Hi Traders,
In my last note I wrote about the trade everyone already has on, and how violent a market gets when a crowded position meets an event that goes the wrong way. I didn’t expect a live demo four days before the vote.
The Nasdaq 100 (QQQ) fell four percent on Friday. That’s only the fifth day that bad since 2023. The chip stocks (SMH) fell eight percent. Intel (INTC) lost almost a third of its value after a quarter where it beat estimates, and Advanced Micro Devices (AMD) lost 12 percent.
Mark Sebastian said it in our chat Friday morning: they might not come to buy ahead of the election. I agree. I think people wanted to hold onto what they had going into Tuesday, and then Alphabet (GOOGL) put the screws to that. It’s month-end too, so the flows are heavy. But the reason it’s so violent is the concentration. Everyone has the same thing on: own AI, short everything else.
You can see it in the month. Going into the last hour of October, the S&P was down about one percent. The tech fund (XLK) was down nine.
The staples fund (XLP) was up 11 percent, its best month since it launched in 1998, and the 20-point gap between staples and tech is the widest since 2001.
Health care (XLV) was up almost 10 percent, its third-best month ever. Nobody pulled money out of the market. They just moved it across the street.
Bonds Are Acting Like a Hedge Again
The interesting thing is bonds. Since the low in long bonds (TLT) that we called in early October, bonds have flipped, and they’re getting money when stocks sell off.
The S&P has had eight down days since then, and TLT went up on seven of them. From July to early October it was the opposite: 38 down days for the S&P, and bonds were up on only nine.
The crude kicker is breaking too. All summer, when oil went up, bonds went down. On October 22nd oil jumped almost two percent, stocks fell more than one, and long bonds rallied almost two.
From 2015 through 2021, stocks and bonds moved opposite each other every year. Since 2022 they’ve moved together, and this year more than any. If that correlation is breaking, even partly, that’s a big signal.
Staples and Health Care Are the New VIX
Staples and health care are being treated like the VIX. Money plows into them on days like Friday. It’s literal panic buying, and then it fades a bit.
Since 2023, on days the Nasdaq 100 fell 1.5 percent or more, staples beat the S&P by about 1.6 percent that day and health care by 1.2. Over the next week they gave about half a point of it back. Before 2023 they got the same kind of bid, but they kept it. On Friday health care was up 1.5 percent before the open and about half a percent by three o’clock.
I booked my staples and health care calls Friday morning. I love booking wins like that when it feels like the market is getting crunched.
One of Two Things
From here, and I’m probably a little early on this, I think correlation across stocks starts to rise as the long-AI, short-everything-else crowd unwinds.
Right now the sectors are moving together less than at almost any time in the last 25 years. The average correlation between the nine original sector funds over the last month is lower than 97 percent of readings going back to 1999. When stocks cancel each other out like that, the index looks calm while the pieces go crazy underneath. That’s how you get a day like Thursday, when 82 percent of S&P stocks went up and the index went down.
When stocks start moving together again, the index has to move more. If the sectors went back to their normal correlation, making the same size moves, the S&P would swing about twice as much as it does now. So it’s one of two things. We either get a washout or a mega rally.
The election is the obvious catalyst. Where I’d be wrong is if the unwind is so gigantic that it goes further than I think, and the QQQs haven’t even started. Yikes.
And the reality is, earnings all in all are fine. A week ago FactSet had 83 percent of S&P companies beating estimates, better than the five-year average. Selling a stock because it went negative free cash flow is the same as selling a stock because it’s doing a takeover deal. Negative free cash flow here is an investment in the future. It’s just not clear how it’s going to pay off.
I do think there are areas of opportunity outside of AI. Thursday night I was as bullish on some areas as I’ve been in weeks. The only thing holding me back is I think QQQ can melt down.
Two things tell me which way this breaks, and both show up before the polls close.
Does TLT catch money on the next down day? And do staples and health care give back the panic bid, or keep it? I’ll have the answers, and what I’m doing about them, when I take the stage Tuesday at our first-ever Midterm Money Multiplier.
Garrett Baldwin has the whole crew lined up for three days, and my slot is Tuesday.
Enjoy the journey,
Tim