Hypothetical Jeopardy answer… drone ants, dogs that chase cars, and stock markets with extended relative strength score readings.
Question: What are three things with short lifespans?
Last week we talked about how the NASDAQ pushed above a relative strength index (RSI) score above 70, putting the index into overbought territory. Normally, indexes/stocks/ETFs… tend to run into selling pressure once they top a 70 RSI.
That didn’t happen last week. Congress passing the infrastructure bill and solid earnings moved stock prices considerably higher, extending the NASDAQ deeper into overbought territory.
Drone ants have a lifespan of three days. We’ll be surprised if the NASDAQ’s overbought days outlast a drone ant born today. As you can see on the chart below, the last two times the NASDAQ got this far out of balance, the NASDAQ fell sharply in the following month(s). The smallest of the two declines was 12.5% and the other was the COVID crash in 2020. A 10% correction would put the NASDAQ in the neighborhood of 14,400, about inline with its 200-day moving average.
Once the selling begins, index investors might consider an inverse exchange traded-fund (ETF) like ProShares Short QQQ (PSQ). The ETF’s objective is to return the opposite of the NASDAQ 100 on a daily basis. For example, if the NASDAQ loses 1%, then PSQ gains 1%. Of course, the opposite is true. If the NASDAQ 100 goes up, then PSQ will go down.
Of course, there isn’t a technical pattern, algorithm, or trading model with perfect timing. Stock prices and the indexes could continue to climb in the near term. However, it’s our opinion the more extended the NASDAQ becomes, the deeper and more painful the selloff will likely be.
SECTOR WATCH
A mixed bag of sectors made an appearance on our top 10 leaderboard with a slight emphasis on telecom. Perhaps 5G is about to finally go into full swing as Defiance 5G Next Gen Connectivity ETF (FIVG) and SPDR S&P Telecom ETF (XTL) were among last week’s biggest winners. However, both charts are also overextended with XTL beginning to reverse course, which is the case for every sector’s chart within our top 10.
STOCK WATCH
It’s impossible to think about adding any company in the face of a potential correction on the horizon. In fact, it’s our opinion that investors might consider raising cash by selling laggards into market strength and then using that cash to acquire market leaders if/when a selloff occurs.
Rich Meyers
Investing Trends
