U.S. equities had a 5-day rally and as many expected, encountered some selling pressure on Tuesday. Counter-trend rallies below their 50- and 200-day moving averages are typically guilty until proven innocent. But there are a few differences between this pullback and that of 2 weeks ago when the Russell 2000 tested its August 24 lows:
- Japanese yen is not rallying this time. A rallying yen is a typical risk-off move that usually leads to a selloff in equities around the globe.
- The U.S. dollar is fading, which is giving a boost to lagging sectors like energy, some basic materials and emerging markets.
- Earnings season is knocking on the door and market expectations are relatively low, which is usually a good foundation for upside surprises.
- Seasonality is on the side of bulls this time.
- Many investors did not participate in the last 5-day rally and are waiting for a pullback to enter. It seems everyone was on the bandwagon two weeks ago and got burned when SPY, QQQ and IWM got slammed near their declining 50-DMAs. “A cat who sits on a hot stove will never sit on a hot stove again. But he won’t sit on a cold stove either”. May investors are the same way and highly impacted by recency bias. It takes time to go from a state of “fear of losing” to the “fear of missing out”.
- The biotech sector is leading the selloff again, but this time correlations among biotech stocks are much smaller than 2 weeks ago. For example, look at (NASDAQ:JUNO), which was up 9% Tuesday.
What has remained the same between today and two weeks ago is that there is still not a very high number of decent long setups among high-growth leaders. Mostly laggards are leading this counter-trend rally. Some say that this is normal for early stages of market recoveries. But the truth is that growth leaders lead in healthy markets and without them any rally isn’t likely to sustain for too long.