Investors Think They’re Bulletproof

The bulls are running wild.

Remember when we discussed the possibility that the red-hot tech leaders were finally running out of gas?

Well, we just witnessed a dramatic mid-air refueling on the heels of last week’s tame Fed meeting, positive earnings reactions, and strong economic data. Just when it looked as if the highest-flying names would finally take a break, frantic buyers stepped in to blast these stocks back into the stratosphere.

Mega-cap tech continued to push higher. Semiconductors roared back to life as the VanEck Vectors Semiconductor ETF (SMH) posted fresh all-time highs. Even the tech-growth trade found its footing to finish the week with respectable gains as the ARK Innovation ETF (ARKK) pushed back toward recent highs — despite flashing an ugly reversal candle on Thursday.

The bulls were nowhere to be found in December. Now, they’re buying up just about everything and memory-holing the big fears from 2022, including steady rate hikes and sticky inflation data.

But here’s the thing…

No one is contemplating a pullback — or what might happen if stocks actually go down for a week or two.

Confident? Or Just Plain Cocky?

Just how cocky are investors right now?

For starters, virtually no one is hedging their bets. Snagging puts has never been cheaper than it is now, according to Bloomberg, with the cost of buying protection against a 5% dip over the next year falling to historically low levels. When hedging is dirt cheap, you’ll have trouble finding anyone who isn’t setting up their portfolio with higher prices in mind.

Even a routine 5% pullback isn’t top of mind right now. I say “routine” here because a 5% dip is downright guaranteed to come knocking sooner rather than later. The major averages will typically post a 5% drop an average of about four times per year.

To think a perfectly normal pullback isn’t lurking around the corner is nothing short of delusional.

Yet we’re cruising into August without a care in the world — and stocks aren’t the only assets driving the bulls wild. Real estate projections are also getting crazy, higher prices and higher rates be damned!

Zillow (Z) is, of course, fanning the flames. These real estate perma-bulls just announced that U.S. home prices will likely rise more than 6% by June 2024, with almost 50 of the 200 biggest markets seeing a jump of more than 7%.

Is this just the way it is? Are we destined to live in a world of never-ending stock market gains and bidding wars for shoddy real estate flips?

I doubt it!

In fact, I’d wager we are much closer to at least a minor market correction (or even an abrupt reset/gut-check move) than most investors believe.

As the great technician Walter Deemer says, “We have nothing to fear but the lack of fear itself.”

Hibernating Bears 

Investors think they’re bulletproof. They’ve erased 2022 from their minds and now believe stocks have nowhere to go but up. If you’re tuned into the animal spirits, you understand these are the times we should be thinking about fear — when everyone else has the rosiest possible outlook on the market.

For the record, these little tidbits don’t mean I’m itching to short the market into oblivion. I’m not attempting to call a top or bet on a serious market crash at the moment.

Quite the opposite!

Over at The Trading Desk, we’ve enjoyed a red-hot July where we were able to go 5-for-5 in our options trading, with the worst gain being an 82% winner on Palantir Inc. (PLTR) calls.

When the calendar flipped to July, I wasn’t expecting this wild rally. I had a suspicion that the market would flatline for the dog days of summer — or even correct through a broad consolidation following the big push higher in June. The Nasdaq — specifically mega-cap tech — was hitting overbought territory. A pause or move lower felt like a sensible prediction.

Obviously, this isn’t what happened. Not even close! But I did not allow my expectations for a move lower to affect the outcome of my trading.

Trading the Disconnect 

As the rally continued to broaden and breakouts extended into July, I had no trouble following the trading signals and hopping on board some strong momentum plays.

I call it trading the disconnect.

Instead of driving myself crazy by trading what I think should be happening in the markets, I open my eyes and trade what I’m seeing on my screen.

This is one of the most important skills any ambitious trader needs to learn. It’s also one of the most difficult concepts for most novices to grasp. I can’t tell you how many times I’ve heard a newer trader tell me they’re going to ignore an obvious buy or sell signal because of some preconceived notion about which direction the market is supposed to be moving.

The stock market is not the economy. I’m sure you’ve heard this old saw a million times. An extended take on this adage is that the market will go through extended periods where it appears to be disconnected from reality.

Sometimes that’s true. Other times, it’s simply a case of the financial media remaining stuck on an old narrative. That’s usually the case in and around market turning points. The investing public’s core feelings about the stock market take time to reverse and move in the opposite direction.

If we apply this idea to the market’s performance so far this year, we can assume the herd was extremely bearish in January, and the narrative was slow to flip bullish until the end of the second quarter.

Now, we find ourselves in a situation where investors are chasing stocks following a historic first-half run.

I’m more than willing to ride this rally until it starts to sputter. But I’m also aggressively taking gains where I can — and carefully watching for signs of weakness.

Just like it surprised everyone by exploding off its lows in January, the market will blindside the unlucky baby bulls during its next 5% drop.