We have a very thorough market update for you that covers the rotation in cloud stocks, bullish broader market scenarios, bearish broader market scenarios and an update on the stocks we've covered over the last 60 days or so.
We had quite a few inquiries in our inbox and also a few on the forum and thought it best to consolidate our thoughts for reference. We will issue market updates at minimum every quarter.
bfea4257-d8aa-4b4a-aaf5-c2f3247fd004_Market-Update-Sept-2019-Premium-Analysis.pdf
Market Update: September 2019
SECTION 1: Shifting Leadership
The orange line is a cloud computing ETF that holds around 60 positions, all of which dominate the cloud space. The lite blue line is an ETF that tracks the Consumer Staples sector, which consists of your big, boring companies that are, in theory, impervious to recessions. These have historically been the laggards in this long, growth driven bull market. And, the dark purple line is the S&P 500.
You’ll notice before the June correction we had this year, the growth names within the cloud space were the clear leader within the market, while the staples were lagging. However, since that first correction, and into today, the staples have become the leaders of this market, while cloud, and growth have sold off.
Over the last week we have seen the high growth leaders in this bull market, mostly cloud, take significant hits.
Workday – down 25% from high
Twilio – down 26% from high
Okta – down 22% from high
Zoom – down 27% from high
Netflix – down 23% from high
Mongo DB – down 29% from high
Roku – down 8% from high
Shopify – down 13% from high
The question remains – is this a much-needed correction before making new highs, or is this the beginning of a much larger shift?
What we will need to watch is how the generals perform – i.e., Microsoft, Apple, Amazon, Facebook, Google. If the cloud players are thought of as the infantry, they can take a beating, and the generals can hold up the market. However, if we see funds rotate out of the generals, that is a major warning that the market is beginning the process of aligning with the negative divergence of economic indicators, as well as the bond market.
This pattern played out in late 2018, which preceded the swift sell-off into December, so it’s worth watching as the market proceeds.
SECTION 2: Big Picture
Long Term RSI and what it’s telling us ….
2012-2015 2012-2015
This chart shows the S&P 500 (SPX) going back to 2012. It’s a weekly chart, so that you can see the long-term trend as well as the slower moving momentum behind this trend in the RSI. In 2012, you’ll notice the RSI moved into a bullish range.
The green arrows show that the pullbacks during the 2012-2015 trend were shallow, and never crossed over the 50 line, while the peaks regularly crossed over the 70 line. However, notice the negative divergence between the RSI’s peak, highlighted in the descending red line in the RSI, which coincides with the price of SPX increasing, highlighted by the green line.
This is a warning of deteriorating momentum; however, the trend of negative divergence, in this case, lasted for over a year before the price finally gave way to the downside. It’s worth noting how long this pattern can play out before giving way to a larger correction.
2015-2017 2015-2017
In 2015, the RSI broke through the 50 line and continued through the 30 line, which is an initiation move into bearish momentum. When the RSI enters a bearish range, it spends most of its time below 40 and will not cross the 60 line. This is what we saw while the market pulled back. You’ll notice that the RSI in 2016 made a higher low, while the market made a lower low. This is an important indication of a trend change, known as positive divergence, which occurred when the RSI broke through the red trend line, and into a bullish range through-out 2017.
2018-2019 2018-2019
Today, what should be noted is the red trend line in the RSI is pushing momentum down. Eventually, it will collapse into bearish momentum, like we saw in 2015, or it will break the trend line and push price back into a new uptrend.
You’ll notice the red arrows show that 3 times the RSI attempted to break to the upside, and each time it failed. Furthermore, the price of SPX is trending up, while its internals are slowing down. As noted before, this negative divergence trend can last for quite some time, but eventually, the price will give way, or the pattern will invalidate by the RSI punching through to new highs.
Today, until proven wrong, I take this as a warning rather than an established downward trend. We expand on both bearish and bullish scenarios below and revisit the stocks that have been covered over the past 60 days.
SECTION 3: Bullish Scenario
Elliot Wave Count
In the bullish scenario above, the market hit its primary Wave IV in the December 2018 lows. Thus, we are currently in the beginning stages of Wave V, which would lead to a S&P 500 of 3800, at minimum.
In this scenario, we have completed Waves 1 and 2 within this larger degree Wave V, and also just completed Waves 1 and 2 of Wave 3, within a larger degree Wave V. If the market can break 3120, and close above this position, we will likely see the market take off, which is typical on the final leg of a bull market. My minimum target for this will be 3800, and we will likely see growth take over once again to lead us up.
Even though the market has taken back the short-term moving averages, indicating strong momentum, you’ll notice that it has broken the trend line in dotted black. It’s still trading below this trend line, and I’d like to see this trend retaken to further validate this scenario.
Remember, price is king. Today, the price in the market, though a shift in leadership is underway, has us trading to near all-time highs. If we close above 3120, that will be an indication that a final surge is underway. This can, and usually does, happen when the fundamentals in the economy and market are deteriorating, so it’s a final euphoric push that’s driven by sentiment.
Sentiment at bullish lows
Furthermore, what supports this thesis is the CNN Fear & Greed Gauge, which has been a fantastic contrarian indicator. Right now, we are not seeing any extremes, with a tilt towards the fear range. However, note the extremes we saw last week – 23. This typically does not precede a bear market. In fact, the sentiment is recovering from levels we typically see towards a bottom.
It’s worth noting, sentiment was at a bearish extreme in early 2008, as well as a bullish extreme in early 2017. Just because sentiment is at an extreme doesn’t always mean that it’s a contrarian indicator. However, more times than not, especially over the last decade, it has been a fabulous contrarian indicator.
With the level of fear we saw in August, and just about every analyst/talking head predicting a recession and market crash, we could, in fact, get the opposite. This is a possibility our readers should carefully weigh.
A Bullish Anomaly
Also, we are witnessing a very rare anomaly in the market. Currently, the 30-year treasury is yielding less than the yield on the S&P 500. This has only happened two other times in just about 40 years – in late 2008 and 2016.
Both times, we saw the market explode higher over the following year. Here is an article by CNBC explaining this further.
There is a saying in finance that money will flow where it is treated the best. Currently, with over $17 trillion in negative yielding sovereign debt, and the yields on US treasuries unable to keep up with inflation, there is a probability (worth mentioning) that we could see a sizable flow into US equities.
Based on the history of this long bull market, I favor giving it the benefit of the doubt by staying long for now. However, it would be foolish to ignore the weakness and warnings that are also out there. That being said, we recommend that you increase your insurance by shorting weak companies, while maintaining/building positions in beaten down high-flying growth companies, just in case the bullish scenario plays out.
Keep a stop on these positions – we recommend 25%, considering how far they’ve already retraced. We will look to add to our positions in strength or as the market bottoms and begins a new uptrend.
SECTION 4: Bearish Scenario
Elliot Wave Count
The weight of evidence within the economy, is leaning towards this being the higher probability scenario, which has us currently in Wave 4 from the 5 Wave push off the March 2009 lows. Here, we have completed the A Wave, had an exaggerated B Wave to new highs, and are just beginning the C Wave down. This C wave will unfold in 5 waves, and the green count has us completing the 1-2, just before the 3rd wave begins.
As you’ll notice, the market is trending in an expanding wedge shape pattern. If this pattern holds, then we can see the market trade as low as 2200 before finding a bottom. If we see the market close below 2700, this scenario will become much more probable.
I consider 2700 the first line in the sand, with the 2600 region as the final limit before closing winning positions. It should be noted that this is a Wave 4 pull back, which will give way to a larger degree Wave 5 push before this primary trend completes from the 2009 lows ends. So, I will look to be a buyer on any significant drawdown.
It’s worth noting, the market has repaired the technical damage from the most recent selloff. We are trading above the 21 and 8-day exponential moving averages, and closed above the 2955 region, which is a show of strength. The likelihood that we will trade to the 3100 range is increasing, and how the market reacts here will determine if we are going to witness a bull trap, or if the market will punch through the 3120 range, and begin a blow-off top to the 3800 region. The takeaway being, don’t get too exuberant if we hit the 3100 range – rather watch this region closely.
Intermarket Divergence
Here, we can see the S&P 500’s performance against multiple risk-on assets – oil, rates on the 10-year treasury, and the Japanese Yen to US Dollar exchange rate. You’ll notice how there is currently a wide separation, showing noticeable divergences amongst the risk-on assets and the market.
In short, all of these metrics are signaling, while the market keeps rising. This is a warning for the market. However, keep in mind, divergences can last for a long time. This chart is something I watch daily, and until the economic indicators reverse up to join the market, I stay hedged and hold my positions with tight stops.
SECTION 5: Market Updates
Zoom, one of our highest conviction stocks, has blown threw the 50% retracement and is holding steady at the 61.8% retrace level, around $78. This completes the 3-step correction, and we suggest buying a small position, which we will add to based on the decision the market makes. We are due for a bounce, and the structure of that bounce (5 waves vs. 3 waves) plus whether we can make new highs will determine if we have more downside vs. a new uptrend.
Below $78, and we will target the 76.4% retrace around $69-$68. We recommend holding a 25% trailing stop on this position.
Slack, also a high conviction position that wall street does not fully understand (i.e. we are ahead of momentum on this stock), is trading and holding around the $25 support. This puts Slack at a $12 billion company, which falls in the high range of our fair value – ideally, we’d like to cost average around the $10 billion market cap range, which is around the $20 range. We are comfortable with pre-momentum (this can take 1-2 years to play out yet has more gains than post-momentum), and have added 1/3 of Slack to our portfolio at the $12 billion market cap.
Now is not the time to build your entire Slack position. Start small with wide stops – 25% – and add as the company reaches mile markers. There will be a minimum of 6 months before the market sees the potential here. With positive divergence in the RSI, we believe Slack is due for a corrective bounce at minimum.
Mongo DB: MDB has shot through the $135 support, making lower lows and confirming an intermediate downtrend. I have exited my position, and will regroup as we enter a new uptrend. If MDB continues its downtrend, I see the $90-$85 region being strong support. This coincides with the 31.8% retrace as well as the 161.8% extension.
Wday: Wday is witnessing a slower bleed than the above, yet it still trades in a weak spot. The lowest I see WDAY trading is between $140-$120, which would be a gift, based on expected future growth. The market is unlikely to understand the machine learning story at this time.
If you have a position around $180-$170, hold with stops and look to add. However, WDAY has entered the upper region of my expected pullback region – $168. If you have not opened a position in WDAY, a recommended scenario is to buy a small amount at these levels.
Alibaba, is having trouble breaking through the $180 resistance. If it cannot break through this price, the $165 support will be crucial for a continued uptrend. Below this support and we can see Baba trade to $130 rather quickly. We could see a deeper pullback based on geo-political events, but not based on cloud growth.
Bitcoin: BTCUSD broke its wedge pattern down, and entered an even tighter trading range. Our expectation is to see it trade in the low $8,000 – high $7,000s. We currently have 1/3 of our position as $10,000 cost basis, and will look to go all in as we retrace deeper to the above targets. (Beth has been in bitcoin since circa 2015). BTC is volatile, and can shift on a dime, so make sure you have an exit strategy in place.
ChainLink: Link broke through the $1.95 support and has entered the upper region of the targeted trading region – $1.70-$1.25. We recommend adding to your position at $1.70, and layering in as we approach $1.25, if we even go that low. So far, Link has confirmed the next leg in the downtrend, and should find strong support just above the region it is currently trading.
Snap: We believe Snap will surprise to the upside. As long as it remains below $16, we consider it a buy. Put a stop in at $13.35.
Roku: This is the stock that Beth has written about the most, preceding nearly every other analyst on the market. We try to be pre-momentum. When the momentum shifts and sell-side analysts pile in without fear of losing their job over a bad recommendation, like what happened with Roku when a herd of analysts went from claiming the stock had too much competition and not enough IP, to a sudden reversal and steady string of buy recommendations after the last earnings report, we see the stock shoot up. I personally own Roku at $29 from December 2018 from following Beth’s early analysis, which occurred after the stock hit $60 (50% drop), and am holding without stops. The price points in the current PDF have an ideal target of $88. Due to the sell-side analysts piling in, something that could not be foreseen prior to the last earnings report, this target has to be adjusted. We will update you on the forum once we have more trading history in the region where Roku is currently trading.
Uber and Lyft: Starting pre-IPO, Beth covered the weak financials of these companies on her free blog. One of the risks she stated was the classification of the drivers. We believe these companies will continue to bleed with a new labor law that is close to passing in the State of California. You can read about this here.
Due to the sheer number of immigrants and H-1 visas in the state (who are easily exploited), California is historically very tough on companies who hire contractors that are treated as employees. This is a common loop hole that is exploited in California, forcing the state to pay for the health care of the uninsured individuals. There is also no social security tax being taken out, and state taxes are often evaded in these situations, weighing very heavily on the state as a whole. California has a long history of pursuing the misclassification of contractors, and this is not ride-share specific.
Quick note:
Historically, central banks react to bear markets, which mostly precede a recession. Today, they are reacting globally to prevent a recession. Their commitment to keeping the expansion going is something to watch closely.
The chart below shows how the market performs one year after a rate cut in two scenarios. The light blue shows how the market performs one year after a rate cut, and within that year after a recession hits. The dark blue line shows the market performance one year after a rate cut, and when within that year, a recession does not hit. In short, the market has had a 100% win rate after a cut where a recession is avoided.
However, with that said, we leave the Federal Reserve commentary and political discussions to the slew of analysts who take this on. We prefer to not get bogged down in the headlines and rather to be solely focused on a combination of strong fundamentals and the predictive guidance of technical analysis. We have found it incredibly hard to perfectly time a crash, or a bull market surge, and there are many losses on both sides of the fence when engaging in this (i.e. losing gains by staying on the sidelines or becoming too exuberant).
It’s always a good idea to have positions in companies you believe in and to short companies that are egregious in their financials or too early/too late in their tech market positioning and product development. In the event of a downturn, we will provide PDF reports on short hedges as you can make money on the down, as well.
As you know, we don’t control the state of fiscal policies or market sentiment. The scope of our analysis is to provide best of class tech industry research and to provide information on recommended entry/exits that we use for our personal portfolios. We are not financial advisors.
Thanks for your readership!