Sectors Relative to QQQ

Biotech in Trouble?

I was bullish on biotech this summer as you know if you were reading back then. I set an alert on XBI's green trendline with the name "Biotech in Trouble?" It triggered near the close today. It's weakness strikes me as bearish and a follow-through on weakness would be bearish in general since this is one of the better performing rally sectors. Conversely, IBB the large-cap biotech still has an inverse H&S pattern going. Since XBI is more volatile nd smaller market cap, I view it as signaling market weakness. I also included large cap pahrma (IHE), small cap (XPH). medical devices (IHI), providers (IHF)

and the overall healthcare sector (XLV).

Dueling Patterns

The End of the Beginning

I'm running my portfolio like a targeted fund. I don't have a name for it, but let's call it Bear 1. I suspect that my "fund" will close this week or the one after and be replaced with Bear 2. Think Elliot Wave for the numbers.

I don't want to go through all the lessons I've learned this year yet, but there are a few relevant to this coming week or two. The most important lessons were simply experience. I didn't start actively trading until around August 2018. As that correction was completing, I realized options were a better strategy. Then I lost a lot of money, with some profit mixed in, in 2019. Then I made a lot in March 2020, but gave much back. I struggled until late 2021 when I starting hitting big wins, such as 20x returns on weekly XLE puts. And I didn't know what was happening and gave most of it back. I did it again in January 2022. I 20x'd my entire main portfolio. And gave it back almost immediately (literally within a couple of days it was halved).

I don't want to get into what's happening now with my portfolio because it jinxes it. I held off on discussing profit many times and literally the one time in each case I did it, that was right when I should have gone to cash. I want to discuss this now, however, because I think another moment is coming up. If I'm 100 percent wrong and the market reverses immediately next week, I need to get out and protect what profit I can salvage. If I'm right and the market starts selling off, I suspect it is days away from a final low. The low should be in before October 21 opex.

There are two ways to deal with my trading errors. One was to decide I'm a degenerate gambler who belongs on WSB and the other is to find a hand that can tap me on the shoulder and say, "We're done here." My frequency of hits and profit told me I was adding value with target selection. I went with the latter option and subscribed to trading service that focuses solely on direction of the major indexes. 

Another thing I learned is I can find high profit targets if I'm on trend, and if I have taken enough time to find them. My other main mistake was to keep trading when I should have stopped and reassessed the market. I was prepared for the rally from June to August, but I wasn't prepared for the rallies before.

Which brings me to the point of this post. Unless you're a daytrader, you should be mentally preparing for the coming rally. I won't say there are no profit opportunities, but if you haven't been trading to this point, then it's too risky to start now. You go into the panic low with the portfolio you have. If everything goes according to plan, sit back and do nothing except wait for the bottom signal.

My one caveat is energy. My opinion and I have money on it, is that the market can't rally unless energy sells off. If you tell me I'm wrong and oil is going back over $100 per barrel next week, then my assumption is the market will panic even worse than I expect because there can be no pivot if oil is already ripping higher. I can be wrong for days and weeks, maybe even months. However, if I'm wrong for months and oil rips towards $150+ as stocks and bonds surge, then I suspect 2023 will go alongside 1929 in the financial history books.

My break with the wider financial community is their assumption that the Federal Reserve is driving rates higher. My hunch is that interest rates are going higher because they must after years of suppression. The Austrian School has the right idea about capital: there's a relatively fixed amount of real capital. (In the short-term. Over the long-term, growing the capital base is what generates wage growth and deflationary trends in prices if not for central banks.) Inflation and interest rate suppression distort price signals, leading to malinvestment. 

I see many smart analysts and investors who know that green policies and Russia sanctions are a disaster, that commodities markets are wrecked and only made worse by green policy, and yet blame the Federal Reserve for raising rates because it doesn't solve the energy crisis. Yet I ask, "Do lower rates solve it?" The Fed's only real mandate is price stability. Kill inflation. If crude oil is going higher for structural reasons, then the Fed must be on high alert for inflation because high energy prices are a very possible catalyst.

The flipside is that if the Fed is wrong on policy and they're the source of trouble, then energy should crash in the coming deflationary wave. Simply, if there's to be a large rally, it should be the inverse of 2022: stocks up, energy down.

Bear 2

If Bear 1's work is do nothing, Bear 2 is find targets. I have some profitable ideas in mind and trying to find more. Figure out how much I want to allocate for possible 0 or 1 DTE daytrades if a crazy reversal V-bottom happens, versus buying calls into January or March (bull moves always seem to take longer than I anticipate).

I expect biotech, as one example, will perform even better than it did this summer.

There are also cyclical signals. I wrote about the won and yuan tumbling this summer. The dollar could have already peaked and it could reverse counter a bottom in stocks, or a major blow-off rally to end this phase could be coming. Either way, it's likely the dollar will soon be topping out for at least a little while.

Where will oil and inflation be next year if the dollar has peaked? How will that affect bond and stock prices? This is very likely a major bear market that has is only completeding phase one.

Biotech Remains Relatively Strong

If you're long only, wait for buying on the dip.

If this is a big bear market, it could play out something like this:

Good Enough for a Top Call

If you're buying puts for October or later, the top is in as far as I'm concerned. Tesla was one of the few winners today among BigTech. Cryptos were down, ARKK barely up considering how the major indexes moved. You might not want to go all in on puts yet because the indexes can be funny. Apple hasn't filled its gap yet and I worry there could be a fakeout pop higher. Having said that, I also wouldn't be shocked if SPX is sub-4000 when the calendar rolls to September.

Divergences

A bunch of stocks haven't joined in today's pop. There were all doing well during the rally. There could be yet one more pop left. All these charts look like they'd produce a spike on a move up. Having said that, I think it would be a fakeout. This is the fumes stage of the rally.

New Bull Market

Seeing reaction to the CPI report, I am concerned the rally could go on longer than anticipated. My sense is many bears are all-in on the "inflation bad" formula. The zero print for July isn't causing a reassessment. It's only one month, but it's a significant move from 1.3 percent in June alone to 0.0 percent in July. I expect August will be negative and the 12-month CPI will start plunging.

Look at prior CPI spike peaks. They came in February 1970, November 1974, March 1980, October 1990, July 2008 and June 2022. 

Stocks bottomed in: May 1970, October 1974, March 1980, October 1990, March 2009 and June 2022. 

The only case where there wasn't a low at the CPI peak was in 2008, and only in 1970 was the low months later. Whether this proves to be a major low or merely a blip will become evident rather quickly because a continued move higher will eventually take out key resistance levels.

The bear case is something more like 2008 unfolds with an ongoing recession that doesn't bottom until 2023. If inflation doesn't crater at least several percentage points, it will break with history.

For the bulls, peace with Russia is the "free lunch." If sanctions lift and energy prices come down, there's the fuel to run much higher. Recession would probably be avoided and new all-time highs on the indexes wouldn't be out of the question.

XBI is one of the most bullish charts out there in terms of arguing for a major bottom in stocks. ARKK, XLC, META and so on are also bottoming if the market is going higher.

I'm not bullish yet. I'd be more confidently bearish if bulls picked up the argument laid out above and ran with it. I'd love to see Apple fill its gap around $173 for example.

Rally Done? Biotech Candle

IBB doesn't have as nice a (potential) reversal candle, but it is failing at the 2015 high...

The ratio chart of biotech to Nasdaq, and energy, both point to potential outperformance. For this reason, I'm not targeting biotech ETFs for shorting. At this moment, I also have no bitoech stocks on my radar. That said, I used this to time the rally and a reversal would support thinking the market rally in ending.

Update: Candle has improved into the afternoon, but still signaling a peaking rally.

Biotech vs Energy

My first pick for the rally was biotech and I said short energy was the trade of the second half.

June 17: If You Gotta Buy, Buy Biotech. IBB up 17% since then, XBI closer to 28 percent.

I mentioned short energy as the second big trade setup of 2022 back in late May. It then moved into full bloom in June.

Remembering this pair, I thought to look at biotech versus energy. The verdict: even more confident in the deflation, short energy call. Biotech beat energy in 2008 too, and there's now an inverse H&S on the ratio chart.

If you think you can't chart ratios, here's XLE and SPY.

This ratio points to around $40 for XLE with the price ratio falling back towards 0.10 versus SPY. If support holds it might stop at 0.15 which would be bullish. If SPY is down around $300, that tranlates into $30 to $45 for XLE.