Morning Market Thoughts

Good morning. It’s not a big surprise that the market is set to open higher this morning. Why isn’t it a surprise? Well, because the market is open today; and that’s what the market does. And we need to run with the bulls while the bulls are running. But what we don’t want to do is get caught in a confirmation bias, feedback loop where a rising market prompts us to get increasingly bullish and complacent to a point where we disregard risk and just focus on how much money we’re going to make in an invincible market.

Focus on what is working now; not what used to be working. There are plenty of former leaders who are now lagging. They’re broken. Don’t hang onto them. They are yesterday’s news. Once a stock breaks, the best case scenario is that it spends the next several weeks or months rebuilding and repairing the supply/demand imbalance as traders try to find a price they agree upon. Trends don’t start in that kind of environment. They start AFTER that environment has matured and a new base has been built that’s solid enough to support a breakout rather than produce a fake out.

This is an ultimate truth that every trader must discover and embrace. Leaders ultimately tire, just like All-Star athletes ultimately get old and slow. They often stay in the game too long as their skills diminish to a point where fans quietly hope that the athlete will hang up the cleats and move to the broadcast booth. (No, I’m not throwing shade on Jay Cutler).

If you are still focusing on the high-profile leaders that have dragged the market higher these past several months, your money isn’t working very hard right now. And it’s at more risk than you realize. The much loved “FAANG” stocks (Facebook ($FB), Amazon ($AMZN), Apple ($AAPL), Netflix ($NFLX) and Google ($GOOGL)) are tired. Only AAPL and FB could be said to be keeping up the the S&P in terms of relative strength…and they are no longer leading. They are both correcting after reporting solid earnings, but not as much as the other three have.

These five stocks are responsible for nearly 30% of the gains in the S&P 500 this year. (See Ryan Vlastelica’s article on MarketWatch this morning)

There are other warning flags. The disparity between the S&P 500 and the Dow Jones Industrial Average is historical. The Dow is a price weighted index/ Stocks with the highest stock prices–such as Boeing ($BA), Goldman Sachs ($GS), McDonald’s ($MCD) and United Health ($UNH)–)have a much greater impact on the price of the Dow than the lower priced stocks like Cisco ($CSCO), Coca-Cola ($KO) and Verizon ($VZ). So any stock that is in a strong uptrend can reach a price where it will have an inordinately large impact on the Dow. We’ve seen this with Boeing ($BA) lately.

That can create the illusion that all is well with the equity market. In reality, breadth is narrowing to a point where we are seeing fewer and fewer setups that can lead to higher prices. There are few Goldilocks stocks. Some are too high, some are too low, and few are just right.

So what do we do? I think we’ve got to fly under the radar. We’ve got to look at small and midcap stocks that don’t get a lot of attention. This takes a bit more imagination and work than simply focusing on yesterday’s all-stars. But at some point, you’ve got to cut the aging All-Stars and start the rebuilding process of filling your lineup with future All-Stars. It takes a lot of effort to find those under appreciated rookies, but it’s what you have to do if you want to be a contender!

I spent quite a bit of time this weekend looking at the roster and finding new prospects. I’ll be continuing that work this week and will have my roster finalized by next weekend. While they will all have lots of potential; they won’t all pan out…but that’s trading.

Hope you are doing well.

–Dan

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