On the surface, the market action on Monday looked benign, but there was some dramatic rotation taking place that was not reflected in the indices.
Software stocks such as Coupa Software (COUP) , CrowdStrike (CRWD) , Twilio (TWLO) and even Microsoft (MSFT) were hit hard for no apparent reason. Other high-flying names like Zoom Video (ZM) , Slack Technologies (WORK) and Pinterest (PINS) sold off hard, as well.
What was unusual was that the indices barely budged as the money rotated into Energy -- and the Energy Select Sector SPDR Fund (XLE) -- Financials and Banks -- and the Financial Select Sector SPDR Fund (XLF) -- and a variety of non-technology stocks, including some small-caps.
This move caught both bulls and bears by surprise. It was not the way in which market players anticipated that a correction would occur. Those market players that had hedged with index shorts, volatility instruments and precious metals were essentially unprotected from the carnage in stocks that have been leading the market. The only safety was to be found in cash or in stocks that have been laggards for months.
The more important issue for market players this morning is whether this strong rotation creates more reverberations. Typically, a move like this does not end abruptly. There is big money at work and it takes time for them to make the transformation that they have planned.
The bullish spin on this action is that market players are simply selling expensive momentum stocks and are looking for better valuations. Perhaps that is the motivation, but that shouldn't provide much comfort. If valuation is the driving force for a rotation, then the likelihood is that the whole market will eventually be viewed as overpriced.
Lagging energy and financial plays may see more bounce as the rotation plays out, but those groups are not going to suddenly turn into leaders that take the entire market higher. The stocks that lead a market to new highs are always going to be momentum names that seem expensive since they have such high levels of growth.
This is a difficult market environment to trade, but the key is discipline. It is extremely important that positions be managed tightly and stops taken if key support is breached. There will be a great temptation to hold to some of the stocks that were hit hard yesterday in the hopes it was just a temporary glitch, but that is how big losses can build quickly.
My game plan is to quickly dump positions that continue to be pressured. I'll also be looking for entries into names that are hit hard and seem to be finding support. Rather than focus on trying to catch stocks that are in freefall, I'll be looking for those that are showing some positive relative strength.
The volatility under the surface of the indices makes for some interesting opportunities, but it illustrates that the core of the market is unhealthy and that there is risk to the downside. We still have the potential for headline news to complicate matters further.
The early indications are soft as market players grapple with the unusual rotation that took place yesterday. It was unsettling action and can't be dismissed as just a one-day aberration.