The stock market had a bit of a meltdown last week. The financial media has had a field day, blaming it on the new tariff regime implemented by the federal government. The question people have is whether the selloff is warranted. Is it overdone? Is there more to go?
Mike and I talked about this and other issues during Office Hours on Friday. My view is that we were overdue for a selloff due to valuation. We use the Buffet indicator (Total Market Cap [i.e., Russell 5000]/GDP) to make this assessment. We have been sharing this chart, and we think it cuts through the noise and tells the story of overvaluation.
In our Office Hours discussion, our thesis is that overvaluation would remain in place until there is a catalyst that will change people’s perspective. It seems the confusion around tariffs is that catalyst. Where do we go from here? We look at this a few ways. Using traditional technical analysis, we see a few stones of support that could represent levels that represent a bottom or support for a temporary bottom.
This approach shows that the selling could be over, and the prices may chop around Friday’s closing level for a while before heading back up. We give this scenario a 50% chance of playing out. The second level of support takes the price of the QQQs sone to the 2022/2023 lows. That implies another downside of up to 38%. We think there is a 40% chance of this scenario playing out. Finally, there is the chance the QQQs fall back to the C-19 low. We see this as a disaster scenario where the QQQs fall another 60%. We think there is a 10% chance of that manifesting. For those who like statistics, a weighted average of these scenarios suggests an expected loss of 21% f from here, with a standard deviation of 22%.
An alternative approach for predicting potential turning points is Fibonacci analysis. The Fibonacci sequence is seen in nature and determines the ebbs and flows of how nature and populations grow and contract. It is an integral part of Elliott Wave analysis. It suggests an additional fall of 7.4% (to $391) before a tradable bottom is put in. More disastrous scenarios would take the price down another 17.8% to $347. An even more challenging scenario would take the QQQs down another 28% to $303.
So, what is the next move one might consider? We suggest doing nothing. We will not offer a trade suggestion this seeking. The reason why is that we see Monday’s price action as being binomial with an upside bias. The chart above shows that the QQQs closed Fridays trading at the lows. This means that people are scared and do not want to carry speculative trading positions over the weekend. This is the kind of matter we see in selling climates. (The challenge is that one does not usually know when a selling climax occurs until after the fact.)
If the selling is indeed over, we could see a big up day on Monday. If, on the other hand, we have more bad news, the selling could continue down to $391 before we get a bounce.
For those who sold the QQQs, as we discussed in a couple of notes this past month, your trades are way in the black. A good trader lets his profits run. We suggest holding those shorts until there is evidence there is a tradable bounce at hand.
