Market Action Is Overheated, Triggering Sales Into Strength

Small and secondary stocks have been ripping higher this week, but the action is so strong that it raises concerns that it may be a blow-off move that is likely to end badly. In a blow-off, the bulls become heavily long and have little buying power left to keep driving extended stocks even higher.

Blow-off moves typically end with substantial intraday reversals. Stocks run up strongly in the morning but then fizzle out and undercut the early lows. If the dip buyers don’t show up on the pullback, then it is strong evidence that buying power is depleted, and the likelihood of additional profit taking is high.

On Wednesday morning, there was another frenzy of buying in smaller stocks with dozens of names jumping over 10%. Traders overlooked the trade war with China, which led to a sell-off on Tuesday. Some of these names are extremely extended and have questionable valuations, but when the action is bubbly, it is stories and not numbers that drive the moves.

Dip buyers did show up, but by 3 p.m. ET, they had been unable to return to day highs. Breadth shifted from approximately 75% green to 50% green as momentum slowed.

The good news is that, while there appears to be some profit-taking in the hottest and most extended stocks, there is more interest in buying names that have not performed as well recently. Traders — and that includes me — are looking for stocks that are good values but have been overlooked as the hot money chases momentum and big moves. There are quite a few good stocks that have been overlooked because they lack relative strength.

With a flood of earnings reports coming up, there will be more focus on fundamentals and the merits of individual stocks. The hot stocks that are primarily just stories will be forced to admit that they aren’t making money and probably won’t make anything substantial for a while. Whether that discourages investors, we will have to wait and see.

I have to head out a bit early. Have a good evening. I’ll see you tomorrow.

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