The market is struggling to reconcile the economic damage of the virus, volatility in global data, the risk of the second wave in China, the fact that the first wave is still in force in US, India and Latin America, a confused message from the Federal Reserve, against a backdrop of what appear to be fully valued equity markets driven by unprecedented policy accommodation from global policy makers
For equity longs it is an uncomfortable stasis, not wishing to sell and miss the upside (FOMO), but not giving up gains that have been made. This suggests to us the market is like to be a buyer at higher prices especially on a break to new highs; OR sellers at lower prices to lock in gains and reduce risk. We have long felt the phrase “buy the dip” is very easy to say, but much harder to do. We often refer to the great maxim from one the Hedge fund greats Paul Tudor Jones; (paraphrased) “Losers add to losers….”
We remain medium term risk bulls, but recognise we are in a corrective phase. The Sector dashboard shows the Equity equal weight indices over the past week are performing roughly in line with the market cap weighted indices – this tells us we are NOT seeing the mega cap stocks leading this bounce, which we have seen in rallies off the lows. Coupled with the weak internals, 63.% declining stocks in yesterday’s US session, the red candles on Monday across sectors, we simply do not see evidence for this correction to just “end”. It feels like more work to be done, both in terms of time and price.
We questioned yesterday whether we are entering an A-B-C corrective phase in risk (noting that many charts looks very similar in our key barometers of SP500, AUDUSD, DXY). We are increasingly of that view. We focus on Nasdaq100 today where the risk reward is very stark. Note the strength of the bounce off the selloff low Monday at 9350 – a break back above the 10160 high and fresh buyers WILL be dragged in – the Fear of missing out on the rally will ensure that. BUT, a failure to extend and break below previous 2020 high at 9765, heralds the chance of a deeper correction, testing 9350 selloff low; 50dma at 9190, and beyond to potentially target 100dma at 8830, a level in line with the 38.2% retracement of the entire Mar-Jun rally.
We remain medium term risk bulls, but there is a short term counter trend opportunity here to play the short side with a stop loss above the highs (150 points), initially targeting 9200/50 zone. This opportunity risks 150 to make 750 pips, or 5:1 return. For risk longs, a partial hedge using this risk-reward setup if worth consideration. (Also note that IF SP500 also tests down to 38.2% retracement, that is 2850 – mid 2800’s was our original downside pullback zone to return to the bullish side).
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