This Wild Card Could Lead to the Market’s Next Leg Down

On February 14, the date of the last consumer price index (CPI) inflation report, the Nasdaq 100 was up 15% on a year-to-date basis.

Yet that report showed what all members of the Fed have been saying in unison: The economy is a long way from getting the inflation rate back to its 2% target.

After some initial wobbling, stocks closed the day basically flat at -0.03%… And the next day, the market rallied 0.28%.

Markets saw no evil and heard no evil… in this case, about the need to keep rates higher for longer – and probably more than expected.

But that rally was a “bull trap”… when a pattern of dip-buying fails.

The market is now down 3.8% since the highs of early February… something we anticipated on February 3 at this year’s peak levels. That was when we called out technical analysis and momentum hunting without looking at fundamentals. We said stocks would break any and all chart patterns people tend to make up.

2023 has been a lesson on what not to do after a widely anticipated economic release… which is to believe in the price reaction. Price is indeed a “liar.”

But now that the market has fallen, where do we go from here?

Will we break October lows? Or will we see a rally to recapture January’s glory days?

Too Expensive

Since February 22, the market seems stuck in a consolidation phase. It has been frustratingly choppy, offering no clarity.

But breaking down the performance of the seven stocks that make up nearly 50% of the Nasdaq-100 can help time the next move using a volume-weighted average price (VWAP).

A VWAP looks at price as a function of volume… where the price is weighted according to how much volume was traded. It’s a more precise way of determining significant price levels while blotting out a lot of noise.

As we said before, “One thing is certain… A 26 price-to-earnings (P/E) ratio – back where it was in 2021 – will not stand for long in a tightening cycle.”

The P/E for the Nasdaq-100 has since fallen to 23.5.

For it to fall further, higher-priced stocks need to start underperforming.

If this market correction continues based on the premise that this index is too expensive, the higher valued names like Tesla (TSLA), NVIDIA (NVDA), Amazon (AMZN), and even Microsoft (MSFT) should start to break away from their multi-week VWAPs and underperform stocks like Meta (META) and Alphabet (GOOGL).

So far… that’s what has been happening.

Here are those levels:

From this perspective, fairly valued names like META and GOOGL have been hovering above their VWAPs during this consolidation since February 22… while the higher-priced names haven’t.

And the higher the valuation, the more those VWAP levels are getting rejected, with the exception of NVDA.

Watching a Wild Card

Stocks get overvalued because growth gets overestimated. If that starts to come off the books, the market tends to fall.

Right now, 40% of the QQQ is tied to just five names that have uncomfortable growth expectations. Underperformance in these names will push the entire index down, possibly significantly.

TSLA is a good example of this development.

Yesterday, it closed at $202.77… above the $201 VWAP, and not really affected by the market-wide sell-off in February.

It then dropped 4.32% post-market when it disappointed on its investor day. The overall index was down 1% on that news at one point that night.

And although the market came off its lows Thursday and closed up on the day… TSLA did not participate in the rally.

So right now, NVDA looks like the wild card.

It’s risen on AI growth prospects, which accelerated after its recent earnings report.

But a significant break below its $230 VWAP could trigger the next move down in the markets at large, with October lows in sight.

Regards,

Eric Shamilov
Analyst, Trading With Larry Benedict

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