After the S&P 500 dipped to its lowest point since mid-July, stocks bounced sharply on Friday, but it was a typical counter-trend move that was driven by inflows on the first day of a new quarter. As we start a new week, sentiment is mixed, and stocks still have work to do to find a support level that will provide a platform for a new uptrend as we head into the end of the year.
Stocks have been undergoing a correction since the start of September, and while it has been painful at times, it has been routine and healthy. There are concerns about a variety of issues such as Evergrande, inflation, the debt ceiling, chaos in Congress, the Delta variant, slowing growth, increased taxes, and employment growth. The bears have had a narrative to work with and have been able to apply some pressure.
The positive spin on this action is that the market has needed a correction. It is necessary to periodically wash out some of the excesses, and that is what has been happening. One of the most notable things about this corrective action is that the small-caps and secondary stocks that have been undergoing a bear market since February have shown relative strength recently.
Another notable issue is the number of stocks that have already corrected far more than the indices. 56% of all stocks are below their 200-day simple moving average of price, and around a quarter of stocks in the Nasdaq 100 ETF (QQQ) are down 20% or more, which is the definition of a bear market.
Some big-cap names and the senior indices are still extended and haven't spent sufficient time undergoing a real correction, but much of the market is struggling to find support, and that should be a good technical setup as we head into third-quarter earnings and the positive seasonality into the end of the year.
While the market is developing in a positive manner, it is important to be patient and let the corrective action payout. The important thing is to not try to guess the exact turning point but to wait for price action to improve and then try to catch some sustained strength. The goal isn't to time the exact lows. The goal is to catch a trend.
I'm optimistic about how things are setting up, but we may see a continuation of the selling pressure for a while longer. The level of negativity is fairly high, and the news flow is providing a good justification for selling which is exactly what we want to hasten the corrective action.
We have a gap down open this morning, and we will see how brave the dip buyers are, but after two big down days last week, they are likely to lack some confidence.
My game plan is to continue to maintain high levels of cash, keep stops tight, and do only limited incremental buying. I'm optimistic, but we need better price action before we risk more of our precious cash.