Rates and Breadth Are a Problem, but a Fourth-Quarter Turn Is Setting Up
Much of the market is already oversold, and the election may trigger a turning point.
You've reached your free article limit
You've read 0 of 1 free Pro articles.
Market action is mixed early Tuesday, with oil and bonds stable and a little bounce in the Magnificent Seven and chips after they led the market lower Monday. A bounce in the mega-caps after a weak day has been the recent pattern, but it won’t change the bigger issue, which is the two-tiered nature of this market and the pressure it is putting on the indexes.
For weeks, the bulls have dismissed poor breadth because the major indexes haven’t cracked. The Nasdaq and S&P 500 are still holding their 50-day moving averages, but the number of new lows keeps growing, and the pressure is building. The equal-weight indexes are starting to reflect the problem more fully. The Invesco S&P 500 Equal Weight ETF (RSP) has been trending lower, and it is clearly diverging from the cap-weighted SPDR S&P 500 ETF (SPY).
The new highs and new lows are even more lopsided. On Monday, the combined numbers on the NYSE and Nasdaq were 66 new 52-week highs against 883 new lows. That is a striking reading for a market with the indexes this close to record highs, and it paints a much different picture than the indexes do.
Goldman Sachs measured the damage done to the median stock in the S&P 500. Half of stocks are doing better, and half are doing worse. By its calculation, the median stock trades 16% below its 52-week high, while the index itself sits within a couple of percentage points of its record. By Goldman’s measure, that is the weakest level of breadth since the internet bubble.
Not a Replay of 2000
The comparison to the internet bubble is interesting because the two markets developed so differently. In 1999 and early 2000, the index was not dominated by a handful of mega-caps the way it is today. The 10 largest stocks accounted for about 27% of the S&P 500 at the dot-com peak, and they account for over 40% now.
Sentiment back then was largely driven by wild speculation in smaller stocks. Big moves in junk names set the tone, and the enthusiasm spread from there. We have not had that in this cycle. If there is an AI bubble, it has formed in the biggest names in the market, and the secondary stocks that would normally carry the speculation are the ones making new lows. In many ways, if there was an AI bubble outside the mega-caps, it has already burst.
Oversold Meets a Seasonal Turn
It will be tough for the indexes to gain traction until breadth starts to improve. However, the correction under the surface has been so severe that many stocks are now deeply oversold, and that is where the opportunity starts to develop.
The near-term problem is that we are still in a period of negative seasonality. September is historically the weakest month of a midterm election year, and the market tends to chop into early October as the election adds its own uncertainty.
Once we move past the vote on November 3, the seasonal picture turns positive. In years when the S&P 500 was up 10% to 20% after nine months, as it is now, the fourth quarter was higher 21 out of 24 times going back to 1928, and the three down years lost only 1%. In the 12 months following a midterm, the S&P 500 has been higher 95% of the time since 1938.
The combination of deeply oversold individual stocks and a seasonal turn is a powerful catalyst. A lot will depend on how things evolve with AI and capital spending, and I’ll be watching oil and bonds for confirmation. A bounce that comes while rates keep climbing is one to trade, not to trust.
Game Plan
My game plan is to keep slowly positioning for fourth-quarter bounce action. That is not the same as bottom fishing. I’m still avoiding stocks with no support, and I’m building positions in pieces rather than all at once.
The easy mistake is to rush into positions too fast, and I’ve done that a little bit myself, so it is imperative to cultivate patience and not be fooled by a few days of strength. When the turn does come, it is usually big enough and persistent enough to allow for entries. You don’t have to nail the absolute bottom to navigate this market effectively.
While we currently have some major problems with the two-tiered market action and poor breadth, I’m optimistic about the opportunities that will develop as we move into the fourth quarter.
At the time of publication, Rev Shark had no positions in any securities mentioned.
