Market Review:
Did stocks rise or fall for the month of April? Normally, that should be an easy question to answer, but lately the market has become so extraordinarily bifurcated that it really depends on how you look at it.
The year started with the various components of the market moving in unison, however starting in March, these components forked with large stocks going one way and small stocks going another.
The chart below shows that the different paths can be ranked by market-cap. The bigger the stocks, the better:
The overwhelming majority of the market’s gains YTD have been driven by just 5 - 10 big-tech giants.
Because these stocks are trending higher and because I follow trends, why not just build a portfolio with these leaders?
Although this would have resulted in a nice YTD gain, the problem is that such a concentrated portfolio will eventually encounter some dramatic risk management issues.
Each stock in such a portfolio is highly correlated with one another, so when the market takes a hit, it just becomes one big bet.
A top-heavy ETF such as QQQ has the potential to get pummelled by a vicious gap down. In fact, QQQ has experienced multiple double-digit down days:
Is losing 12.32% of your net-worth in a single day acceptable to you? It isn’t to me. And future plunges could be even greater than this.
Concentration is a double-edged sword that can produce big gains, but will also deliver mind-blowing drawdowns along the way. The Nasdaq has experienced a maximum drawdown of 82.90%. From there, it took 3,292 trading days to recover these losses.
One way to mitigate massive drawdowns is to construct a portfolio that contains both long and short components.
For instance, despite the S&P 500’s strong start to the year, the index is actually at the same level today as it was May 2022.
And it’s also at the same level today as it was on May 2021.
So despite perpetually being in a confirmed uptrend over and over again, the S&P 500 hasn’t gained a single percentage point in 24 months. That’s a pretty weird uptrend.
To enhance this dismal performance (and reduce risk) one could add a short component. Given that the folks at IBD have been so reliably offtrack, one could produce a real confirmed uptrend by shorting the IBD 50 while going long SPY.
In the long-run, I expect that the S&P 500 will continue to outperform. This is because SPY is more or less a trend-following system that adds to winners and cuts out losers.
On the other hand, a fund like FFTY or especially ARKK will hang on to losing trades and even quintuple-double-down on a dog such as ZM.
VIX Analysis:
One observation this week is that the VIX is drifting towards the 15 area. That’s interesting because that has been support on at least six prior occasions (red arrows):
In addition, the VIX has just registered an oversold reading (red circle). Due to the mean-reverting nature of the fear index, this oversold reading has the potential to lead to a bounce, which would put pressure on stocks.
For the month of April, the VIX declined 15.61%. That typically should be a major tail-wind for stocks, yet most small-cap stocks fell nevertheless.
One such small-cap ETF that took a hit this month was DWAS. Tracking less known momentum names, this ETF fell 2.40% in April.
I have a bad feeling about this chart. I’ve been looking at charts for roughly 6 hours a day, everyday, for 18 years and so sometimes I get vibes and this chart gives me some bad vibes.
To be more specific, it appears to me that DWAS is breaking down from a bearish continuation pattern.
Another thought: if small-cap stocks cannot catch a bid when the VIX is falling, what exactly is going to happen if the VIX reverses and starts rising?
Individual Stocks:
On the surface, the markets appears relatively strong but, beneath the surface, there remains massive concerns.
Last week, I described the price action of FSLR as “weak” and pointed out the lack of follow through.
Fast forward to today, and we can see how unhealthy this breakout really was:
An investment of $100,000 in FSLR at the moment the stock gapped higher would still be worth $100,000 two months later. Since buying breakouts isn’t making money in today’s market, let’s focus on what is working.