market got nothing new on Iran on Wednesday except a harder line from President Trump, who said there will be no deal unless Iran gives up control of the Strait of Hormuz and gives up its nuclear program. Either Iran agrees, or other action will be taken. Iran keeps putting out misleading press releases but Trump is making his intentions clear. It raises the bar on what a final agreement has to deliver but the clarity is helpful.

The most notable action was that oil was sharply lower for a second session, but the equity market shrugged and did not respond. That tells us the cooler-oil leg of the Iran trade may already be fully discounted. The market has been running on hope of a deal for weeks, and the oil aspect has been the easiest piece of that hope to price. With oil down hard and equities flat, the easy gains from that trade appear to have been taken.

If a deal does occur, the risk of a sell-the-news response in equities is higher because the benefit of lower oil is already priced in. If the deal stalls or breaks down, the risk of more downside is greater as there will be a rush to reprice oil again. Either outcome produces more volatility.

Breadth Mixed, Highs and Lows Stayed Constructive

Breadth turned slightly negative at about 48% positive, which is the first time it has slipped under 50% in several sessions. The more important number is that the 12-month highs continued to outpace new lows by close to three to one. That kind of ratio inside a flat-to-mixed session tells us the leaders are still leading even when the indices take a breather, and the corrective pressure was not broad enough to threaten the rotation thesis.

A good amount of stocks still posted gains over 10% on the day. The list was smaller than on Tuesday, but the names that ran continued to attract retail speculation. Chips took a break after the Micron-led move, and the speculative froth in the memory and space groups cooled. None of that is overtly bearish. It is just the digestion of a fast move.

Catch-Up Trade in Mag 7

The Magnificent Seven exhibited some catch-up action, which is the kind of rotation inside the rotation that often shows up after the most extended speculative names cool. Capital looking to stay in the market but not chase the hottest pockets tends to find its way back to the largest and most liquid names for a session or two. That is what happened on Wednesday.

Strategy

A day of digestion is what we needed at this point. The rotation is intact, breadth held up under the surface, the new highs versus new lows ratio stayed strongly in favor of highs, and the macro tailwinds are still in place. We will have to see what sort of momentum, if any, can build at this point.

The Iran developments complicate matters. The softer oil that has been supporting the rotation is now showing signs of being fully priced and may not be a strong positive catalyst for much longer.

As I mentioned, I’m trading tightly and playing more aggressive defense. I’m trimming a few names that had run hard and adding selectively where the setups still looked attractive. The reactive approach continues to work because the market is still rewarding stock picking over chasing the indices, and the environment supports patience if you are holding names with solid fundamentals.

Have a good evening. I’ll see you tomorrow.