How to Spot a Major Market Correction
Stocks bounced off their September lows yesterday.
Despite the recovery, the chop is still in control of the major averages. And like most traders, we’re stuck in a holding pattern as we wait for the market to give us some direction.
This week’s volatile action tore down a lot of positive momentum that was bubbling up under the market’s surface. As recently as Monday, our thesis has been that the market has quietly shifted to “risk-on” mode while most investors are cowering the corner.
The evidence was all around us. Investors were ditching safety plays like utilities and consumer staples stocks that were so popular earlier in the year. Even the price of gold fell off a cliff…
Tuesday’s swoon was enough to coax skittish investors to pound the sell button. Now that the dust has settled, our job is to figure out whether this move lower is the final shake before a year-end rally—or the beginning of a bigger drawdown.
Here are three key indicators we’re watching to help us navigate an angry (and unpredictable) market:
1. Hedge Fund Hotels
Earlier this month, we told you how performance was beginning to “trickle-up” to some of the biggest, most recognizable names on the market. The gigantic stocks that held the major averages together over the past 24 choppy months were taking back the wheel…
These megacaps are the bread and butter investments of some of the biggest funds on the Street. Yesterday, many of these “hedge fund hotels” tagged their 50-day moving averages and popped higher. That’s a sign that the big, institutional buyers are swooping back in.
Facebook, Google, and Alibaba all posted nice bounces off their respective 50-day moving averages. That’s a positive sign as we barrel toward the end of the trading week.
We’ll be keeping an eye on these charts to see if the moves stick…
2. Speculative Biotechs
While most investors were throwing in the towel yesterday, we noticed a bright spot of green on the screen.
Biotechs were catching a bid. While the Dow was off by almost 150 points early Thursday, biotech stocks were sneaking into positive territory.
Biotech stocks are quickly becoming one of the market’s big “tells.” The biotech sector was one of the hardest-hit areas of the market over the past couple of years. But it enjoyed a nice summer rally.
Over the past three months, biotechs were incredibly strong. These stocks led the major averages in a big way. They’ve now endured some selling over the past couple of weeks.
Now we’re treated to a true test of biotech’s strength. Can these stocks hold up under fire? We would like to see this group of speculative stocks retain its leadership position as we head into earnings season. Yesterday’s bounce was a good start…
Small-cap and microcap names were also finding new life and spanking the major averages just a few short weeks ago.
But this was another group of speculative stocks that took a beating earlier this week as the market tanked. Over the past three trading days, the S&P 500 has dropped less than 1.5%. The small-cap Russell 2000 has lost 2.8% over that same timeframe.
Small-caps dropped a collective 1% yesterday while the major averages recovered from their morning losses. We’re going to need to see these stocks bounce to regain some confidence in the market moving forward…
Remember, most investors are incredibly bearish this month. They don’t believe stocks have anywhere to go but down. A surprise recovery would catch almost everyone off guard, potentially leading to the year-end rally we’ve been waiting for…