What to Do Before Stocks Snap Back
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Another “hot” inflation report… Taking some chips off the table… A breadth divergence signal that you can’t ignore… Every election year for 72 years shows we’re in for a rough few weeks…
By Michael Salvatore, Editor, TradeSmith DailyIf economic data teaches you one thing, it’s that we should take every “economist expectation” with not just a grain, but a handful of salt.
One has to wonder if these expectations are actually serious, or just fuel for mainstream media clickbait headlines designed to make you worry… and keep reading.
I bring this up because of the Producer Price Index numbers that came out Friday. Brace yourself.
The PPI rose 0.3% in January against economist expectations of 0.1%.
Oh, the horror!
Don’t get me wrong. I understand the PPI is important. It’s a leading indicator of inflation. If we have a hot PPI, that tends to precede hot consumer prices as well.
But it’s the overall trend that’s important. The headline, month-over-month numbers are just noise. The big picture shows that inflation is largely under control, with consumer prices down from a high of 9.1% in less than two years. That’s incredibly swift progress.
And, as we keep shouting from the rooftops here in TradeSmith Daily… inflation, interest rates, and most of what you see in mainstream headlines are factors completely outside our control.
They can tell you a few important things — namely that they’ll weigh on under-capitalized, small-cap companies. But outside of that, it’s a factor so broad that it isn’t going to help you beat the market.
Let’s instead focus on factors that WILL help you beat the market.
And one of those is knowing when to take profits before prices snap back…
❖ Quantum Edge Pro Senior Analyst Jason Bodner is confident a pullback is coming…
Not because he’s reading mainstream media headlines about economist expectations. Because his own proprietary system, the Big Money Index, shows that Wall Street institutions are buying less and less even as the market climbs higher.Take a look at this chart:
Regular readers have seen this one before. The BMI is the yellow line, and the blue line is the S&P 500.
When the BMI crosses above the red threshold just under 80%, stocks are overbought. That’s what happened late last year. It also happened to reach one of the highest overbought levels ever.
Now it’s crossing down below the threshold. The last time that happened was just before the July selloff… which threw stocks into a devastating three-month slump.
His advice for this situation is simple: take some — but not all — chips off the table.
Here’s what he wrote to readers of his free newsletter, Power Trends:
Remember, selling doesn’t have to be all-or-nothing. You can sell some shares just as easily as you can sell all shares.
You can lock in profits, reduce risk, and stay in a great stock all at the same time. A triple winner.
Should the pullback be mild, you still own some or possibly most of the shares you once did in stocks making you money. And if it’s a steeper drop, you have cash to redeploy in great stocks that have pulled back to lower prices. You may even get to buy back shares you just sold at lower prices, boosting your long-term returns in the stock.
You can lock in profits, reduce risk, and stay in a great stock all at the same time. A triple winner.
Should the pullback be mild, you still own some or possibly most of the shares you once did in stocks making you money. And if it’s a steeper drop, you have cash to redeploy in great stocks that have pulled back to lower prices. You may even get to buy back shares you just sold at lower prices, boosting your long-term returns in the stock.
If you’re anything like me, you’re sitting on quite a few wins over the past several months. As I write this, I personally took some of those wins to the bank — literally.
Depending on the risk level of the position, as determined by the Volatility Quotient that powers the TradeStops software, I sold between a third and a fifth of 10 separate stock positions.
It felt good to realize those gains. It’ll feel even better if and when the stock market turns down and I have some dry powder to deploy.
But there’s no way anyone’s feeling as good as Jason Bodner and his readers.
Jason did a rare thing last week: he timed the top of one of the bubbliest A.I. stocks in the market. Here’s Jason:
Selling partial positions in winners is a form of rebalancing. That’s why we sold one-third of our shares in four Quantum Edge Pro winners that had gained nearly 75% on average. We also cut one loser (a modest in comparison 18% loss) to further reduce risk and free up more cash for better opportunities.
And guess what? One of the stocks we sold a third of for 149.1% gains kept going through the roof. So, we sold another third just today in Super Micro Computer (SMCI) for 258% gains.
We’ve now locked in a double on the entire investment… while still holding one-third of our shares. Which, by the way, are now worth more than what we paid for all of our shares initially.
And guess what? One of the stocks we sold a third of for 149.1% gains kept going through the roof. So, we sold another third just today in Super Micro Computer (SMCI) for 258% gains.
We’ve now locked in a double on the entire investment… while still holding one-third of our shares. Which, by the way, are now worth more than what we paid for all of our shares initially.
If you need help on the math, that’s a risk-free ride in SMCI with a position valued higher than the initial investment. Oh, and it took about five months.
In all my years in this business, I can think of no better example of strategic profit-taking than this.
When the market opens tomorrow, take a look at your portfolio and consider trimming some of your own big winners. If stocks fall like Jason expects, you’ll be glad you did a few weeks down the line.
Of course, Jason’s not the only one…
❖ TradeSmith’s income superstar Mike Burnick is also warning of a downswing…
In addition to heading up our Ultimate Income advisory, which uses a three-pronged approach to generate income through stock dividends, selling covered calls, and selling puts, Mike writes Inside TradeSmith — a regular look at what TradeSmith’s tools are showing about broad market conditions.Last week, he featured another useful dataset telling us to be cautious: breadth.
We discussed breadth not too long ago. It’s a measure of how many stocks are participating in a broad-based rally.
The more stocks that participate in a rally, the healthier the trend is.
Mike pointed out that as stock prices have lurched higher since the end of 2023, we’ve seen a sharp reversal in the number of stocks participating in that trend.
Take a look:
Here’s what Mike had to say…
Just as a powerful upside breadth thrust signaled the start of the rally last November, today market breadth has turned negative — signaling the start of a new downturn.
This chart of the S&P 500 shows prices (top panel), plus the percentage of S&P stocks above their 50-day (middle panel) and 200-day (lower panel) moving averages.
As you can see, while the index itself has been surging to new highs above 5,000, both of these key breadth measures have been steadily declining since December.
My take: Fewer and fewer stocks in the index are participating in the recent rally to new highs. Meanwhile, more stocks under the surface of the S&P are falling.
And this negative divergence between market price and breadth has been going on for almost two months now. Something’s got to give — and most likely it will be prices.
As you can see, while the index itself has been surging to new highs above 5,000, both of these key breadth measures have been steadily declining since December.
My take: Fewer and fewer stocks in the index are participating in the recent rally to new highs. Meanwhile, more stocks under the surface of the S&P are falling.
And this negative divergence between market price and breadth has been going on for almost two months now. Something’s got to give — and most likely it will be prices.
And we have yet another piece of evidence to wave the crash flag…
❖ Election-year seasonality says “sell now and take a month off”…
Check out this chart…
This chart shows the average performance of stocks for all election years going back to 1952. You can see that stock prices historically experience a big dip in March before a major, but volatile lift through the end of the year.
Throw this chart on the pile of reasons why you should expect a pullback in the next several weeks.
If you do what Jason did and captured profits on several positions, then turn off the screens until the Ides of March, chances are good you’ll be in an incredible position to buy stocks at a discount of 10%, 20%, or even more.
And yes, that goes for crypto, too. Bitcoin may have made a new local high this week, but at the end of the day, it’s a risk asset. It will probably dip along with the rest of the market soon.
I know the temptation of FOMO, especially as 2024 has gotten off to such a roaring start.
But a big part of beating the market is knowing not to force your way into a stampede when it’s just about to crest the cliffside.
I’ll be happy to hang out in boring old cash for the next few weeks, even if the PPI tells me prices are rising. The warning signs we’re seeing from multiple angles right now are far too great.
We’ll be back with you tomorrow with a new signal study from Lucas Downey — showing you why building a small-cap shopping list for 2024 should be your top priority.
To your health and wealth,
Michael Salvatore
Editor, TradeSmith Daily