The equity markets are trading at pivotal levels, as the S&P 500 breaks through its pre-COVID highs and closes at a record level. The stock market has been on a seemingly endless rally to the moon, with big tech as the engine, but is it running out of fuel?
My concerns about stocks are largely short-term, with indexes reaching fundamental resistance levels, and my oscillators displaying an overbought market.
For those new pandemic traders & investors: make sure you don't get stuck in the mindset that "stocks only go up." This strategy has worked for the last 5 months as the market recovered dramatically, but it could quickly turn against you at the lofty levels we have reached, specifically in tech.
The Jerome Powell and his dovish band of central bankers at the Federal Reserve have taken unprecedented actions throughout this pandemic that has kept Wall Street afloat. The Fed is now preparing to abandon its inflation smoothing strategy in order to provide leeway for the economy to reach full employment.
Jerome is telegraphing to the markets that we should expect the benchmark Fed Funds interest rate to remain at effectively 0% indefinitely so that the jobs market can recover quickly. This move is justified by the years of low inflation below the Fed's target 2%.
The prolonged low-interest-rate environment has pushed the valuations of innovation-driven growth stocks to new levels, with analysts now able to discount future cash-flows at a much lower rate, making projected earnings more valuable.
The indefinite low-interest rates have led to an extended rally in the tech sector, giving stocks like Amazon (AMZN - Free Report) , Nvidia (NVDA - Free Report) , and even Tesla (TSLA - Free Report) the justification to further stretch their valuations with their future earnings now worth more. This is on top of the massive digitalization tailwinds that the pandemic has offered these firms, pushing these stocks to seemingly unreachable levels in a matter of months.
The Fed is releasing Minutes from its July policy, which should provide some color on what their plan for the remainder of the year will be. This policy release, combined with the S&P 500 hitting its pre-COVID levels, could be a catalyst for a broad market sell-off.
Investors have tended to pull profits in these unprecedented market conditions once they've seen what they wanted, whether its quarterly earnings or the Fed Minutes. The party conventions' poll moving action the next couple weeks could also catalyze a downside move in secular tech.
For more information on the elections potential impact on the market check out my latest article: Looming Election Volatility: Scenario Analysis .
How To Play Potential Volatility
The current mindset of many retail investors is that we hit the bottom in March (which is more than likely correct) and that the stock market can only go up from here (which is incorrect). Beware of this mind trap and consider what actions you would take if the market does begin turning against you.
I have been trading Nasdaq 100 ETF QQQ (QQQ - Free Report) puts to hedge my tech-heavy portfolio and smooth out my gains through volatility. I like to buy options with at least a month till expiration, so I have time to recover if it turns against me. I never hold these options until expiration and make my trades based on market indicators like levels and oscillators.
Below are a couple of graphs I charted up utilizing TradingView. I have circled overbought and resistance levels for both the S&P 500 and Nasdaq 100 that I'm watching for my put option purchases.
Those of you who are not yet comfortable trading options can still hedge your portfolio with inverse ETFs. Utilize ETFs like ProShare's S&P 500 short (SH - Free Report) , or if you want to hedge with a lower allocation, you can use ProShare's 3x leveraged Nasdaq 100 short (SQQQ - Free Report) .
There are many more inverse ETFs that you can take advantage of, but be careful with the leveraged ones due to the deteriorating nature of the ETF. Those are trading tools and should only be held for no more than a couple of weeks.
Long-Term Outlook Still Bright
The market is still ripe with long-term opportunities, specifically in underperforming sectors like banks, energy, materials, and utilities. These sectors need to start participating in the market rally materially if the S&P 500 is going to continue its skyward trajectory.
Stocks I like in some of the underperforming segments include the captain of high finance Goldman Sachs (GS - Free Report) , America's primary defense contractor Lockheed Martin (LMT - Free Report) , Standard Oil successor Chevron (CVX - Free Report) and SPDR utility ETF (XLU - Free Report) . These should all provide you with the right portfolio performers for the market's notable rotation into cyclical industries as the economy recovers.
I would be hesitant to put any substantial positions unless you can stomach potential short-term volatility.
Analysts have been upwardly readjusting their price targets as equities and the economy recover much quicker than initially anticipated. The rapid digitalization effect of the pandemic combined with the Fed's indefinite low-interest-rate environment has propped up the equity markets and pushed well-positioned secular tech stocks to continuously all-time highs.
I've made some good money in this rally, and I hope you have as well, but we need to keep a flexible investment strategy as the trading environment shifts. I am learning something new about the markets and the increasingly digital pulse that drives them daily.
If you continue to follow my recommendations and strategies, we can get through any volatile market conditions thrown our way.
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