Respect the Rally, Question the Sustainability
We have the biggest weekly gains since April, but a number of negative catalysts are lurking.
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The key question for investors right now is whether we have a sustained uptrend developing or whether this turns into a failed move and a rollover.
The price action is favorable. The S&P 500 and the Dow are up 2.9% and 2.7%, respectively, through Thursday, putting both on track for their largest weekly gains since the week ending April 17. The Nasdaq has gained 3.8% and is on pace for its biggest week since the week ending May 8.
The names that led are the ones that were destroyed in July. Coherent (COHR) and Lumentum (LITE), both optical networking companies that received investments from Nvidia (NVDA) this year, rose 27% and 17% this week after tumbling sharply last month. The pattern of the worst-hit names leading the bounce is characteristic of a recovery driven by positioning rather than by any change in the underlying picture. While I respect this price action, I also have concerns about its sustainability.
Nothing That Caused the Correction Was Resolved
The issues that drove the sharp July decline are all still sitting there. The capital spending debate has not been settled. The financing cost problem has not gone anywhere. The 30-year Treasury is near its highest level since 2007 and that doesn’t appear to be reversing. Memory pricing is still under threat from new Chinese competition. The Fed is leaning hawkish with three dissenters at the last meeting and hike odds around 85% by December.
What changed this week was the mood. Traders who were positioned defensively were trapped and had to scramble to reposition. That produced two enormous trend days, and optimism about a potential deal to reopen the Strait of Hormuz gave the move an assist. Strong earnings reports helped as well.
A mood shift is a good reason for stocks to rise and it often runs further than skeptics expect. However, it doesn’t mean that the underlying problems have been fixed.
The Catalyst Calendar Empties Out
What concerns me most is that earnings are mostly finished. The secondary names have been producing large moves all week, and that has been the best source of opportunity in this market, but that wraps up next week. After that we do not have clear catalysts for technology or most of the market. There will be macro-economic news but company-specific news will be sparse until earnings start again in October.
We are also heading into a difficult stretch seasonally. August through October is historically the weakest period of the year, and it arrives just as the news flow that has been driving individual stocks dries up. Thin summer volume with few catalysts is not a combination that sustains rallies.
Today’s Number
The jobs report Friday morning matters more than usual because the rate picture has been the persistent headwind all summer and this is the data point that moves it in either direction. A hot number revives the hike worry and puts pressure back on the long end. A weak number eases the rate problem but raises a different question about whether the economy is slowing while the Fed leans hawkish. Neither outcome is straightforwardly good for stocks.
Oil and Iran remain a mess as well. The optimism about Hormuz helped this week, but Tehran and the administration have described entirely different states of negotiation more than once already this summer, and crude has run toward $100 twice on escalations nobody saw coming.
Game Plan
My approach is to respect what the market is doing while staying cognizant of the fundamental issues that still exist.
The best opportunities this week were in the secondary names reporting earnings, and I have been busy trading those reactions. That continues through next week and then the calendar goes quiet.
What I want to avoid is being lulled by a strong week into treating a positioning rally as a resolution and a new trend. If this is the start of a sustained advance, there will be pullbacks and consolidations that offer entries at levels worth buying. If it fails, I would rather be holding cash and a shopping list than chasing names that already moved 20% in five sessions.
At the time of publication, Rev Shark had no positions in any securities mentioned.
