Youâve been warned⦠[TradeSmith Daily]( This Market Canary Is About to Keel Over
By Lucas Downey, Contributing Editor, TradeSmith Daily Stocks go up… and they go down. If youâve only been investing since late October, youâve only felt the UP. But markets arenât always balloons and butterflies. Sometimes, stocks need a healthy pullback to set the stage for a sustained move higher. A few short weeks ago, I made the case for you to get your buy-the-dip list ready. Thatâs because my favorite technical indicator was flashing a warning sign. Today, Iâm doubling down on this idea. The evidence points to weaker price action in the coming weeks and months. If history is a guide, we should expect both small and large caps to fall… offering a better entry point than todayâs overbought levels. As usual, weâll study history to not only back up these claims, but give us a plan of action. RECOMMENDED LINK [Get Your "Portfolio Pulse Check" (Before the coming crisis)](
An overvalued market, a coming wave of bankruptcies, and crushing debt.
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To gauge the overall health of the market, letâs start by reviewing the price action. Most of us know that the S&P 500 is near all-time highs. But as usual, thatâs only part of the story. You see, plenty of stocks arenât participating in the rally. A great way to see this is by looking at equal-weighted stock indexes. The S&P 500 is weighted heavily towards the stocks with the biggest market cap. For example, the top five stocks in the index, or 1% of all the names, make up nearly 27% of its value. Equal-weighted indexes treat all stocks the same. In the case of an equal-weighted S&P 500, each stock would carry a 0.2% weighting. The table below shows the dichotomy between new highs and hidden weaknesses. While the S&P 500 is up 3.73% in 2024, the S&P 500 equal-weight index is down 0.15%. Even worse, the Russell 2000 small-cap index is drastically underperforming, with a 4.37% drop:
FactSet
This is whatâs called a narrow market, where leadership is led by a few mega-cap companies. Imagine if only the generals charged into battle, while the army stayed behind. It would spell trouble. But this is only one of the technical challenges the market faces. The other, bigger dynamic at play is how Wall Street institutions have started to shift bearish… RECOMMENDED LINK [Biden RETIRING August 19th?](
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Back in mid-January I shared that my favorite market indicator, the Big Money Index (BMI) was [extremely overbought](. As a reminder, this proprietary indicator plots the trend of institutional buying and selling in thousands of stocks. It gives you a beautiful picture of Wall Streetâs demand. When this line goes up, it tells you buyers are in control. When itâs heading south, look out below. Weâve been overheated for nearly six weeks. The red zone threshold is 80% or greater. Back in January, we were clocking a red-hot 90% — one of the most extreme readings in years. Back then I told you to pay attention once the BMI falls below 80%. This morning, thatâs exactly what happened:
There are two important pieces of information here:
- First, a down-trending BMI indicates waning demand for stocks. Selling pressure is picking up.
- Second, and more important… Whenever we fall out of overbought, markets struggle mightily. Note the white circles and corresponding red arrows above.
The second point is powerful. Back in January, I showed you how [the S&P 500 turns red in the weeks and months post overbought levels](. To take that framework a step further, letâs zero-in on small-caps. Below, Iâve included details on all overbought periods since 2009. From the first day the BMI falls out of overbought, hereâs how the Russell 2000 (IWM) fares:
- A week later, IWM is down 1.5%
- A month later, IWM is still red at 1%
- Even two months later, small caps are off by 0.9% Even more striking is the fact that out to two months, you have less than a coin-flip chance of a positive outcome. Looks like this market canary is running out of air. But to drive home how prescient this signal is, notice how striking the behavioral difference is compared to normal market action. The chart below shows how both the Russell 2000 (IWM) and S&P 500 fare after this signal. The orange bars display how the S&P 500 ordinarily acts on average in these time fames:
Now you can understand why I rattle the cage when this rare signal fires… Itâs got a great track record of predicting pullbacks. Which brings me to the most important takeaway for YOU: Pullbacks are part of the game. Theyâre to be expected. Donât react emotionally during market gyrations… Thatâll only lead to regret. Instead, take this potential warning for what it truly is: an opportunity to buy amazing companies on sale. I donât know about you, but there are many stocks Iâm watching that have run past my buy levels. Iâd love another shot to scoop them up cheaper. Chances are youâll get that opportunity, and sooner than most think. Take the time now, craft your buy list and be patient. Use software, like TradeSmith Finance, to bring you the leading names in the market, primed to rip once the selling dries up. The canaryâs about to fall on the floor. Youâve been warned. Now go do something about it. Regards, Lucas Downey,
Contributing Editor, TradeSmith Daily P.S. Situations like this are the perfect time to use [TradeSmithâs proprietary âPulse Checkâ software](. After securely syncing your brokerage account, this software automatically scans your portfolio for trouble spots that can drag on your returns… Youâll receive [an easy-to-read report]( revealing which of your stocks are healthy… which ones show warning signs… and most importantly, which stocks are in critical condition and on the verge of crashing. More than 100,000 TradeSmith readers are already using the Pulse Check to protect their wealth. [Click here to learn how you can join them.]( Get Instant Access
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