The Speed and Size of Corrective Action Catches Investors By Surprise
Conditions for a pullback have been in place for a while, but the abruptness of the selling on Tuesday was not anticipated.
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It isn’t surprising that the market stumbled in the seasonally weak month of September. However, the size and abruptness of the weakness on the first trading day of the month caught investors by surprise. The headlines are that worries about economic growth caused the drop, but there is a combination of factors that are coming into play at the same time.
The first issue is that the Goldilocks economic scenario is being questioned again. While it is clear that inflation is now under control, there has been a high level of optimism that the Fed will be able to engineer a soft economic landing. The Fed has had little success in the past with such a maneuver, but the market is always hopeful that the central bank will finally time things correctly.
Some vague worries about growth developed on Tuesday, and that is what triggered the very poor action. These growth concerns are correlated with a shift in the major AI stocks.
It was the chip names, which are providing the infrastructure for AI, that were the worst-performing stocks on Tuesday. Nvidia NVDA fell sharply and then fell even more on the news after the close that it is being investigated by the FTC for unfair competition. I believe this pullback in Nvidia is a good opportunity, but I will be buying slowly and incrementally over a matter of weeks or months.
The AI names were the primary market leaders for most of the year, and it is logical that a reassessment of the group is triggering corrective action. One theme that was very clear in the second quarter was that it was going to cost much more and take longer before mega-stocks such as Google GOOGL and Microsoft MSFT could start reaping the great profits of AI.
Another factor that is coming into play is that, technically, the market was overbought, and the anticipated rate cuts by the Fed are a classic sell-the-news setup. If the market is at highs when the Fed starts cutting, it is too obvious of a sell signal. The market recognized this and is inclined to front-run that action rather than wait for it to actually occur.
The immediate concern of the market will be labor data that may confirm that things are cooling off faster than expected. There is data on job openings at 10 a.m. ET on Wednesday and then the August payroll news on Friday morning. Weaker-than-expected data will undermine the Goldilocks economic scenario, but it may also increase the likelihood of a half-point cut by the Fed on September 18. A half-point cut would be an indication that the Fed is worried that it is behind the curve and cause more worries about growth.
We are grappling with corrective action right now, and the most important thing you can do is stay patient and wait for it to play out. This will create great opportunities, but it is important to wait for them and not be too quick to try to buy weakness.
The indexes are indicated lower in the early going Wednesday.
At the time of publication, Rev Shark was long NVDA.
