The Market Is a Mess — And the Indexes Are Hiding the Truth
The indexes are terrible timing devices, and this week proves it.
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We have a little bounce action early Friday after Thursday’s damage. The Dow fell 704 points, or 1.3%, with the Nasdaq composite down 1% and the S&P 500 off 0.9% Thursday, but the damage to many individual stocks was far worse.
Despite what has been happening for weeks, the senior indexes are still in fairly good shape technically. However, they paint a picture of health that isn’t warranted if you look at what’s happening under the surface.
I’ve recently been watching the Investor’s Business Daily market-timing model very closely. After the poor action Thursday, it cut its recommended market exposure to 40% to 60% from 60% to 80%. Just a few days ago, it suggested maximum exposure of 80% to 100%. The reasoning for the adjustment Thursday night was that the Nasdaq breached its 21-day exponential moving average and closed below the low of its August 4 follow-through day.
The Indexes Are Poor Timing Devices
IBD went from 0% to 20% invested on July 29, to the maximum 80% to 100% by August 14, and back down to 40% to 60% Thursday. That is the full range of their model in about three weeks, although there really hasn’t been a major change in the character of the market.
I want to be clear that this is not a criticism of their work. IBD’s market-timing system does exactly what it is designed to do, which is react to index price action. This reactive approach is much better than the anticipatory approach used by most market strategists, but the issue is more basic. The indexes just aren’t the best way to measure market health.
The basic premise is that the indexes matter because most stocks are correlated to them to some extent. That is usually true. But the degree of correlation varies enormously, and it has been unusually weak this year because of the constant rotational action. When money moves from group to group without ever leaving the market, the indexes hold up while individual stocks take turns getting destroyed. An index reading tells you almost nothing about what your positions or segments of the market are doing.
A model built on that assumption gets jerked around when the assumption is invalid. Two weeks of steady increases in market exposure followed by two sharp cuts is not a helpful signal. It is a model responding to noise because the thing it measures has stopped producing useful information.
I have been writing all summer that the indexes are hiding what is really happening. This is the clearest example yet of my thesis.
What the Indexes Are Hiding
The problems brewing underneath have not changed and they are accumulating rather than resolving. Negative seasonality is now in full swing and September is historically the weakest month of the year. Catalysts are also lacking, with company news going quiet until October, when third-quarter earnings start.
The consumer is weakening, which Walmart (WMT) confirmed Thursday with its slowest sales growth in six years. Oil remains elevated with no resolution in the Iran conflict, and Americans have spent an estimated $88 billion more on fuel this year than they would have without the energy shock. Inflationary pressures persist above 3%.
Put those together and you get the stagflation risk I wrote about after the Walmart report. Slowing growth and persistent inflation is a combination that leaves policymakers without a good option, and no amount of Treasury bond buying resolves it.
Economists and market pundits are concerned that Treasury Secretary Bessent’s expanded buyback program is just a Band-Aid that does not fix the problem. Thursday proved that point almost immediately, with the 10-year Treasury jumping to 4.697% despite Bessent saying on television that coming buybacks could exceed $4 billion per operation.
One Note on Wednesday
Institutional investors are struggling with aspects of the market action just as much as retail traders. Moderna’s (MRNA) 177% move on Wednesday scorched short-sellers, and Goldman Sachs said it was the worst day in more than two years for systematic long-short managers, with those funds losing 1.4% by early afternoon. Morgan Stanley’s desk described a record for short-covering across biotech.
Wednesday’s biotech strength was not investors deciding they liked the sector. It was quantitative funds being forced to buy stock they had sold short. That is why the sector was hit hard and gave 3% back Thursday.
As I reported, I made several sales into the biotechnology strength Wednesday, but in retrospect I should have been much more aggressive with my reductions.
Game Plan
My game plan here is painfully obvious: stand aside with high cash levels and wait for this to play out.
There may be a few opportunities along the way and I bought one Thursday. But we are in a transition period that coincides with the weakest stretch of the calendar, and transitions take time. The setups I want come after this kind of selling rather than during it.
I would rather watch this patiently with capital available than anxiously try to make something happen in this mess.
At the time of publication, Rev Shark had no positions in any securities mentioned.
