Nvidia is breaking support, while also strongly diverging from the broad market. If this level fails, the next level will be our first buy spot around $126.
Bitcoin is extending the 3rd wave of 5. We're not chasing this. Our game plan remains the same – buy the 4th wave drop and ride the 5th wave to new highs. Then sell most of it. The only thing that has changed is the 4th wave target – now, $90K – $80K.
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This article was originally published on Forbes on Oct 10, 2024,10:58pm EDTForbesForbes on Oct 10, 2024,10:58pm EDT
The Fed surprised the market with an aggressive 50 bps cut recently, which has pushed the S&P 500 back to new all-time highs. However, not all markets are celebrating this move. Bond yields and mortgage rates, for example, have been in an uptrend since this decision, which is not normal to see at the onset of a rate cutting cycle.
Also, the bull market leaders – the Mag 7 and AI focused semiconductors – are making a series of lower highs, not confirming this move in the S&P 500. This divergence between the market leaders and the broad market has been the consistent theme of the I/O Fund’s broad market reports in 2024. More times than not, the bull market leaders will lead on the way up, as well on the way down. So, when my firm sees the primary beneficiaries of a bull market start to make lower highs while the broad market makes higher highs, it tends to be a warning.
In this report, my team will address the risks brewing in the market. The strange behavior in the bond market could be signaling that the FOMC has made a policy error. This coupled with key tech stocks trending lower against the S&P 500’s advance, has my firm cautious for the time being.
What Big Tech and AI Stocks Are Telling Us
In 2023 we saw these market leaders trending higher with the broad market. This was a powerful trend that lasted into late 2023. As a result, the collective Mag 7 returned around 90% in 2023 vs. the S&P 500 returning 24%. However, this trend is not continuing into 2024, as we are beginning to see cracks in market leadership.
This year, the Mag 7 are up ~30% compared to the S&P 500’s ~20%. Though this year has been excellent for investors, it’s concerning the relative strength between the bull market leaders and the broad market is narrowing, which has been a constant theme in our broad market analysis throughout all of 2024.
“When the cycle leaders start to underperform, it tends to mark the start of a trend change. The FAANGs have been the undoubted leaders of this bull run, and we are now seeing them start to trend lower against the indexes. More times than not, the leaders on the way up, tend to be the leaders on the way down.”
More importantly, the Mag 7 is making a lower high, while the S&P 500 makes a higher high. In other words, the bull market leaders are not confirming this push higher in the broad market. This is a rare pattern that has only shown up one other time in this bull market – July of 2023, just before we saw an almost 11% correction in the broad market.
A rare pattern observed in the bull market, similar to July 2023, preceding an 11% correction in the broad market. – I/O Fund
This divergence is not only happening with the Mag 7, but it’s also happening with the most important sub-sector within tech due to AI – semiconductors.
Since the current bull market began on October 13th of 2022, the Mag 7 has returned over 102% vs. the S&P 500’s 61%. During the same period, semiconductors have returned over 174%. The leading stock, Nvidia, is up over 967% over the same period. So, while the Mag 7 are the popular market leaders, the true market leaders of the current bull cycle are semiconductors, and specifically, Nvidia. This is a trend that the I/O Fund positioned for in 2022, making NVDA our largest position, as we rotated out of cloud stocks and into AI.
Performance of the Mag 7, S&P 500, and semiconductors since October 13, 2022: The Mag 7 returned over 102%, the S&P 500 returned 61%, and semiconductors returned over 174%, with Nvidia up over 967%. – I/O Fund
Semiconductor Index (SMH)Semiconductor Index (SMH)
SMH has a history of leading market swings in the broad market. Since 2021, every time the S&P 500 made a new high without SMH, it preceded a period of volatility. Today’s divergence is one of the largest on record. The Semiconductor Index topped in July at $283, and is still well below this high, compared to the S&P 500 that just pushed to new a new high this week at 5796.
Chart illustrating the semiconductor sub-sector’s corrective pattern, featuring a 3-wave drop since June followed by a bounce from the August 5th low, suggesting a potential final drop targeting $190 to $165. – 123
When digging deeper into this key sub-sector, we can see that a clear corrective pattern is playing out. Since the June top, there is a clear 3 waves down. This has been followed, so far, by a symmetrical 3 wave bounce off the August 5th low. This pattern best fits a standard corrective patten. This implies that a final drop is still needed, which is targeting between $190 – $165.
The advance seen today is poking above the downtrend line from the July top. However, this is happening on less volume and less momentum. Note the momentum indicator below the chart. It has given three lower highs while price provided three higher highs. This is a rare pattern that tends to precede a trend reversal.
Chart depicting the current market advance above the July downtrend line, showing decreasing volume and momentum. The momentum indicator reveals three lower highs, while the price shows three higher highs, suggesting a potential trend reversal. – I/O Fund
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Nvidia (NVDA)Nvidia (NVDA)
Nvidia topped in June at $140, and failed to make a new high in July with the rest of the Semiconductor Index. This was a warning that semis, and the broad market, were heading lower.
This same relative weakness is still present today. While most semiconductors have broken out above their August high, NVDA remained below it. This week, it has moved above the August high, which appears to be the final move in this bounce which is happening on less momentum and less volume. This lines up with the I/O Fund’s game plan, which was to sell a quarter of our NVDA position in June around $129, and attempt to buy it lower in the coming months, which was discussed in detail on my recent interview.
Chart illustrating NVDA’s incomplete corrective pattern, indicating potential drops below $114 and $108, which could lead to a decline toward the $90 – $70 region, completing a multi-month correction. – I/O Fund
Like SMH, NVDA appears to be tracing an incomplete corrective pattern. A move below $114 and then $108 will signal that the stock is heading toward the $90 – $70 region, which would complete this multi-month correction.
NVDA remains weaker than the broad market, as well as SMH. Considering the importance of this stock, as long as it remains below its June high, it is a warning to the current broad market advance.
Are New Leaders Developing?
Some have argued that the market is taking gains in the AI leaders and spreading that money out into beaten down sectors. In other words, there is a healthy broadening out of the market, which typically exhibits strength.
The narrative that supports this idea is that the FOMC just offered a surprise 50 bps rate cut into a seemingly healthy economy. The cheaper cost of borrowing should propel more economically sensitive sectors to play catch-up as the economic expansion continues.
As plausible as this sounds, it’s just not showing up in data, yet. Since the Fed cut rates on September 18th, we are not seeing money flowing into your beaten down sectors that should do well if this narrative is playing out.
Sectors like, transportation, small caps, retail sales, consumer discretionary and high beta are still under their 2021 highs. These are the sectors that would benefit from a soft-landing. As you can see below, aside from consumer discretionary, they are all underperforming the S&P 500.
Chart illustrating the market dynamics where AI leaders are gaining, but beaten down sectors like transportation, small caps, retail sales, consumer discretionary, and high beta are still lagging behind the S&P 500, showing no significant investment flow after the FOMC’s 50 bps rate cut. – I/O Fund
While Nvidia and Semiconductors are making a lower high, there is more money flowing into defensive and inflationary markets, like, Energy, Apple, Utilities and even the US dollar is doing better than the markets that would support the broadening out narrative.
What the Bond Market is Telling Us
Another unusual development since the Fed cut rates is that bonds are not acting as they should at the onset of a rate cutting cycle. Historically, the relationship between long-dated bonds and the Fed cutting rates has been an inverse relationship. As the Fed cuts rates, it is usually in the face of a weakening economy. If prices are going down due to demand collapsing, then a fixed yield is desirable in that environment, meaning that we should see bonds going higher.
This is not what is happening today. The day the Fed cut rates, the 10-year government bond began a sharp decline and is currently down nearly 4% from its high. This is a big move for the 10-year bond.
Chart showing the 10-year government bond’s sharp decline after the Fed’s rate cut, highlighting an unusual trend where bond prices typically rise in a weakening economy. The bond is down nearly 4% from its high. – I/O Fund
This is unusual behavior, as the above chart shows. Bonds should be going higher, not lower, based on historical comparisons. The popular narrative for this behavior in the bond market is that this is evidence that the FED accomplished a soft landing.
If we were going into a slowing economy, which could lead to a deflationary event, then bonds would be catching a bid. So, the fact that we are not must mean that the economy is strong, and the economic expansion will only continue. This will then propel asset prices higher, as well as inflation, making the need for fixed yields a poor investment.
As we just saw, the market is not buying this narrative, as money is not flowing into the sectors that would support this thesis. So, what could be going on?
It’s important to understand that the Fed does not control the 10-year yield; this is controlled by the bond market’s expectations for future growth and inflation. The Fed’s reasoning for aggressively dropping rates on September 18th was that inflation is heading to 2% and the employment market is starting to show weakness.
Since then, the ISM non-manufacturing PMI posted its hottest reading since February of 2023. Twelve out of the 18 segments of this report stated that prices are rising, not falling.
Chart highlighting the ISM non-manufacturing PMI’s highest reading since February 2023, with 12 of 18 segments reporting rising prices. Additionally, the labor market added 107,000 more jobs than expected, revising September figures up by 17,000, causing the unemployment rate to drop from 4.22% to 4.05%. – YCharts
This was accompanied with a labor market that is much stronger than expected. The most recent jobs report showed that the US added 107,000 more jobs than expected, while September’s report was revised higher by 17,000 jobs. This caused the unemployment rate to drop back to 4.05% from 4.22%.
This is further confirmed with current mortgage rates. Everyone was expecting mortgage rates to drop with the Fed Funds Rate. However, since the cut, there has been a sharp increase in average mortgage rate from 6% to 6.32%.
Current mortgage rates defy expectations, rising sharply from 6% to 6.32% following the Fed’s rate cut, contrary to the anticipated decrease. – YCharts
The reason for this is because mortgage rates are not determined by the Fed. Instead, they are the result of an equation that includes the 10-year yield and the borrower’s credit score. So, the 10-year getting sold, means yields are going up.
This happening on the day of the FED’s rate cut policy means the bond market is not convinced inflation is heading to 2%, which is pushing mortgage rates higher. This means that we could be getting signals that the FED made a policy error, and dropped rates too soon, as yields continue to climb in the weeks after this decision.
Interesting enough, at the Grant’s Annual Fall Conference, Druckenmiller stated that his largest bet is shorting the US bond market.
His reasoning is not because the Fed achieved a successful soft landing, which the consensus believes, but it is because “bipartisan fiscal recklessness is on the horizon.” In other words, the larger our deficits become, the more money will need to be borrowed to cover interest payments. As more and more debt gets created, yields will have to go up to attract more buyers, which will put pressure on fiscal budgets, and therefore creates a vicious cycle.
To put this into perspective, the budget deficit for the fiscal year 2024 is going to come in around $1.9 Trillion, or 6.7% of GDP. There is no other year in US history where the budget deficient was this large outside of a major war, like WW I & WW II, or dealing with a major recession, like 2008. It is unheard of to have fiscal spending this high, in an expanding economy, with historically low unemployment. This makes you wonder what the deficit will look like in the face of a contraction.
This was an issue that the market has been aware of for decades but was able to ignore due to historically low interest rates. With rates low and trending lower, this fiscal recklessness was allowed to go on. However, we are seeing for the first time in 30 years, bond yields are starting a new uptrend.
Since 1981, the 10-year yield has been in a classic downtrend, making a series of lower highs. This trend made borrowing easier, as low rates made the cost of borrowing affordable. However, in 2021, yields broke this downtrend and made their first higher highs in 30 years. Today, yields are higher than they were in 2008, making the cost of borrowing higher than most investors are used to in over 20 years.
Diagram illustrating the market’s awareness of excessive debt and low interest rates enabling fiscal recklessness. Since 1981, the 10-year yield has followed a downtrend until breaking the trend in 2021, resulting in the highest borrowing costs seen in over 20 years. – I/O Fund
If this uptrend in yields continues, which looks likely, it would become problematic for inflation expectations, as well as the Fed’s ability to lower rates. It will also become problematic for the cost to service government debts, as more debt will be issued at higher rates to cover current service requirements. And, it will become problematic for stocks, specifically high beta stocks that need to borrow to fund operations, as estimates on future cash flows will have to account for a higher cost to borrow. In short, the last +20 years have built on the idea that inflation will not happen, and the FED can keep rates close to zero.
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Broad Market Analysis
The bull market pattern off the 2022 low has taken the shape of a messy diagonal pattern. This is a 5 wave pattern where the internal waves are 3 waves in all directions. It is also marked with large, overlapping swings. Note how wave 4 went into wave 1 territory – this is typical of diagonals. The 5th wave in this pattern is a blow off, and from what I can tell, we are in the final swing of this pattern.
If SPX can breakout above 5825, then it can likely push into the 6000 – 6185 region. If instead, it breaks down below 5675 this will be your first indication of a potential trend change. Below 5500 and then 5115 will be the final confirmations.
Chart illustrating a messy diagonal pattern in the bull market since the 2022 low, consisting of 5 waves with overlapping swings. Key breakout points are at 5825, while downtrend confirmations are at 5675 and 5500, indicating potential trend changes. I/O Fund
In conclusion, as the economic expansion continues, the odds of a recession remain low. However, money is not flowing into the beaten down sectors that would benefit from this reality. Instead, defensive and inflationary names are getting more flows than transportation, small caps, high beta and retail sales. The market leaders continue to make lower highs while the broad market pushes higher, and bonds are getting sold as if the FED stopped cutting rates, not started. The warning signs are high, and my firm remains defensive until these signals reverse, or the market corrects.
If you want to track the potential top in equities, join I/O Fund next Thursday, October 17th at 4:30 pm EST, for our premium webinar. We will go over the levels that need to hold and the specific AI stocks we are targeting for the next leg higher.
Knox Ridley, Portfolio Manager of the I/O Fund, contributed to this analysis.
Please note: The I/O Fund conducts research and draws conclusions for the company’s portfolio. We then share that information with our readers and offer real-time trade notifications. This is not a guarantee of a stock’s performance and it is not financial advice. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis. Beth Kindig and the I/O Fund own shares in NVDA at the time of writing and may own stocks pictured in the charts.
We warned our readers about the coming volatility in Nvidia. We sold ¼ of our position at $129 in June, as a result. However, we also stated that the drop is likely only a 4th wave in an ongoing 5 wave uptrend. So, we sent out several buy alerts for NVDA between $118 – $105 in July – August. We are now over 25% higher from our last buy alert and may reduce risk again due to valuation concerns as well as NVDA being in a risky technical spot.
As long as NVDA holds over $118, we can see a continued push into the low $130s. However, below $118, and we should see volatility return. If this does happen, $103 is the line in the sand. If we can hold this and turn higher, we will be targeting between $155 – $176 into October. Below $103 and we will set up a new buy plan to get more NVDA below $100.
Broadcom (AVGO)
AVGO had a lower drawdown than most AI stocks, which shows its strength. The pattern, as you can see, is clearly a 3 wave move down from the recent high. This tends to suggest a correction within a larger uptrend. As long as we hold over $142, I’m expecting a push to the low $200s next.
Bitcoin (BTCUSD)
Bitcoin appears to have completed a correction within a larger uptrend. As long as we can hold over $56,000, I’m expecting us to push into the low $80,000 range next. This is where we will begin taking gains after nearly 2 years of buying at key corrections.
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Watch Portfolio Manager Knox Ridley as he covers the broad market, Nvidia, Broadcom, and Bitcoin. We also have a special guest, Vincent Duchaine of Wealth Umbrella, with whom we partnered to create our hedge signal available to our advanced tier members.
Timestamps:
00:00 Introduction
20:11 Bitcoin
37:08 Knox Ridley (Broad Market)
50:08 Nvidia
52:18 Broadcom
52:57 Bitcoin
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Watch Portfolio Manager Knox Ridley as he covers the broad market, Nvidia, Broadcom, and Bitcoin.
Broad Market
Nvidia, Broadcom, and Bitcoin
Pro premium members receive deep-dive research on all the stocks in the portfolio and participate in the quarterly earnings kickoff webinar. In addition, the Advanced Market Signals Members receive regular technical and broad market analysis, weekly webinars from our Portfolio Manager, Knox Ridley, hedge signal, and trade alerts. We booked a total 275% gain on Super Micro in early May across all entries and exits. Also, we booked sizable gains in two cybersecurity stocks in April. Learn more here.We booked a total 275% gain on Super Micro in early May across all entries and exits. Also, we booked sizable gains in two cybersecurity stocks in April. Learn more here.
The market is currently pricing in up to three rate cuts this year, which is putting pressure on Magnificent 7 stocks, defined as Apple, Alphabet, Amazon, Meta, Microsoft, Nvidia and Tesla. Due to their global exposure, heavy cash positions and positioning within the growing AI trend, they have been perfectly situated to benefit from a bifurcated and complex macro environment. Because of this, the Mag 7 has significantly outperformed the broad market, and also led it higher for nearly 2 years.
To put this into perspective, the first six months in 2023 was the biggest 6-month rally in Nasdaq history – and since then, over a year ago now, the NASDAQ has plowed through key levels to reach a staggering 72% return in a little over 21 months. It’s not only the returns we’ve seen in 2023 and 2024 that are unusual, but the fact it happened back-to-back. Tech investors can thank the Mag 7 for this spectacular outperformance.
However, we are now getting evidence that a change is happening. As excitement over reduced rates has investors rotating into beaten down small caps and consumer facing stocks that have sat out tech’s historic rally.
By not participating, small caps and other pockets in tech that are more traditionally cash-strapped are now undervalued. Optimism around the Fed could spark a continuation of the relief rally in the Russell 2000 and further rotation out of the Mag 7. Below, we look at the pros and cons of a Mag 7 rotation and how we plan to personally handle this shifting landscape.
Why The Mag 7 Worked
The complexity of this business cycle can’t be overstated. On one hand we are seeing one of the longest and steepest yield curve inversions in market history. This signal has a near perfect track record of predicting recession, which is being backed up by a weakening consumer, and a deep and prolonged manufacturing recession that is now filtering into the services sector. On the other hand, corporate profits are healthy, the job market remains relatively tight, and AI is creating a new economy that is driving historic top line and bottom line growth for the AI leader (we think there will be many moremany more beneficiaries beyond Nvidia).
This bifurcation within the economy can be seen in equity markets. For example, markets that are dependent on a strong consumer, thrive with lower interest rates, or in need of cheap money to expand – like high beta tech, small caps, real estate, consumer discretionary – are still well below their 2021-2022 highs.
At the same time, we are seeing markets that have global exposure, flush with cash and are not dependent on the consumer, all well above their 2021-2022 highs. This is most obvious with the Mag 7, who were leading this market higher in early 2023, and continuing into today.
For this reason, we need to take a closer look at select charts within the Mag 7 to get an idea on where the market is going over the short-term, as well as the medium to long-term.
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Certain Stocks Within the Mag 7 Continue to Provide Clues
Our broad market analysis in 2024 has been focused on the relative performance of the Mag 7. Without question, these 7 stocks are the most important stocks in the current bull market. Historically, as long as the cycle leaders continue to move higher with the market, all is well. However, as stated in our March Report…
“When the cycle leaders start to underperform, it tends to mark the start of a trend change. The Magnificent 7 have been the undoubted leaders of this bull run, and we are now seeing them start to trend lower against the indexes. More times than not, the leaders on the way up, tend to be the leaders on the way down.”
This was the pattern that warned us about the April selloff, and again in July.
What followed our March report was a 6.3% drop in the broad market. However, high fliers like NVDA and META dropped 22%, TSLA dropped an additional 32% while the rest of the Mag 7 dropped between 15% – 10%.
Since then, the market has recovered and resumed the bull market higher; however, we have seen new leadership emerge from the Mag 7. Since the April 19th low, the S&P 500 is up +12%, while Apple is up 32%, Nvidia is up 64% and Tesla is up 77%. Lead Tech Analyst, Beth Kindig, pointed out on Bloomberg Asia that Tesla was simply trading too low at the time, and to look for a bounce.
What is interesting is that the same pattern that we saw from the Mag 7 in early March, was also warning investors leading into the July 16th high.
Nvidia first started making lower highs on June 10th, followed by Tesla on July 10th, and then finally Apple on July 15th. So, while the broad market continued to make higher highs, it was doing so without its leaders, signaling that trouble is likely ahead.
What The Majority of the Mag 7 is Saying Now
The divergence above within the Mag 7 stocks warned us of the coming volatility. We can use further analysis of these important stocks to help tell us what the market may do next.
Of the Mag 7 charts, Apple, Microsoft, Nvidia, Amazon and Google are the clearest. They all suggest that what we are seeing is a correction within a larger uptrend, and that it is likely that we see higher levels in the coming weeks. While Meta and Tesla can be interpreted in the same way, they are not as clear as the ones we will discuss below. For reference, the 5 stocks below account for ~28% of the S&P 500, and should have a very strong correlation on the direction of the broad market over the coming weeks to months.
Nvidia
Nvidia is the most important stock in the current bull market. Within the most recent bull market, it has gone from a top 25 stock in the S&P 500 to now the 2nd most valuable company in the U.S. due to its positioning within the new AI trend. Our firm was the first to lay out NVDA’s path to becoming the most valuable company in the world. Now that it has surpassed Apple, we further presented how it has a clear path to becoming a $10 Trillion Company by 2030.
Since the 2022 low, NVDA has been tracing out a very large 5 wave pattern higher. Note the vertical move higher in early 2024. This was met with max volume and max momentum to the upside. This is the marker that you are in the most powerful moment of a trend, which is the 3rd wave. This is also around the halfway point of the entire 5 wave pattern.
The pattern appears to be incomplete. Even though NVDA topped early, the drop is a clean 3 wave pattern within an incomplete uptrend. We still need a 5th wave to new highs in order to complete the larger 5 wave move.
Nvidia may have one more drop into the $113 region before bottoming, but appears to be developing a bottom right now. Look at the momentum indicator below. It is bottoming in the exact same region the April low tagged, and it is doing so while price is much higher. These are the type of bottoming signals we look for when degerming a low is close within a developing uptrend. As long as any further drop holds $103, we expect NVDA to push higher.
Apple
With Apple’s push into bringing AI to the consumer, coupled with the likelihood that the Fed will lower rates soon, Apple has stopped becoming a laggard and is instead one of the leading Mag 7.
It appears to be a bit further along in its uptrend pattern off the 2022 low. While NVDA needs a large degree 5th wave, Apple is missing a smaller degree 5th wave. Like NVDA, the pattern is incomplete while giving us clear bottoming signals.
Note how the momentum indicator is making a lower low from the June low into today’s low. This is happening while price is making a higher low. This is the type of pattern we see in on-going uptrends, and supports that we should see another swing higher into late summer/early fall. As long as Apple hold over $206, we expect to see this move higher manifest.
Microsoft
Our firm recently closed MSFT for a sizable profit due to valuation concerns. While the chart does suggest it has one more swing higher, we see other stocks within tech having more upside in both valuations and technical targets. For this reason, we have rotated these gains into Nvidia, as well as other AI stocks that we have been targeting for months.
However, like Apple and Nvidia, Microsoft is a bellwether for the broader market and an important stock to cover. It is very rare to see MSFT move against the market, and when it does, it is a sign of a brewing trend change.
The below chart shows a very mature uptrend off the 2022 low. We have a very large 5 wave pattern that is suggesting it has one more swing left. This would be wave 5 of a larger 5th wave, and is estimated to be anywhere between 8 – 15%.
We are seeing similar bottoming patterns in MSFT as we saw in AAPL. Microsoft appears to be completing what looks like a 4th wave drop. As long as any further weakness holds $406, I expect a final 5th wave push in the coming weeks.
Amazon
Amazon looks a lot like MSFT and AAPL. It is tracing out a 5 wave pattern and needs the final 5th wave higher to complete the uptrend. The current drop also appears to be a 4th wave and showing bottoming signals like the above charts. As long as AMZN can hold $174.50, we expect a 5th wave bounce in the coming weeks.
Google
Google is making a lower high while it is at extreme oversold conditions. Like the above charts, it looks like it needs one more high to complete the larger 5 wave pattern. As long as any additional weakness can hold $169, it looks like it needs a 5th wave bounce to complete the bigger uptrend.
Broad Market
The broad market in the S&P 500 is signaling the same push higher that we are seeing in the above key stocks. While it appears that we have another move higher to look forward to, according to the larger pattern in play, the next move will likely be the final move we see before having to contend with, at best, a multi-month and deep correction.
The pattern that the S&P 500 is tracing off the 2022 low is what is called an ending diagonal pattern. It is the only pattern that can account for the messy, overlapping moves that we have seen in both directions. The only question is what degree of a 5 wave pattern is in play, which is what my two counts represent.
Green – This count has the 2022 bear market as a large degree 4th wave in the secular bull market that started in March of 2009. That would put us in the final 5th wave, which is developing as a large ending diagonal pattern.
These patterns are 5 wave patterns that overlap. More times than not, the 4th wave will go be so deep, as to move into 1st wave territory. The next swing higher would be the final move in the 3rd wave, which would be targeting 5850 – 6340. Once this 3rd wave ends, the 4th wave would likely be a multi-month drop and on the larger side of a bull market correction. This would set up a tremendous buying opportunity, once completed.
Red – This count has us in a smaller degree ending diagonal pattern. It has an extended 5th wave that is playing out. The targets would be the same as above, 5850 – 6340 SPX. However, unlike the green count, we would not see a 5th wave to new highs, but instead a lower high in a much larger downtrend.
As long as any further weakness holds over 5375 – 5200, we should continue to see the bull market continue for another move higher. Below this level decrease the odds of this happening. The final support for any pattern that can take us higher would be 5,200. Below this level and the larger period of volatility will have likely begun.
Small Caps
The June CPI numbers came in softer than expected. This coupled with weakening economic data, triggered the market into a rotation based on the expectation that the FED will have to cut rates sooner rather than later. As a result, the Russell 2000 is up about 9% from that moment, while the Mag 7 are down an average of 13%. Furthermore, we are seeing an expansion of breadth into more consumer based value stocks as well as some high beta names.
As stated, it appears that the majority of the Mag 7 and the S&P 500 are supporting another push higher. This is also supported by small caps. The benchmark for small caps, the Russell 2000, for example, appears to be in a 4th wave correction, which is around the halfway point of the move higher. As long as any further weakness holds $211 (IWM), like the rest of the markets and stocks we covered, it should continue higher before putting in a more meaningful top.
The broads Small Cap Index is also suggesting that a low is being put in and we should see another swing higher. The upside pattern is incomplete and likely around the halfway point of the move higher. However, we do still believe this is a stock pickers market, so we have positioned some of our portfolio into select small cap positions that have exposure to AI. While the rotation into small caps may continue, it looks like the bulk of this rotation is complete, as the broad market is setting up the next leg higher.
Realized Volatility
Realized volatility (RV) is a measurement of price swings on a day-to-day basis. The lower RV is, the smaller swings in either direction are to be expected. Ideally, you want to see RV trending lower as price moves higher. This tends to mark a healthy uptrend.
The best way to think about Realized Volatility is as a measurement of liquidity entering or exiting the markets. The more liquidity there is, the smaller the moves we tend to see, as the market continues to grind higher. The higher Realized Volatility goes, the less liquidity is in the market – i.e., big money is raising cash, which can cause larger swings in the market.
What matters to me is how Realized Volatility is trending with the market. This is what we are seeing today. Look at the 10-day, 20-day and 30-day measurement of Realized Volatility is trending up with price. The last time RV hit these levels that we last around the April low. This is significant, as it is indicating that liquidity is leaving the markets while price is much higher.
As long as Realized Volatility continues to trend higher with price, it is a warning that liquidity is exiting. However, this also means that less liquidity can propel the markets higher up to several months.
Note the two most recent periods this happened – 2020 and 2022. Once we saw RV start trending higher with price in 2022, we only saw a 5% move higher over a 1.5 month period. However, in 2020, this trend lasted for +3 months and led to a 10% swing higher in the markets.
Conclusion
In conclusion, the stage is set for a meaningful move higher, if we can see SPX break above 5670. While less liquidity tends to mark the early warning of trend reversals, it also means that any bullish catalyst can propel the markets higher in larger than normal daily swings. This lines up with what the majority of the Mag 7 is suggesting – a 5th wave rally to new highs is needed to complete the larger uptrend.
As long as the supports listed hold, this is what we are expecting. While the next move higher could last anywhere from a few weeks to several months, it’s important for investors who are buying the dip to realize the risks involved within the larger picture. While being nimble can pay off handsomely in moments like this, not having a risk management plan can do the opposite once the market rolls over.
If you are sitting on outsized gains from the current bull market, looking to protect those positions, or interested in owning AI leaders at reasonable prices, join us each Thursday, at 4:30 EST for our premium members webinar. This week we will discuss our risk management plan, buy and trim targets for various AI positions as well as crypto. Learn more about I/O Fund’s premium services herepremium services here.
Please note: The I/O Fund conducts research and draws conclusions for the Fund’s positions. We then share that information with our readers. This is not a guarantee of a stock’s performance. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis.
Watch Portfolio Manager Knox Ridley as he covers the broad market, Nvidia, Broadcom, and Bitcoin.
Timestamps:
00:00 – Broad Market
16:31 – Nvidia
20:17 – Broadcom
22:15 – Bitcoin
Pro premium members receive deep-dive research on all the stocks in the portfolio and quarterly earnings kickoff webinars. In addition, the Advanced Market Signals Members receive regular technical and broad market analysis and weekly webinars from our Portfolio Manager, Knox Ridley. We closed Super Micro in early May for an average gain of 275% gains across all entries and exits. Also, we booked sizable gains in two cybersecurity stocks in April. Learn more here.We closed Super Micro in early May for an average gain of 275% gains across all entries and exits. Also, we booked sizable gains in two cybersecurity stocks in April. Learn more here.
I spent extra time on NVDA, considering it is our largest position. The smaller time frame seems to be quite clear – we are trending up into the $1050 – $1315 target zone that we identified in our April report. The developing pattern is 5 waves, which means that we now have a fully formed 5 wave pattern into the target zone. This should set us up for some type of a reversal.
While a pullback from the current swing high appears to be reasonable, the question is what degree of correction will this become? When we zoom out to answer this question NVDA’s chart provides two potential answers.
When charting, there are two scales to measure price – linear scale and logarithmic scale. In linear scale, the Y axis has the same division in price from top to bottom. So, if the division is every $100, then a move from $100 – $200 is a 100% move. However, a move from $1000 – $1100 is only a 10% move. This gives the appearance of small moves at the based on the trend and dramatic moves the higher we go.
The other option is logarithmic scale for the Y axis. The measurements here are divided by equal % gains, not equal price measurements. This gives a more balanced account of historic trends up into the current one.
There are no rules on what scale to use. Some analysts prefer one over the other, while I tend to use both. I have found that some stocks tend to work better in one scale vs. the other. With Nvidia, each scale is telling us to wait to buy. Where they differ is the size of the drop that is likely building.
When we put NVDA in linear scale, it appears that we are completing a large degree 3rd wave, which could keep extending. The coming 4th wave would retrace the prior swing, before bottoming and starting a new large degree 5th wave higher. The targets for this 3rd wave are in the $1200 – $1300 range. A breakdown below $1035 will signal that we are in this correction, which we would use to setup buy targets.
When we put NVDA in logarithmic scale, it appears that we have a fully formed 5 wave pattern, where the 5th wave extended. The targets overhead are roughly the same and the break down price point remains $1035. However, this count suggests that we would see a deeper pullback than the count in linear scale.
Interestingly, the fundamentals simply do not line up with either of the counts, especially the one suggesting a deeper pullback is coming. The valuations are not exorbitant, as price would suggest. With each report, forward sales have continued to accelerate higher, and in some instance cases more than price increased.
A move to those levels would require deep revisions, or an unforeseen macro catalyst. This has been a fundamental story, as I have been forced to re-write this chart several times throughout the uptrend. So, we do not plan to take drastic measures now that NVDA has hit our technical targets.
Since 2023, we have seen three greater than 20% drawdowns in NVDA. Our plan will be to buy on these ~20% dips, and if we see an even deeper one, as outlined by these two counts, we will buy more. Until the story shifts and the fundamentals get reversed, we see no reason to not buy the dip on NVDA as it remains our top position, and will likely hold that spot into the foreseeable future.
Bitcoin (BTCUSD)
Bitcoin hit our $57,000 target and has bounced back to retest the highs. I still think we are going higher; the question is if it will be directly from here or after we make one more drop into the high $40,000s first? If we break out to new ATHs, then we should see the $83,000 level next.
There is an important cycle cluster coming up in late June. How we are trending into these cycles is what is important. If we are trending higher into ATHs, then we will likely see some type of a reversal. If we are trending lower, then we will likely see some type of low.
Broadcom (AVGO)
AVGO is a new addition and one that we plan to continue to buy on further weakness. The long-term trend appears to be quite bullish; however, we will need to contend with some volatility along the way. If we zoom in on the current uptrend that we are in, we are either in the final swing lower in the 4th wave correction, or still in the larger 3rd wave higher.
If we see a breakdown below $1305, we will be in the 4th wave and target the $1100 region for bigger buys. If we are still in the 3rd wave, then we should see a breakout to new ATHs (above $1450), followed by one more swing higher to complete the 3rd wave. This would mean that the larger 4th wave pullback would happen later into the year.
Broad Market Technical Analysis
Regarding the horizontal lines, black lines represent strong support/resistance, while dark red lines mark very strong support/resistance.
Elliott Wave counts are meant to provide context. Each colored count represents the most probable paths given the current price data. There is a pattern unfolding in real-time, one of which will play out. By monitoring price levels that are held/broken, it will help us figure out which one is in play, so that we can better manage risk.
We continue to track the secular bull market that started in March of 2009. Instead of 3 counts, as discussed in the April report, we are now only tracking 2 counts.
Red – The secular bull market that started in March of 2009, completed its final 5th wave in early April of 2024. We are now in the first corrective pattern of this new secular bear market. We should trend side-ways to down until early 2025, which would then see the larger drop.
Green – This count relies on an extended 3rd wave that pushed into the 2022 top. The 2022 bear market was the 4th wave, and we are in the final moves of wave 3 within a large 5 wave pattern. We should see a break above 5465, which would signal that we can see the bull market extend into 2025.
These two counts differ on where the large degree 5th wave in the secular bull market started. the red count has this 5th wave starting on the COVID low. This would make the 2022 bear market a 4th wave within this larger 5 wave structure.
What’s important to recognize in this count is the structure of the final 5th wave within this larger 5 wave pattern, which started in October of 2022. It is a common pattern for 5th waves, called an ending diagonal pattern. I discussed this pattern in great detail in the February Report. In short, it is a choppy, 5 wave pattern that has large swings in both directions, some overlap between each wave, and tends to operate within a defined trend channel.
This pattern best completed in early April. This would then put the current push to new all-time-highs as an extended bounce within a larger correction, and should give way to a sharp drop once completed.
The green count best fits as a much larger ending diagonal. While the red count has the final 5th wave of the secular bull market starting off the COVID low, the green count has the final 5th wave starting on the October 2022 low. While the pattern is the same, the green count has it playing out on a larger scale.
This would have us still in the 3rd wave of this larger ending diagonal, which would need to tag the 5750 range.
If we zoom into the ending diagonal that is currently playing out, we can get more context on the levels that we need to monitor for confirmation of a future direction in the market.
If we can see a push above 5465 in SPX then it will confirm that the green count, or some variation, is likely playing out. This meansthat we will be targeting the +5700 region more directly, which will be followed by a large correction into year-end. On the other hand, a break down below 5255 in SPX will confirm this the red count is in play. This means that the early April high was the top for the secular bull market that has been playing out since 2009.
Pro premium members receive deep-dive research on all the stocks in the portfolio and quarterly earnings kickoff webinars. In addition, the Advanced Market Signals Members receive regular technical and broad market analysis and weekly webinars from our Portfolio Manager, Knox Ridley. We closed Super Micro in early May for an average gain of 275% across all entries and exits. Also, we booked sizable gains in two cybersecurity stocks in April. Learn more here.We closed Super Micro in early May for an average gain of 275% across all entries and exits. Also, we booked sizable gains in two cybersecurity stocks in April. Learn more here.
For reference to terminology used, please look at technical analysis under our resources section here. Regarding the horizontal lines, black lines represent strong support/resistance, while dark red lines mark very strong support/resistance.here. Regarding the horizontal lines, black lines represent strong support/resistance, while dark red lines mark very strong support/resistance.
Elliott Wave counts are meant to provide context. Each colored count represents the most probable paths given the current price data. There is a pattern unfolding in real-time, one of which will play out. By monitoring price levels that are held/broken, it will help us figure out which one is in play, so that we can better manage risk.
I/O Fund Positioning
Over the last couple of months, we have held a healthy defensive posture while adding to strong strategic positions. We closed two stocks, and greatly reduced three others. We then continued to rotate that money into fundamentally sound companies that are in the middle of the AI trend, as well as crypto. This has netted us a lower cash position than last month and more market exposure.
Regarding the changes we have made since the last report, we closed Super Micro for an average of 275% gains across all entries and exits. We also closed Netflix for an average of 98% gains across all entries and exits. We cut our Lam Research position down to 1%, having to log an 8% loss, as the earnings call signaled that we are too early to this play. This followed further reductions in CrowdStrike and Cloudflare in April, for sizable gains.
We then added exposure to our crypto positions since our last report. We set up predetermined targets, and once these targets were it, we went on a buying spree, which included Bitcoin at $59,000, Chainlink at $12, Ethereum at $2,900 and Solana at $153.
We also added to our AI positions since the last report. We built out Micron, Broadcom and AMD positions around the late April lows. We then followed up with breakout buys in Dell and AVGO, which have since reversed.
Regarding these stocks, we have little to no concern with AVGO; however, Dell’s margins shrunk, which puts it outside the boundaries of our current fundamental process. We believe their margins are bottoming, as the technical picture also supports this being a correction, for now. If the tehncicals devolve from here, we may lower this position into a 2% holding, or even cut it all together. However, we have no plan to add until we get more clarity.
The below pie chart represents our invested assets, not including cash or hedges. As of now, we are about 60% invested in AI stocks, 30% in crypto, with small allocations to various tech trends. We do have a sizable overweigh to AI while still counter balancing this exposure with a healthy cash position. The market is at an inflection point, and if it decides to take the more bullish path, discussed below, then we will continue adding our cash into key positions on pre-determined breakout.
Nvidia (NVDA)
I will spend extra time on NVDA, considering it is our largest position. The smaller time frame seems to be quite clear – we are trending up into the $1050 – $1315 target zone that we identified in our April report. The developing pattern is 5 waves, which means that we now have a fully formed 5 wave pattern into the target zone. This should set us up for some type of a reversal.
While a pullback from the current swing high appears to be reasonable, the question is what degree of correction will this become? When we zoom out to answer this question NVDA’s chart provides two potential answers.
When charting, there are two scales to measure price – linear scale and logarithmic scale. In linear scale, the Y axis has the same division in price from top to bottom. So, if the division is every $100, then a move from $100 – $200 is a 100% move. However, a move from $1000 – $1100 is only a 10% move. This gives the appearance of small moves at the based on the trend and dramatic moves the higher we go.
The other option is logarithmic scale for the Y axis. The measurements here are divided by equal % gains, not equal price measurements. This gives a more balanced account of historic trends up into the current one.
There are no rules on what scale to use. Some analysts prefer one over the other, while I tend to use both. I have found that some stocks tend to work better in one scale vs. the other. With Nvidia, each scale is telling us to wait to buy. Where they differ is the size of the drop that is likely building.
When we put NVDA is linear scale, it appears that we are completing a large degree 3rd wave, which could keep extending. The coming 4th wave would retrace the prior swing, before bottoming and starting a new large degree 5th wave higher. The targets for this 3rd wave are in the $1200 – $1300 range. A breakdown below $1035 will signal that we are in this correction, which we would use to setup buy targets.
When we put NVDA in logarithmic scale, it appears that we have a fully formed 5 wave pattern, where the 5th wave extended. The targets overhead are roughly the same and the break down price point remains $1035. However, this count suggests that we would see a deeper pullback than the count in linear scale.
Interestingly, the fundamentals simply do not line up with either of the counts, especially the one suggesting a deeper pullback is coming. The valuations are not exorbitant, as price would suggest. With each report, forward sales have continued to accelerate higher, and in some instance cases more than price increased.
A move to those levels would require deep revisions, or an unforeseen macro catalyst. This has been a fundamental story, as I have been forced to re-write this chart several times throughout the uptrend. So, we do not plan to take drastic measures now that NVDA has hit our technical targets.
Since 2023, we have seen three greater than 20% drawdowns in NVDA. Our plan will be to buy on these ~20% dips, and if we see an even deeper one, as outlined by these two counts, we will buy more. Until the story shifts and the fundamentals get reversed, we see no reason to not buy the dip on NVDA as it remains our top position, and will likely hold that spot into the foreseeable future.
Micron (MU)
In our last report, we were targeting a 4th wave pullback into the low $100s. So far, this is exactly what we have seen, as we used our targets to pick up shares of MU around $110 on April 24. It is clear that we have been in a 3rd wave (note the vertical move higher). If accurate, we still need a 4th and 5th wave to complete to the larger pattern.
The current dip is simply not big enough in time to constitute a 4th wave of this degree. If we see one more drop back into the low $100s, then we will certainly have a fully developed 4th wave pattern. This is demonstrated by the red count in the chart below.
Note the decelerating momentum in the composite index on the weekly chart. This is happening while price is making a higher high. To me, this looks like a B wave. A drop below $120 will signal this count is in play.
On the other hand, if we simply breakout over the $134 high, then the odds will start building that we are still in the larger 3rd wave. This is my blue count below, and it will mean that the 4th wave will likely happen later this year.
Bitcoin (BTCUSD)
Bitcoin hit our $57,000 target and has bounced back to retest the highs. I still think we are going higher; the question is if it will be directly from here or after we make one more drop into the high $40,000s first? If we break out to new ATHs, then we should see the $83,000 level next.
There is an important cycle cluster coming up in late June. How we are trending into these cycles is what is important. If we are trending higher into ATHs, then we will likely see some type of a reversal. If we are trending lower, then we will likely see some type of low.
Advanced Micro Devices (AMD)
The size of the bounce off of the May low tells me that the 38% drawdown from the March high is likely over. The question I have is what type of bounce are we in? My green count has us in the 5th wave in a large degree diagonal pattern, which would target new highs in the coming months. Diagonals are characterized by large swings in both directions that tend to overlap with one another.
The red count will look similar to the green count; however, we should see an overlapping uptrend that fails to make new highs. This would have us in a large degree B bounce within a larger correction.
If we zoom in on the current bounce, keep in mind that both counts are expecting a 3 wave uptrend for both counts (A wave higher, B wave lower, and then C wave will be the most bullish portion of this move).
It looks like AMD has completed the A wave higher and is still in the B wave contraction. If we breakdown below $158, the final move of this B wave should hit our target box at $152 – $148. On the other hand, if we instead breakout over $174, then I’d consider us being in the most bullish portion of the bounce, which is the C wave. This would likely push toward $195. If this happens, we will reassess what count is in play, as both will point to the same general target. The type of pullback we get from this region will tell us if we are going higher.
Broadcom (AVGO)
AVGO is a new addition and one that we plan to continue to buy on further weakness. The long-term trend appears to be quite bullish; however, we will need to contend with some volatility along the way. If we zoom in on the current uptrend that we are in, we are either in the final swing lower in the 4th wave correction, or still in the larger 3rd wave higher.
If we see a breakdown below $1305, we will be in the 4th wave and target the $1100 region for bigger buys. If we are still in the 3rd wave, then we should see a breakout to new ATHs (above $1450), followed by one more swing higher to complete the 3rd wave. This would mean that the larger 4th wave pullback would happen later into the year.
Ethereum (ETHUSD)
I’ve been reworking the count on Ethereum to fall in line with the Bitcoin count. I still think we are in a minor 4th wave and need one more drop to complete the pattern. Note how we got 3 waves down from the March high, which was followed by 3 waves higher off the April low. I think we need one more small push into the low $4000 region to complete the B wave. If we see any sizable drop from this high, and it is in the form of a 5 wave pattern, then we know that this thesis is correct. If we instead breakout above $4,259 then the 4th wave is over, and we will continue higher in the larger 3rd wave.
Dell (DELL)
Like Micron, Dell appears to be tracing an incomplete 5 wave pattern. Note the vertical move higher on heavy volume and max momentum; this is what 3rd waves look like. If accurate, this drop should only be a 4th wave, which could take a month or more to play out. The current drop should be the A wave, and we should see a B wave bounce soon.
The $135 region has proven to be solid support, so far. The below levels to monitor are $121, $116, $106. If we see any further weakness below $105, the 5 wave pattern will be in threat of invalidating, which means a bigger top could be developing.
Chainlink (LINKUSD)
We only have a 3 wave drop from the high, so far, followed by another 3 wave bounce. This is what we wanted to see, and further supports the bigger move higher that we have been preparing for. However, we are now watching for the potential for one more drop to complete the bigger B wave, which is the green count below.
If the next drop is a 5 wave pattern that breaks below $14.15, then we will be in the green count, and target the $10 – $9 region for the next buy. As long as any further weakness holds over $7, we can keep looking higher; however, below the $7 support and the uptrend is in threat of getting invalidated.
If instead, we drop in a 3 wave pattern that holds over $14.15, followed by one more high, then we have strong evidence that the drop to $11.75 was all of the B wave, which is shown in the blue count below. We will continue to buy the dip in this scenario until we reach our targets overhead, or break below a critical support.
Solana (SOLUSD)
Solana is in a large 4th wave. What we are trying to determine is when that 4th wave will turn lower and complete the pattern around the $100 – $90 level. The red count has us in the early stages of the final leg lower. A break below $159 will confirm this, and we will likely setup more buy targets in the low $100 region. On the other hand, if we can keep trending higher, the B wave can extend to the $209 – $230 region, which is shown in the green count below. If this happens, we will likely start taking gains in Solana.
Crowdstrike (CRWD)
CRWD is still in its large degree 4th wave. After giving us a double top, which counts best as the B wave in this larger 4th wave, we then got a direct drop that followed. It’s a 5 wave pattern. This is important because the final leg in all corrections is a C wave, which is always a 5 wave pattern.
As long as we see a bounce that holds the $350 region, I’m still expecting CRWD to drop into our target zone, which has been on our charts for months. If this happens, we will buy more. The levels to monitor are: over $365 and the 4th wave is over, as we target new highs; a breakdown below $304 will signal the C wave drop is developing and we will setup buy targets.
Baidu (BIDU)
BIDU still appears to be in a consolidation pattern. Our purchase was on a false breakout, and we are hanging on until the downward wedge pattern fails to the downside. This will be somewhere between $90-$85. These momentum plays are risky, and always come with stops. We prefer to layer in small and set a wide stop, while some prefer a tighter stop. We’re going to give this one some more room to develop before bailing. We will need to see the low hold and a breakout above $116.50 for us to add to this position.
Tencent (TCEHY)
Tencent is a lower conviction momentum play, but this is what a breakout from a falling wedge looks like. TCEHY should be in a minor 4th wave. If true, then we need to hold the $45 – $43.30 region. Below here and the uptrend pattern we are tracking has failed. If it continues higher, we will continue to raise our stop along the way.
Microsoft (MSFT)
The monthly chart from MSFT is flashing a warning. First off, we have a fully completed 5 wave pattern off the 2009 low. I think this is a 3rd wave within a larger 5 wave pattern, but it is still setting up for a reasonable 4th wave pullback. The symmetry of the move is also signaling the double top at $432 is the final target for this very large 5 wave pattern.
To further back the claim, look at the momentum indicators below. The composite index is flashing negative divergence (making lower highs while price makes higher highs). It is rare to see a monthly chart provide divergence, and when it does, it tends to precede a turning point in the trend. The detrend oscillator is also in a precarious spot. It is at the same amplitude as the 2022 top.
If we zoom in on the final 5th wave of this large 5 wave pattern just discussed, we can see a very mature trend. All 5 waves are in place, which has led into the March 21st top.
If we zoom into the current correction, what is interesting is that we are in what looks like an expanded flat correction. The B wave made a slight new high, and what has followed is a clean 5 wave drop followed by a 3 wave retrace.
So, the down side setup, from the monthly to the hourly charts are in place. If MSFT breaks below $404, then it will be confirmed, as the next drop targets $365 – $325. If it can instead break to new all-time highs, it will invalidate this setup, and it can keep pushing higher in an extended B wave or 5th wave.
Lam Research (LRCX)
LRCX looks like it is still in a correction. Note the 3 waves down and 3 waves up into a lower high. The red count suggests that we will see the final leg of this correction into the $827 – $750 region. This would set up a nice push higher for the final swing in this developing 5 wave pattern. The alternative scenario in green suggests that the correction is over. This means that we will breakout over $1007 and continue into the $1160 – $1350 range.
Cloudflare (NET)
Our decision to exit NET with a +60% gain has proven to be the right call. Since our last report, which warned readers that the $90 support was failing, NET has dropped over 25%. As of now, there is a path higher; however, it will need to hold $59 on any further weakness.
If we instead break below $59, then we are in the red count, which suggests that we should retest the 2022 lows. If we can hold $59 and turn higher, then we are in the green count, which suggests we will see a 5th wave within a large leading diagonal pattern. Because the pattern higher will look identical to a corrective bounce pointing lower, it will be tough to gauge what count is playing out if $59 holds and we do see a bounce.
Hedge Strategy and Underlying Data
This section was a contribution from the creator of our hedge signal, Vincent Duchaine of WealthUmbrella. He provides an update on the I/O Fund hedge as well as the internal components that push the signal from buy to sell and also gauge the health of the market.
As the market is making new all-time highs this week, it would be tempting to conclude that we should not be concerned with the hedge strategy triggering a sell. However, the on-going volatility we have experienced since May has brought several of the internal metrics within the hedge strategy to their key thresholds, signaling that the market is unhealthier than most suspect.
When designing the hedge strategy, one of the objectives was to find the optimal threshold for each indicator that historically distinguished between a correction and larger bear event. This implies that in many instances we should see a reversal, or bounce, just before these significant separation points. This is exactly where the internal metrics are. The good news regarding the signal is that price is only 1 of many metrics that we use to determine if we hedge. This allows us to raise our shields relatively close to the market highs and reverse around lows in these bigger bear events.
Market Breadth
One of the most important inputs for the hedge is related to market breadth. Over prior decades, this data set usually does not trigger often. However, since 2021, it has provided an unusual amount of sell signals due to several periods of narrow leadership.
Outside of its use within the hedge signal, the indicator alone is helpful in identifying unhealthy markets. When the indicator is moving higher, it is signaling that market breadth is fading. This is even more concerning when the indicator is moving higher while the market is at all-time highs. This pattern is what triggered the hedge signal in November 2021, a month and a half before the 2022 bear market started, and it is starting to play out right now.
While the trend is worth monitoring, we are not yet at the threshold that will trigger the hedge. This reflects an unhealthy market, but the current position of this indicator is not yet at a decision point. If it starts to fall, and breadth starts to improve, this will likely be a headwind for stocks and potentially justify another leg higher. However, if it resumes ticking up, indicating breath is deteriorating, while the market continues higher, this should quickly reach the point of telling us to exit the market.
Options Market
When the price action started to go sideways around May 16th, one of the things that struck me was that the options market was not positioned in a way that would usually allow the market to fall at a high velocity. As you probably know, although the options world is a separate market from the stock market, some of the bets that investors take in this arena force them to buy or sell the underlying assets, particularly the market makers. This creates selling or buying pressure that usually pushes the market in one of the two directions.
Two weeks ago, the options market was relatively bullish while the real market was taking a breather. Today, our assertion is that this market is now sending mixed signals.
One of the most bearish signals is our Options Model, which is presented below. The Options Model is not directly part of our hedge signal (probably in the next version), but it is a model that has a very good historical hit rate (around 78%) and often has the advantage of leading the market. Look at how often it led the market in 2023.
This signal is now on the brink of flipping red, which is usually not a good sign, and in fact did flip red through today’s trading day.
While the above two indicators are weakening, the one indicator that is still hearty is our Vix Ribbon. This measures various VIX contracts of different durations – from 9 days to 1 year. This is, in essence, how the futures market perceives the potential for volatility over these durations. The lower it is, the more confident and clam the markets react.
While the VIX 9-day contract is still in backwardation with the VIX 1-month contract (blue moving into orange), the overall ribbon is healthy, as it is historically low and trending downward. This is what we want to see, and as long as this trend holds, we should be in an environment that has low volatility, which is usually favorable to the market.
Another interesting signal that came from the options world was from our indicator that measures at-the-money (ATM) and outside-the-money (OTM) puts and calls. It is based on the CBOE SKEW data, which is a robust way to measure sentiment and perceived risk in the markets.
When the market is nervous and uncertain, OTM put options are used to protect portfolios, because they are relatively cheap. This increased demand for options having strike prices below the underlying asset drives up these options' implied volatility. The SKEW index detects this increase in profitable downside protection or lack thereof, and our indicator detects anomalous spikes within this data.
On Friday, May 17th it triggered a rare spike that tends to precede uptrends in the market.
The spike signaled a significant change in how investors were positioned in the options world in terms of ATM and OTM puts and calls.
As you can see on this graph, an impulse of that magnitude is usually followed by good times in the market, even in a bear market. This was actually one of the signals I was looking for, along with the phase angle, to gain confidence in re-entering the market during the 2022 bear market.
In conclusion, many of the hedge signal’s inputs are at a decisions point. Based on our experience it could swing either way, as there is ample evidence to support both cases. We will monitor some of these key data points to rapidly assess in which direction the market is heading. At this moment, if I had to bet, I think that this data could swing either way, but is slightly more bullish, at the moment, than bearish. I could be wrong, and the good news about the mixed data is that our hedge is currently not far behind and should rapidly tell us to exit the market in case the wind turns. We will keep you informed.
Broad Market Technical Analysis
We continue to track the secular bull market that started in March of 2009. Instead of 3 counts, as discussed in the April report, we are now only tracking 2 counts.
Red – The secular bull market that started in March of 2009, completed its final 5th wave in early April of 2024. We are now in the first corrective pattern of this new secular bear market. We should trend side-ways to down until early 2025, which would then see the larger drop.
Green – This count relies on an extended 3rd wave that pushed into the 2022 top. The 2022 bear market was the 4th wave, and we are in the final moves of wave 3 within a large 5 wave pattern. We should see a break above 5465, which would signal that we can see the bull market extend into 2025.
These two counts differ on where the large degree 5th wave in the secular bull market started. the red count has this 5th wave starting on the COVID low. This would make the 2022 bear market a 4th wave within this larger 5 wave structure.
What’s important to recognize in this count is the structure of the final 5th wave within this larger 5 wave pattern, which started in October of 2022. It is a common pattern for 5th waves, called an ending diagonal pattern. I discussed this pattern in great detail in the February Report. In short, it is a choppy, 5 wave pattern that has large swings in both directions, some overlap between each wave, and tends to operate within a defined trend channel.
This pattern best completed in early April. This would then put the current push to new all-time-highs as an extended bounce within a larger correction, and should give way to a sharp drop once completed.
The green count best fits as a much larger ending diagonal. While the red count has the final 5th wave of the secular bull market starting off the COVID low, the green count has the final 5th wave starting on the October 2022 low. While the pattern is the same, the green count has it playing out on a larger scale.
This would have us still in the 3rd wave of this larger ending diagonal, which would need to tag the 5750 range.
If we zoom into the ending diagonal that is currently playing out, we can get more context on the levels that we need to monitor for confirmation of a future direction in the market.
If we can see a push above 5465 in SPX then it will confirm that the green count, or some variation, is likely playing out. This meansthat we will be targeting the +5700 region more directly, which will be followed by a large correction into year-end. On the other hand, a break down below 5255 in SPX will confirm this the red count is in play. This means that the early April high was the top for the secular bull market that has been playing out since 2009.
Supporting Markets
There are only four basic corrective patterns markets take. This is true for a decade-long secular bear market or a small correction throughout the trading day. These patterns are repeated in all markets and all time frames, over and over again. The type of correction that the above red count is suggesting is what is known as an expanded flat.
What is unique about this type of corrective pattern is that the B wave will go above the start of the A wave. This is typically followed by a rather sharp C wave, which is always in the form of a 5 wave drop.
The most famous expanded flat correction was in the S&P 500 is 2018 – 2020. The C wave was 200% the length of the A wave, while the B wave went just past the 1.618 extension of A.
The current price action we are in does resemble a potential expanded flat, yet on a smaller time frame. Note the 3 waves down for A, and another 3 waves up for B. The B wave in SPX appears to still be pushing higher, and is targeting the green box in the chart below.
The final drop in a correction is a C wave, and they are always 5 wave moves. What is key to understanding this type of analysis is that these patterns are all fractal. So, a small 5 waves will turn into a larger on until you hit your target. If we can find evidence of a smaller 5 wave pattern developing where a C wave should be starting, then we have strong evidence that we are heading lower.
Equal Weight S&P 500 (RSP)
The Equal Weight S&P 500 appears to be in a standard correction, called a Flat corrective pattern. These are the most common corrections that we see. This is when the B wave retraces most of the A wave drop but does not make a new high. It is then followed by a C wave, which more times than not, makes new lows.
That being said, we have a very clean 5 wave drop from the B wave top in the equal weight S&P 500. While SPX is making new highs, RSP noticeable bellow it’s high. Instead, it is giving us a choppy and messy bounce higher, indicating that it is at risk of moving lower. Unlike SPX, which is still pushing higher, RSP appears to be in an on-going correction.
Dow Jones Industrial Average (DJI)
The DJI looks similar to RSP. We have a vertical drop from what looks like a B wave bounce. This vertical drop is best counted as a 5 wave pattern, which lines up with us being in a C wave down. While we are tracking SPX making a new high, DJI is clearly following through with a C wave lower. It has retraced most of the bounce that started in late April in a vertical fashion and is giving us a choppy bounce higher.
New York Stock Exchange (NYSE)
The NYSE has a similar setup as the above major indexes. After completing a 3 wave bounce that made marginally new highs, we have seen a vertical drop that resembles a 5 wave move down. This, as stated prior, lines up with the C wave portion of the correction. The 5 wave pattern has also been followed by a choppy, 3 wave bounce, signaling that waves 1 and 2 of the C wave are potentially in place. If this is playing out, the 3rd wave will break below the end of the 1st wave and we will continue lower
Financial (XLF)
Financials is also looking like the above indexes. We have a clean 5 wave drop for wave 1, followed by a 3 wave bounce for the 2nd wave. We then have what looks like another small 5 wave drop, which is threatening more downside. XLF appears to be in a developing C wave, and as long as it stays below its May highs the risk remains.
NASDAQ-100
Now, let’s compare the above markets to the NASDAQ-100, which is heavily weighted toward tech. It looks identical to SPX. The price action best counts as a B wave in an expanded flat. If we see a larger 3 wave drop from the next high, it would be an indication that tech is going higher, and an early warning that the green count in SPX might be what’s developing.
In conclusion, not all markets are in sync. Divergences like this tend to precede trend changes, which is why we are cautious right now. The S&P 500 and NASDAQ-100 are heavily weighted toward Big Tech and AI. In fact, over 28% of the S&P 500 is focused in the biggest 7 tech names. So, Big Tech, especially the stocks tied to AI, are why SPX and NDX are making new highs.
However, when we take the same 500 stocks and weight them equally (RSP), which gives the same weighting to Home Depot as Microsoft, we have an entirely different picture unfolding. This same downside setup is present in the New York Stock exchange, which has 1897 stocks, and the Dow Jones Industrial Index, which has 30 stocks, and the Financial Index, which has 71 stocks. These indexes are not making new highs, and simply not participating in the recent rally we are seeing in the S&P 500.
So, once again, we are at a point where Big Tech, specifically AI, is hanging in, while your more value oriented names are notably correcting. What is different this time is the amount markets and stocks giving us a 5 wave drops from B wave highs. In order to break these setups, we need to see SPX break above 5465, while the above indexes invalidate the developing downside setups. In order to do this, they need to push to new highs. We are open and prepared to pivot completely out of a defensive posture if this happens.
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