I’m Seeing More Troubling Signs In The Market

This week I want to start with an update of the same chart I opened with last week.

It’s a chart of the Invesco QQQ Trust (NASDAQ: QQQ), an ETF that tracks the Nasdaq 100 Index. A 52-week rate of change (ROC) indicator is at the bottom of the chart. The dashed line is at the 40% level for the indicator.

As I noted last week, when the 52-week ROC tops 40%, we’re most likely near the end of a bubble. That’s because the fundamentals in the market tend to change slowly. And when the ROC tops 40%, the stock market is most likely ahead of the fundamentals.

Even after last week’s selloff of more than 3%, ROC remains above 40%. This shows how speculative the stock market has become. Actually, both parts of that sentence show how speculative the stock market has become. ROC shows how rapidly investors have been buying stocks. The selloff highlights how narrow their buying has become.

The GameStop Story Is Further Evidence

The biggest story last week was GameStop, a stock that is now disconnected from fundamentals. It seems like it’s a battleground between individual investors who are buying to teach Wall Street hedge funds a lesson. At least that’s one of the storylines in the media. (I weighed in on the situation in this piece.)

Looking at the story dispassionately, it’s obvious to me the message from GameStop is that “the end is near” (as I noted last week) — and the end is going to be really bad.

That analysis is based on what we are seeing happen with Robinhood and other brokers. They were forced to halt trading in GameStop and other stocks. They weren’t doing this for sinister reasons. They did it because regulations require minimum margin requirements in the financial system. Trading in speculative stocks is increasing those margins for some brokers, and they need to find the cash.

To me, that is an important story. A few brokers are undercapitalized in volatile markets. It reminds me of the news in June 2007 that Bear Stearns was bailing out a hedge fund in the subprime mortgage market.

Bank of America noted at the time, “We continue to see this issue as more a reputation issue for Bear versus one that could lead to significant loss of equity capital.”

You could say something similar today, calling the GameStop mess a reputation issue for Robinhood. Or you could recognize that this is a warning that there are stresses in market structure that could lead to yet another once-in-a-generation crisis in the stock market. That would be the third one since 2000.

Looking Ahead

My indicators are telling me the stock market is likely to remain weak for at least for a few more weeks. Below is a chart of the SPDR S&P 500 ETF (NYSE: SPY) with my Income Trader Volatility (ITV) indicator at the bottom.

ITV is interpreted like the more popular VIX Index. Increases in the indicator coincide with price declines in the stock market. At the end of last week, ITV crossed above its moving average, the dotted line in the bottom panel of the chart. That is a “sell” signal. My Profit Amplifier Momentum (PAM) indicator confirmed the signal.

We could see some bargain hunting in the market in the short term. But I believe the tide has shifted and expect the next significant move in major stock market averages to be down.

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