Hey There Income Hunters,
Would you believe the rally from Monday to Wednesday was the largest three-day uptrend of the year?
It was a pretty quiet melt-up. However, regular Power Income readers know to enjoy the bounce while it lasts — and probably killed it yesterday, like I did.
I shared this week that Jerome Powell boxed himself into a corner by getting so aggressive on fighting inflation. He telegraphed that the Fed support for the market is much lower now.
Then this news flashed across the screen yesterder …
BIDEN SAYS U.S. INFLATION DATA DUE FRIDAY WILL NOT REFLECT RECENT DROP IN SOME PRICES, INCLUDING ENERGY
Are you kidding me!?
Is Biden now the new “transitory inflation” voice?
Now, we know every message from Washington is political, so is Biden admitting inflation is costing them voters?
Certainly that means DC approves tightening and the Fed letting the market correct meaningfully.
This is critical intel and today we’ll check on market internals and trades that make sense into next week.
Cracks in the Tech Internals
The graph below highlights the damage being done away from the FAANG stocks.
As the overall NASDAQ index has rallied, the average drawdown per stock has been trending lower.
The comparison of the average drawdown to the index is at the highest level in two years …
I think we will see this divergence revert early next year. The FAANG names have become the new safe haven for cash on the sidelines.
These stocks are benefiting from the uncertainties hanging over the market’s head, including the debt ceiling, the spending bills, the Fed, etc.
As we move forward and growth slows, earnings will have to come down and the FAANG names will catch up to the drawdowns of the overall index.
Tech (NASDAQ) vs S&P 500
The ratio of tech, via Nasdaq, to S&P 500 is illustrated below. Notice how tech has soared above the levels reached during the dot-com bubble and now have confirmed a negative RSI/price divergence.
The timing of this signal is ideal. The reason the ratio has remained elevated while many tech stocks have seen 50%+ drawdowns in the past 12 months is because of the outperformance from the FAANGs.
As I have been saying, tax-loss selling is hurting smaller-cap growth names with cash being parked in mega-caps for safety.
The two points above highlight how fragile the broad tech index is. We will see a reversal in Q1.
The best way to play this trade is to put spreads on the Nasdaq or individual FAANG names when the market is at the high end of the range.
Then when the market corrects and we are at support, buy call spreads on the S&P 500 or Russell 2000.
This strategy allows you to maximize your returns on the option spreads because you could catch a trade where both spreads expire above/below their higher/lower strike, which is the home run trade.
Bring It Home
I’m confident Power Income (and my Power Income Trader program) will hit many home runs in 2022.
The Fed is cornered, the Administration is desperate and investors are unsure of the impact inflation will have on policy or the markets.
I feel certain of where the Fed is and what they intend to do.
The Christmas Massacre could be on its way and it all depends on how serious the Fed and administration are about slowing inflation.
I would say after Biden’s remarks yesterday, they are more serious than priced into the markets.
Stay tuned and as always …
Live and Trade With Passion My Friends,