The market has been immune to worries about the surging number of Covid-19 cases but as we head into earnings season there is more focus on the economy and economic fallout. Market players have been riding strong momentum and a surge in speculative trading, but the action cooled on Tuesday as the Nasdaq reversed intraday after hitting a new all-time high.
At the high on Tuesday, the Nasdaq was roughly 20% above its 200-day simple moving average which is around 8775. According to Investors Business Daily, the Nasdaq peaked in February when it was around 18% above its 200-day SMA. The overbought conditions are primarily a function of the speed of the recovery off the March lows but healthy markets need to consolidate gains of this size and earnings season may be the catalyst for doing so.
It is important that just because the market might be overbought that doesn't mean that it is going to reverse and go straight down. Extended market conditions can be relieved in a variety of ways. Simply churning and doing nothing much is effective in dealing with some of the excesses that have developed.
One aspect of the market that is different at this point is the aggressive speculative trading I've been discussing for a while. There are no indications that liquidity is driving up or that traders are becoming more cautious. The EV group took a hit yesterday as some of the huge moves finally lead to profit-taking, but there are indications that underlying support exists and that traders are not giving up.
The speculative trading will be boosted in part by a surge in China as mainland shares extended their winning streak for a seventh straight day. Small investors are fueling the rise after signals that the China authorities are determined to keep boosting the economy and the market.
Earnings season starts next week with a number of big banks reporting. Banks have been one of the major laggards during this market rise and some gloomy reports are expected as the problem of bad loans is building. Bad news there may have an impact on sentiment but confidence in technology, biotechnology and FAANG stocks is very high.
While I remain generally positive about trading opportunities in this market, the chances of choppier action in the indices is increasing and that means that there will be a need for a strong defense. This has been a great run lately for aggressive, speculative traders but holding on to gains is the key to long term success.
My game plan is to be more aggressive with cutting some positions that are languishing and to be more selective with new buys. However, at this point this looks like a market that needs a rest rather than one that is going to suddenly fall apart.