The stock market continues to send warning signs that all may not be well. Yesterday was the latest shot across the bow…
Nvidia sold off 9.5% – nearly $12 a share. Qualcomm dropped 7%. Teradyne lost 9%. AMD fell 8%. Apple got hit for nearly 6% from its highs on Friday. Broadcom down 6%, Micron down 8%, Snowflake down 15%…
The nuclear stock I told you about on August 19 fell 11% yesterday (after rallying ~10% from August 19).
These stocks all have two things in common. 1 – They are all highly touted AI plays, popular with individual investors, and 2 – they are now below their 50-day Moving Averages.
A moving average is a measure of relative strength, traders use the 50-day Moving Average to define the medium-term trend (3-6 months). A stock above its 50-day moving average is in an uptrend. Below the 50-day MA and it’s a downtrend.
Don’t overthink it. I guarantee you the trading algorithms that control +70% of the trading action each and every day don’t. For the trading algos, the 50-day MA is like flipping a switch from buy to sell. So a stock below its 50-day MA is more likely to sell-off than it is to rally.
So the entire AI complex of stocks is now below their 50-day Moving Average and in a medium-term downtrend. The fact that individual investors have concentrated their money in these stocks is why we can expect them to sell off more than the overall market for the foreseeable future, ie the next couple of months.
Valuations for most of these stocks are high. Nvidia’s Price-to-Sales ratio is 28. Most of these stocks also get a high percentage of their revenue from a very concentrated group of so-called “hyperscalers’ – Microsoft, Meta, Google, and Amazon.
These are the types of details that many individual investors do not consider. So when those conditions start to change – like a slowdown of the triple-digit growth rates that pushed Nvidia to such an extreme valuation – individual investors will be slow to act…
“Nvidia is the best, it’ll come back” they say.
Individual investors tend to get suckered by the margin loans their brokers offer that are backed by the value of the stocks they own. The temptation to use margin to buy on a pullback is very real. Adding a little leverage with a margin loan during an uptrend can juice returns. But as someone who’s had a trading account devastated by margin calls – I can tell you they bite in a downtrend.
FINRA says that as of July, margin lending was up 14% over the last year and now totals $880 billion. With the most popular stocks in medium-term downtrends, it’s a bad time to be leveraged to the hilt.
I haven’t heard about any spectacular leveraged account blowups yet, but they will come. They always do.
Stocks Take the Stairs Up and the Elevator Down
“Stairs up and elevator down” is one of those old-school investment sayings that sounds kind of trite until all your stocks are down 10% in a single day…
I’ll tell you straight – I wasn’t expecting a huge down day yesterday. In fact, after the S&P 500 closed within a few points of all-time highs on Friday, I started to wonder if maybe the worst months of the year for stocks (September and October), maybe they wouldn’t be so bad…
I’m already in a defensive posture, so there was no panic as the market got pounded yesterday. The beatdown seemed to come out of nowhere, but it was rooted in a bunch of weak economic reports that clearly show the U.S. economy is slowing down. Manufacturing spending was slightly negative for the second month in a row…
Yes, interest rate cuts are coming. But the market is clearly concerned that it will be too little, too late.
Yesterday’s painful sell-off took the S&P 500 down 2.6%. The index is now 400 points above its August 5 lows. A re-test of those lows would mean another 7% drop from current levels. A 7% drop for the S&P 500 will almost certainly mean another 15%-20% bite out of Nvidia and the other AI stocks.
The market has given investors plenty of opportunity to lighten up a little over the last 6 weeks. It’s also given plenty of signals that risk is to the downside. Raising cash is a good idea. Owning stocks using margin loans from your broker is a very bad idea right now.
Cheers,
Briton Ryle
Chief Investment Strategist
Outsider Club
X/Twitter: https://twitter.com/BritonRyle
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