Submitted by Nicholas Colas of DataTrek Research
Never short a new high or buy a new low. I learned that sitting in the trading room with Stevie Cohen at the old SAC Capital, although it is not something I recall him ever actually saying. The sentiment does, however, capture the sense of the room’s general outlook on trading. And, frankly, life…
The logic around it looks something like this:
Someone always knows more than you about a stock, a sector, or the market as a whole.
If that “someone” decides to bid up a stock to a new high, you really don’t want to get in their way. It takes a LOT of conviction to keep buying even as a stock breaks out, so whoever is pushing it there feels they know something. Yes, they could be wrong (just look at FB’s new high right before last quarter’s horrible earnings). But they usually aren’t.
That makes a breakout an important “Tell” and prudent risk management says you wait for the stock to stop making fresh highs before you short it.
The same thing applies to new lows. Someone is selling that name even though it is cheaper than at any point in the last year. Wait for it to stop going down before buying. “Seller reloads” is a bad thing to hear when you are on the buy side of the trade.
With the breakouts this week in the S&P 500, NASDAQ and Russell 2000, we now have a US equity market that, to a trader’s eye at least, is essentially “unshortable.” Pile on the fact we have a light volume week ahead of us, plus that there’s not much economic/fundamental news flow until after Labor Day, and there could be a series of new highs in the coming days.
Whenever equities break out to fresh records, we like to do a quick reality check for you. It’s not that we’re bearish; long time readers know we have been steadfastly recommending a US equity market overweight all year. But we hew to the old “Trust but verify” mantra of the late Ronald Reagan. With that, a few points:
#1. Valuations still look reasonable, especially as long-term interest rates seemed capped at 3%.
#2. Technology is still leadership, with some modest help from Health Care.
#3. There is a broad dispersion of valuation by sector based on 12-month forward earnings estimates.
#4. The best-case scenario for the S&P 500 is a further 8.7% advance into the end of the year.
#5. The S&P 500’s solid YTD returns mask remarkable dichotomies in investment style performance that persist even in this latest melt-up:
If one does appear, it will most likely come in the form of a market shock. That means Value will decline less than Growth, not that it will deliver positive absolute returns.
Summing up: today’s breakout to new highs was a function of a baseline assumption (further corporate earnings growth and low rates) and a fresh input (a US Mexico trade deal means other trade/tariff negotiations are also likely). Trade has been the biggest overhang on US stocks, so the latter point has some runway to shove large caps even higher in the near term. You know our thoughts: stay long US large cap stocks. And if you disagree, don’t short them until they stop breaking out.
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