Weekly newsletter of Danny Merkel - Issue #94
Market Review:
When markets are extremely choppy, I find it beneficial to lengthen my timeframe and focus on weekly, rather than daily charts.
Despite non-stop erratic moves, the weekly chart of the Nasdaq Equal Weight Index remains in a clear downtrend:
Notice the series of lower highs (black arrows) as well as the series of lower lows (red arrows).
In addition, the long-term trend remains down (blue zones) so there is absolutely zero reason to seek exposure on the long side from a purely Trend Following point of view.
Zooming out further, the monthly chart of the ARK Innovation ETF displays a remarkably clear downtrend:
The chart above has all of the characteristics of a bubble that has burst. And if you study past market bubbles, you’ll come to the conclusion that they’ll typically deflate by 80 - 90%.
As of right now, ARKK has deflated by 78%, which brings it into a tricky juncture whereby it could find some support at the 80% zone, but there is also the possibility of a full collapse.
In the event of a full 90% decline, ARKK would tumble to around the $15 level.
That may sound extreme, but it’s actually a pattern that has repeated over and again throughout market history. One technical analyst named Louise Yamada has called charts like ARK the “Christmas tree” pattern and she has pointed out several past cases of this formation:
As shown above, Cisco Systems, Lucent Technologies and Radio Corporation of America all exhibited 80 - 90% declines.
Another very important point is that once the “Christmas tree” is complete, the stocks will tend to grind sideways for years, even decades.
For example, focusing on RCA in particular, notice that after plummeting from around $115 to around $5, the stock just ground sideways for 18 years afterwards:
Moving back to ARK today, grinding sideways is exactly what is going on now.
The way I see it, if the decline in ARKK is over, then market history would suggest a protracted sideways grind that could last over a decade.
Alternatively, if ARKK completes a full 90% collapse from the top, then prices have the potential to fall much further.
Bottomline is that I see this as an asymmetric trade to the downside, which means there is no reason to even consider gaining exposure here.
The next market cycle higher will almost certainly be led by a totally different group of stocks than these former leaders, these burnt out stars.
It’s impossible to know ahead of time what these new future leaders will be, and it’s not really necessary to predict them. As I’ve said before, just scan for new highs everyday and the new leaders will find you.
But if I were to venture a guess, one area that looks promising is Biotech and Pharmaceuticals. For instance, XPH has been building a base for 7 years now:
XPH Pharmaceuticals ETF - monthly (2008 - present)
Although it’s far too premature to gain exposure to this sector now, a breakout to a new 52-week-high could be quite bullish.
When will this breakout actually take place and which stocks exactly will be the new leaders? I don’t know, but I’ll be running my scans each day and my scans will tell me everything I need to know.
Stock Scanning:
Speaking of scans, I can’t stress enough how useful it can be to screen for new 52-week-highs and new 52-week-lows each day.
Taking just 5 minutes a day, this habit will enable you to gain unique insights into the market as well as generate your next trading ideas.
I personally use StockCharts.com to run my scans but even if you’re not a paying member, they have a free area where you can see a list of new highs and lows.
Let’s look at an example to see what I mean exactly. On Friday, the S&P 500 was up 1.36%, which is bullish; everything must be fine, right?
Yet let’s delve deeper under the surface and see what the scans say. On Friday, there were 203 stocks making new 52-week-highs, which means that there are indeed a few pockets of strength out there:
However, there are two sides to the coin and we must also consider all 52-week-lows. In spite of the market rising on Friday, there were actually 476 stocks making new lows:
In particular, notice the new lows on the Nasdaq (219) completely overwhelming new highs (39). That’s useful information.
Beneath the surface, there are a huge number of stocks just absolutely getting murdered, but you would never guess that by simply looking at the S&P 500 alone.
VIX Analysis:
With so many stocks getting killed, one might think that the VIX - the fear index - would be shooting higher, yet the opposite is actually happening.
After falling close to 20 days in a row, the index is now at it’s most oversold reading in five years:
To quickly re-cap past issues, I’m not a fan of the RSI Indicator, but for a mean-reverting index such as the VIX, it can be useful.
If market history is a guide, then it’s worth noting that market bottoms have never occurred when VIX is collapsing - quite the contrary.