Second Warning Shot

This market is wobbling.  AI is the only game in town.   NVDA is holding up the Nasdaq.  There is a growing number of individual names showing weakness underneath the surface of calm in the S&P 500 and Nasdaq.  This triggered a Hindenburg Omen signal for the Nasdaq on May 23.  

The last 2 signals were triggered on March 12 and 13, so it was early in forecasting a correction then.  It also triggered 6 times from mid January to early February without any negative consequences.  A cluster of these signals are more meaningful, but even one signal is a negative for the intermediate term.  A cluster of Hindenburg Omen signals  preceded corrections by firing off on November 2021, February 2020, July/August 2019, August/September 2018, and July 2015.  In the past 10 years, it provided false signals in December 2014, June 2017, August 2017, and November 2017.  The hit rate is about 60% for predicting a correction within a month, which is actually a strong bearish signal because any random 1 month period in the S&P 500 historically has gone down less than 40% of the time.  

The COT futures positioning data also supports the bear case for an imminent pullback.  As expected, asset managers chased the market as it went higher and net longs in SPX futures are back to late March levels.  Dealers also added to shorts, taking net shorts down to late March/April levels.  Positioning is now saturated, making the market vulnerable again. 

Speculation is rampant again among small cap daytrader favorites.  Two weeks ago it was the meme stocks.  Last week was NVDA and various small cap stocks that spiked out of long term downtrends amidst intense daytrader speculation.  This week has been tertiary AI names that have rallied.  This kind of activity in small cap stocks happen when optimism is high and positioning is quite long already.  This is not a perfect indicator and is usually early, but its another sign that bulls have gotten too aggressive taking the market higher and a pullback is likely within the next month.  

NVDA has been catching my attention since its earnings report came out.  It has gone up 20% in the past 4 trading days, taking its market cap to nosebleed levels.  NVDA's market cap is now almost the same as AAPL, and only 10% less than the biggest of them all MSFT.  Its market cap is $700B larger than GOOG.  $1000B larger than AMZN.  From a 30,000 foot view on NVDA's long term return prospects versus AAPL, MSFT, GOOG, and AMZN. I would take all 4 over NVDA all day long.  NVDA is being valued as if this AI capex build out will go on in perpetuity.  There is so much hype surrounding AI, while the use cases are so much more limited than the amount of enthusiasm about the technology.  I am looking into putting on a long term short position in NVDA within the next 3 months.  You could get one last bubble spurt higher post-split, as the lower stock price will trick investors to think its less expensive. 

On the macro front, bonds trade horribly both in the US and Europe.  The slightly lower than expected CPI number happened to be the top for both Treasuries and Bunds.  Since then, its been a downhill slide for bonds, despite almost no economic data of consequence.  Treasury auctions have tailed badly and demand is not strong enough for the huge supply deluge.  And this is during the seasonally strong mid to late May time period post refunding auctions for 10 and 30 year Treasuries.   This is not a good sign for June, especially if Powell finally stops trying to force his dovish bias onto the market and accepts that the market wants to price yields higher given sticky inflation, the strength of the stock market, and tight credit spreads.  This bond market weakness is likely to persist into the election, as bond investors will not want to get too long ahead of what has been bad news for bond investors in the past 2 Presidential elections (selloffs after 2016 and 2020 elections) with 2 deficit loving Presidents.

We have price action in individual stocks giving a bearish signal (Hindenburg Omen), we have positioning back to near max long in SPX futures, and lastly, we have the complacency, lack of fear, and rampant greed among individual investors as meme stocks and AI stocks like NVDA have gone crazy.  This is lining up for a high risk/reward short going into June.  The only fly in the ointment that I see is that CTAs that I track are still not long SPX, based on correlations with daily hedge fund CTA return data and positions in the most popular trend following CTA ETF, DBMF.  If they did start getting longer, that would be the final piece that would line up for a super bearish setup.  As it is, its still a bearish setup but I don't like to short in the hole when the SPX is in such a strong uptrend.  I am not seeing much euphoria or enthusiasm about the SPX so that gives me pause about shorting into this market right away.  The next rally that takes it towards last week's highs would probably be a good short opportunity, but we'll need to see how the indicators and investors react to it.