Timing in the market is everything. I’ve been bearish on the overall market for a few weeks now and have been making some short trades. You can read about my TSLA and QQQ shorts here and here.
Yesterday was no exception. The new Omicron virus, in my opinion, is just an excuse to explain the selloff. Powell’s taper plans are the real reason the market is weak. However, there have been plenty of other signals in the market that had me on my toes.
I was running through all the reasons the market might be due to a significant pullback yesterday in my live mentoring session. The QQQ’s proceeded to sell off 3% shortly afterward. I was able to take a bunch of risk-off in my positions as there were a lot of signals flashing danger!
Sometimes if you don’t have paper hands, you end up with bloody hands, and I did a great job of reducing my exposure before yesterday’s selloff.
Here’s how yesterday played out:
Here are the reasons I thought the market could be due for a significant pullback:
The market has gone up since Covid for one reason, the amount of liquidity being pumped into the system by central banks. In a fiat system, credit is money, and when you print a lot of and give it to banks at 0% interest, this increases the supply of money and thus the demand for assets.
The chart above shows that the inflows to equities over the last 12 months has exceeded the combined inflow over the last 19 years. We are finally seeing a little pullback in this inflow, and with the Fed beginning to discuss tapering, the fuel that has driven this rally in stocks is being slowly taken away.
Market Breadth
The market cap of the 5 largest companies as a share of the S & P 500 total hit historical highs at 25%. Having such concentration in the index could lead to severe overvaluation. Not too long ago, AAPL had a market cap of less than 1 trillion, this week, it approached 3 trillion. It appears that this is not sustainable, and if we look at the chart above, such a large index concentration has preceded some severe market pullbacks.
Despite the SPY and QQQ’s being close to all-time highs, there are numerous high flying stocks that are significantly off their all-time highs, i.e. 37% or more. This can be interpreted 1 of 2 ways. Either, these stocks are now more fairly valued and should see a rotation of money into stocks trading at a discount. Or, as we saw in the 2000 bubble as the QQQ’s collapsed while the SPY held for 6 months, this could signal the beginning of a flight to safety.
Furthermore, as we can see in the chart above, the percentage of stocks with very high price/sales ratios has exploded to historical highs. This is indicative of very speculative action, as funds chase growth and are unsustainable.
Finally, the NFT boom seems to be slowing down. When pictures of Apes are selling for hundreds of thousands of dollars, this tells me that it’s a risk-on environment. This speculative action has slowed down in the last month and is another sign that the speculative mania could be coming to an end. This usually precedes a significant market pullback.
Positioning
Earlier this week I have been trimming my portfolio and getting out of some of my short puts. I’ve also been trying to short the market with trades in AMZN and QQQ’s. Although I haven’t executed perfectly, I reduced my exposure to make sure I take a few papercuts and avoid a huge headache. Knowing when to take risk-off is just as important as knowing when to put risk on.
Bottom Line
There have been numerous Macro signals that the market might be due to taking a breather.
I have been preaching about a potential market pullback for weeks now. Weakness across some high-flying names has finally made it into the indexes such as SPY and QQQ’s.
By being aware of what was happening across market sectors I was able to reduce some of my positions before the majority of the carnage this week. In fact, I was warning of potential market frothiness right before a 3% selloff in the QQQ’s. Whilst the market is known to take the staircase up, it can take the elevator down as everyone looks for the exit door at the same time!
