Introduction
It Was the Best of Times...
Borrowing from Charles Dickens, the phrase feels particularly appropriate for today's market. It has been the worst of times for growth investors overweight the Momentum Factor, yet the best of times for value investors positioned in many of the market's long-neglected laggard sectors.
We've discussed the historic unwind in the Momentum Factor over the past month in our prior reports, and that decline has only accelerated. The Goldman Sachs Momentum basket is now down an astonishing ~45% from its recent highs.
Marking the current environment as the worst drawdown in history.
This is not isolated to the U.S. market, but rather to any market where the AI infrastructure trade has dominated. Look no further than South Korea, where the unwind has created utter chaos in its equity market.
What makes this environment even more perplexing is that the average stock is breaking out, as evidenced by the Equal Weight S&P 500, which recently recorded a new all-time high before pulling back. The question now is whether the major indexes will revert higher, or whether the rest of the market will catch down.
Meanwhile, NYSE Net New Highs have rebounded back to the top of their recent range.
The Equal Weight S&P 500 continues to significantly outperform the Semiconductor Index.
Which makes the pair trade we highlighted in our June 28 report look particularly compelling, now outperforming by more than 2,200 bps.
We get asked all the time what will reverse the slide in growth stocks. Ultimately, it comes down to positioning. Only when the sellers have exhausted themselves can the healing begin.
The AI infrastructure trade fueled a crowded and parabolic advance in growth stocks, largely at the expense of the rest of the market. That dynamic set the stage for the historic unwind we are now witnessing.
The narrative has also turned decidedly negative. It has shifted from one centered on years of sustained earnings and cash flow growth to one arguing that capex has peaked and that the rate of earnings growth will begin to slow. The truth is likely somewhere in the middle. For some companies, earnings may have already peaked, while others remain in the midst of one of the largest infrastructure buildouts in history. Sifting through the rubble is where the real opportunities will emerge, and that is what we will be looking for as sellers eventually run out of ammunition.
The other issue plaguing the market is the surge in CDS risk across the ecosystem, suggesting default risk is rising. This could prove to be the other proverbial shoe to drop for the AI infrastructure trade and is another reason to remain cautious.
Look no further than Oracle, whose stock has experienced a stunning collapse over the past two months. The recent increase in its CDS has been equally noteworthy. The cost of insuring Oracle Corp. against default reached a multi-year high this week, rising to more than 215 basis points, up from roughly 145 basis points at the end of last year.
Outside of the usual AI-related developments, the FOMC met today and delivered a fairly hawkish message, despite bond traders lowering their expectations for a Federal Reserve rate hike in September. Markets are still pricing in roughly a 60% probability of an additional increase.
While the 2-year Treasury yield, a proxy for short-term interest rates, declined following the announcement, long-term yields moved sharply higher, with the 30-year Treasury reaching its highest level in 19 years.
This likely explains the abrupt reversal in the S&P 500, which surrendered nearly 2% from its intraday high.
After the bell, we heard from two of the hyperscalers, with Meta taking the disappointment prize. The stock traded down roughly 10% after hours following a weaker revenue outlook. On the positive side, the company did not raise its capex forecast, which could also weigh on the AI infrastructure names. Microsoft fared better, but we question whether its results will be enough to rescue the growth trade from the abyss.
As our readers can attest, we began turning increasingly cautious roughly a week and a half ago in our report titled Rough Air. In that report, we explicitly advised caution and suggested that any rebound attempts would likely be sold. Since then, the Nasdaq 100 has declined another ~6%.
That begs the question: is it time to buy?
Let's check the charts.
Analysis
To answer the question above, we first need to see the semiconductor complex stabilize.
In our June 28 report, where we first highlighted the potential short opportunity in SMH, we also outlined two initial downside targets. Both have now been reached, with the more significant 517–532 target range giving way today. That leaves the 61.8% Fibonacci retracement (~480) as the final major support level before the 200-day moving average comes into view.
SMH is now trading below its lower Bollinger Band, suggesting conditions are becoming increasingly oversold. As a result, there is scope for a reversal tomorrow, particularly if the ETF gaps lower to test the ~480 support level, potentially setting up a lower risk tactical long trade.
The Nasdaq 100 Index (NDX) has now declined more than 11% from its June peak, breaking below the 50% Fibonacci retracement level today. A gap-down open that tests the 61.8% Fibonacci retracement/200-day moving average confluence would present an ideal area for a bounce, particularly with the NDX already trading below its lower Bollinger Band.
The NDX printed a DeMark 9 Buy on Monday, but it has yet to have an impact. Typical reactions occur within 1–4 trading days, so we remain within that window. That said, the NDX needs to reverse soon; otherwise, the count will likely progress to a 13, with a Combo 13 Buy still at least six trading days away.
The NDX is now trading below the DeMark Channel 3 indicator, arguing for a short-term reversal and adding further confluence to the case for a near-term bounce.
The NDX is already testing the lower DeMark TrendFactor level we highlighted in our July 26 report, providing additional confluence that support is nearby. Should this level fail to hold, the next downside TrendFactor level sits at 26,559, which aligns closely with the broader support zone outlined above.
As we alluded to above, the bifurcation within the market makes assessing direction particularly challenging. With a narrow group defensive sectors holding the S&P 500 together, you have to wonder how long that dynamic can persist. We've long believed—and reiterated recently—that the market cannot sustain a durable advance without technology leadership. The last time Growth vs. Value broke to a two-year low, the broader market struggled for nearly an entire year. Bulls need to see that red dotted line (shown below) reclaimed.
The catch-down scenario we discussed above is beginning to play out in the S&P 500, which until now had been holding the broader market together.
The S&P 500 has finally broken below the minor uptrend line from June, losing the 23.6% Fibonacci retracement in the process. The next major support level is the 38.2% Fibonacci retracement, which aligns with the 100-day moving average (~7,180). Recall that the DeMark TrendFactor level we highlighted in our July 26 report also falls in this area (7,133), adding further support confluence.
The S&P 500 is also trading below its lower Bollinger Band, suggesting conditions are becoming increasingly oversold and that a near-term bounce could occur soon, possibly as early as tomorrow.
This is especially noteworthy given that the DeMark 9 Buy also perfected today, adding further confluence to the case for a near-term bounce.
We had also been highlighting the weakening technical backdrop in the Russell 2000, with our initial 50-day moving average downside target being reached. That level, however, failed to hold today, leaving the index vulnerable to further downside. There is a DeMark Propulsion target at 2,881 that could be reached as early as tomorrow. With a DeMark 9 buy also scheduled to print in three trading days, that combination could provide the catalyst for a reversal.
The biggest macro issue facing the market remains oil prices. While neither we nor anyone else can offer precise insight into when the Iran conflict will end, the longer oil remains elevated, the greater the damage to the global economy, where recession cannot be ruled out. This also implies that a durable ceasefire could quickly change the market's trajectory, while the absence of one could prove to be its undoing.
From a technical standpoint, oil failed to break above the downtrend line and could either be forming a lower high or a higher low. At this stage, we simply do not have enough information to determine which outcome will prevail. That uncertainty continues to make the investing and trading landscape treacherous, which is why we've been advocating doing less. It may be time to enjoy the remainder of the summer while the market wrestles with a number of difficult crosscurrents. For those who remain active, stay tactical.
If you must put money to work, we continue to favor the leading sectors driving many of our relative strength indicators. Most recently, we highlighted Energy (XLE) as an alpha idea, adding to our earlier recommendations of Financials (XLF) and Healthcare (XLV). All three sectors continue to rank among the market's strongest performers.
Conclusion
We'll leave it there. The evidence continues to argue for caution, but not complacency. While the market is becoming increasingly oversold and several indexes are approaching areas that could support a tradable bounce, we still view any near-term strength as guilty until proven innocent. The burden of proof remains on the bulls to reclaim key technical levels and, more importantly, for technology leadership to reassert itself, or at the very least, stabilize.
Until that happens, we think capital preservation and patience remain the higher-probability strategy. There will be a time to become more aggressive again, but we don't think the market has earned that benefit of the doubt just yet. Stay tactical, stay selective, and let the evidence—not emotion—dictate the next move.
That’s it for us. Have a great rest of the week.
CSC Team
Coiled Spring Capital LLC, Founder
http://www.coiledspringcapital.com
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