The whole market sold off on Monday, basically the exact opposite of last Monday, and we are still retesting last Monday’s bullish candle with this price action. The number of bearish catalysts and charts continues to mount, and I think it is wise to approach this market with some caution and elevated risk management right now.
QQQ Daily Chart
Bond yields pushed higher again, which is the likely cause of the weakness across equities. The 10 year just hit its highest level since 2007, and the 30 year hit its highest point since 2004.
US 10 Year Bond Yields
Right now, 16 of the 18 Fed officials expect at least one more hike this year, and the odds show only a 5.6% chance that rates remain unchanged at the next two meetings. This matters because if cracks start to appear in the bond market or the equity market, it will be hard for the Fed to rescue anything. In the past, like in 2018, which I think is a great analog for this period, Powell and company simply pivoted to a more dovish stance and the market exploded higher. Of course, the market has not fallen yet, and we have not seen the kind of cascading waterfall event we saw in December. But many of the same elements that tend to show up before larger drawdowns are lining up.
We have surging bond yields, a new Fed tightening cycle, and soaring oil. That combination has preceded several of the market’s larger drops, including the bear markets of 1973, 1981, 1990, 2008, and 2022. If it were not for AI and the massive boost it has given the economy, there is no doubt we would be in a much more dire spot. But we do have AI, so the question is whether AI and the current pace of growth can help us weather this storm and shrug off the downturn that history says is likely coming.
I always keep in mind that once everyone expects a correction and positions for it, it usually does not happen, at least not right away. That is one of the main reasons I still think we may see a trap into new all time highs before a larger pullback. That move would suck bullish traders in, make everyone feel comfortable and bullish, and create exit liquidity for the smart money right before the real downside move begins.
So far, the positioning does not look like a market bracing for a large drop. We are still seeing rotation into AI tech, high beta names, some crypto, and other risk assets. The CNN Fear & Greed Index is firmly in Fear, and retail sentiment is clearly bearish, but investors are still heavily invested, and so are most fund managers. Feeling bearish and actually getting defensive are two different things. Ironically, a market that is not positioned for a drawdown is one that is more susceptible to one.
The old adage “don’t fight the Fed” certainly comes to mind, and it seems applicable here. I am not a macro expert, but I can see that we are entering a more financially restrictive period. From my study of the charts, I know that when this happens the market tends to see decent sized drawdowns, which would line up with the seasonal weakness we often see in midterm years. Raising a bit more cash, tightening up stops, entering collars, and buying protective puts at key levels won’t cost me much. Ignoring the signs I am seeing and holding through a large drawdown would cost me both mentally and financially.
While this might read like a doom and gloom newsletter, it really isn’t. If I am correct and we do get an early fourth quarter drawdown, I believe it will be a tremendous buying opportunity going into the end of this year and early next year. Every drawdown caused by a new tightening cycle has ended up being exactly that, and I don’t see a reason this one would be different. I love Black Friday each year because some of my favorite things to buy go on sale. My all time favorite things to buy are great stocks, and if they go on sale just in time for Black Friday, I will be a very happy shopper.
QQQ Fourth Quarter Thesis
