MorningWord 11/04/16: Don’t want a nation under the new mania

by Dan November 4, 2016 8:39 am • FREE ACCESS

Alright, maybe it’s starting to sound like the boy who cried wolf, or merely my fairly convicted view that the concentration in the Nasdaq among a handful of stocks will eventually be the stock market’s undoing. Last week in this space (Breadth Mints – QQQ), for the umpteenth time I hit the big 5:

My continued concern as it relates to the health of the rally is the performance concentration of top 5 holdings in the Nasdaq, but particularly the NDX. The top 5 holdings (AAPL, MSFT, GOOGL, FB & AMZN) in the QQQ (105 stocks total), the etf that tracks the NDX make up about 40% of the $5.6 trillion index’s weight. Year to date the index is up nearly 7%, or about $390 billion. When you take the year to date gains in market cap terms of the top 5 holdings they equal nearly $370 billion. That’s fairly astounding from a concentration point, showing what appears to be a lot of poor performance of dozens of stocks in the index, possibly masking some nasty fundamentals.

This has not been a table pounding call to short the Nasdaq, (despite making the occasional defined risk trading call), and it certainly has not been a proclamation to sell (AMZN, FB & GOOGL), but merely to be aware that taking a peek under the hood, there is a lot of bad price action in the Nasdaq 100. I suspect the most important take-away from the declines in AAPL, AMZN, GOOGL, FB (and MSFT from its post earnings gap) over the last 10 days is the acknowledgement of the fact that they all put up great calendar Q3 results, but it was a metric here or there, or conservative guidance that has caused investors to rethink if that was as good as it gets sending all of the above down 5 to 10% from recent highs.

These concerns should not merely be isolated to the tech heavy Nasdaq where these stocks have the potential to wreak disproportionate havoc, on Wednesday’s Fast Money on CNBC, Carter Worth of Cornerstone Macro Research highlighted the concentration, of the top 5 stocks (AAPL, MSFT, GOOGL, AMZN & FB) in the S&P 500 (SPX) by market capitalization, equal to the weight of the combined bottom 250, about $2.5 trillion vs $2.5), watch here:

Carter’s call is for a re-test of the long term uptrend in the SPX, and his historical data suggests that when this top 5 to bottom 250 happens, the top 5 usually under-performs the SPX during the next 6 month period. You get the point by now.

Despite what has been a fairly orderly sell off in U.S. stocks from the recent all time highs, albeit with this week’s nearly record breaking surge in spot VIX, there are some fairly troubling technical breaches taking place in all three major U.S. equity indices.

The S&P 500 (SPX) last month broke the uptrend that had been in place since the February lows, closed below the July break-out level (which lead to new all time highs) three consecutive times this week, and is now approaching its 200 day moving average, a level it has closed below only once since mid March, and that was in the throes of the post Brexit crisis in late June:

SPX 1yr chart from Bloomberg
SPX 1yr chart from Bloomberg

The Nasdaq 100 (NDX) has lost about 5% since making a new all time high on Oct 24th, which is obviously attributable to the give-back in its top 5 holdings, but also the absolute collapse in biotech stocks in the last couple weeks. A move back to the uptrend is likely in the cards in the coming weeks/months (which would probably be very healthy in working off excess exuberance):

NDX 1yr chart from Bloomberg
NDX 1yr chart from Bloomberg

And small caps stocks, ugh, the Russell 2000 (RTY) is down 8.5% from its 52 week highs, but possibly more importantly, it did not keep pace with the SPX and the NDX making a new high in 2016, and is down nearly 11% from its June 2015 high. The index collapsed last month once it broke its uptrend from its February lows, and is now approaching its 200 day moving average, an what appears to be important technical support at 2150:

RTY 2 year chart from Bloomberg
RTY 2 year chart from Bloomberg

That’s a lot of technical mumbo jumbo from a guy who is, well not a technician. But I think its important to consider positioning, momentum, sentiment etc, which all speak to the dangerous concentration in large caps stocks at a time when small cap stocks are very susceptible to vol shocks from careening crude prices and ticks lower in high yield credit.

It’s been my view that a decisive win on Tuesday by Clinton and we have spot VIX back at 15 and the SPX likely back towards 2150. Market participants this week are pricing in the potential for a Trump win, which if it happens, I am hard-pressed to see anything other than the SPX re-testing its post Brexit lows near 2000. This is all a lot of guess work, and there are plenty of scenarios in between, but given the fact that the probability is more likely for a Clinton victory (about 65% chance right now), I think it is safe to say the lower we go prior to Tuesday’s close, the greater the likelihood of a post election bounce in stocks and a decline in volatility measures (although if it’s close they could stay elevated to a degree given Trump’s rhetoric about not accepting results).

Regardless of you view on politics, and whether you agree with me or not, it has been my view for months that committing new cash to equities has not been a great risk reward as we head into a rate tightening cycle, the possible lessening of easy monetary policy in Europe & Japan, a global uprising of populism and I guess most importantly, a very fragile global economy and financial market framework. If I have said it once, I have said it a dozen times in 2016, the risk of volatility shocks since the end of QE, and then ZIRP, have been heavily weighted to the downside, aside from V reversals after sharp declines. Given my fairly cautious view on macro conditions heading into 2017, and the increasing risk of political Armageddon here in the U.S., sitting on your hands for the time being might be the best strategy. That doesn’t mean panic buying protection, or liquidating portfolios, it just means being aware of the worst case scenarios for risk assets.

I have no idea what is going to happen, but I do know that if you are the sort that was contemplating buying Facebook at $130 last week, and the stock is $110 at some point in the near future, and the recent news about investment/spending doesn’t deter you then starting to dollar cost average with a plan makes a lot of sense in volatile times like we may be on the cusp of.

So it really depends whether or not you are a glass half full or empty sort of gal when eye-balling those charts. Maybe the volatility bands have merely been widened, and they are all just trading within a 6 month range, near the 52 week highs. From where I sit, the VIX’s 70% surge in two weeks, coupled with the SPX’s 5% orderly decline does not speak to the sort of panic in equity markets that screams opportunistic buying opportunity, high 20s VIX and 2000 SPX likely would, and we may see that by Wednesday morning. But if we also have the mostly likely electoral outcome prevail, but prepared to see spot VIX as a mid teenager again, and the SPX testing what was 2130 support as resistance on the way back up.

You are well aware by now that financial markets were ill prepared for the Leave vote in Britain in late June, and the vote led to financial market anarchy, I am hard-pressed to think we see a redo of that, cooler heads should prevail in the voting booths and on trading desks… but all bets are off for 2017.