Last week was a WHIRLWIND of a week in the stock market and there are a couple of fascinating data points that are worth your attention.
1. Prospero's Signals Alerted Us Of Tuesday's Drop Before It Happened.
Tuesday morning, around 9:00 am CST, I was digesting the market open and I do what I do every day, which is open up Prospero and check SPY and QQQ Net Options Sentiment. My mouth fell open. SPY NOS had dropped to 0 and QQQ was at 4. For context, in late March when the Market began its massive decline, the combined Net Options score of QQQ and SPY was at 3. So a combined score of 6 is REALLY bearish. I texted our CEO George Kailas and let him know. We sent an alert to our followers on X a few minutes later. By the next morning, the Nasdaq had dropped around -3%. These signals certainly got out in front of this dip.
2. Institutions are Ramping Up Their Caution
After Fed Chairman Powell's Speech last week, the markets rallied. But interestingly Net Options Sentiment stayed extremely low heading into the speech. (Which isn’t exactly a surprise after 5 red days) What does that mean? That means institutions might be losing faith in the “buy the dip” market. Do we know the extent that Powell caught Wall St. off guard by what he said? No. But we do know that institutions were worried that the bottom might fall out if Powell doubled down again on the need for patience with rates. Their behavior was clearly to hedge aggressively and hedge in the QQQ much more than they had in recent weeks. One note of interest is that there is some evidence that economists over the weekend were waving the banner that Powell's comments weren't as dovish as people thought. Despite that we can see conclusively that there is still enough enthusiasm in the market that positive events will rally it. But are we starting to see enough concern that a negative event could pop the bubble? That is our concern and why we will continue to monitor QQQ/SPY Net Options Sentiment closely. There is a reason we went into Powell’s speech close to even long/short despite low QQQ/SPY Net Options Sentiment. That is because we still see both sides to this market. Increasing downward concerns about the market but still a healthy appetite for growth even at all time highs.
Think Value Over Growth
Because of the (possible) incoming rate cuts, it's very plausible that the market could continue rallying on Monday. Still, it's extremely important to keep in mind that the market is at historically high valuations. By historic, we mean that the S&P is at a higher valuation than the Dot.com Bubble of 2000. We wrote about it in last week's letter; the market and the underlying fundamentals of the economy are growing increasingly disconnected. And despite that shaky foundation, the market finished Friday deeply in the green – and we just might keep going up. When you look at all the data points, wisdom would say that at this juncture in the market, the risk vs. reward of Value over Growth becomes pretty obvious to us. Value is the way to go. Take LULU for example. Lulu Lemmon got hammered over the last couple of quarters over tariff fears. This occurred despite the company growing top and bottom line numbers as well as expanding into other markets around the world. Their current P/E ratio is a very reasonable 14.06. Over the last few days, Lulu started showing real strength in Proserpo's signals. This is after months of weakness. So do the math – which makes more sense? PLTR who has a P/E ratio of around 520 and has gone straight up for months? Or LULU who has gone down for months, has a P/E of 13 and is finally showing strength in our signals? We believe the answer is found in managing your downside by looking at beat up value plays like UNH, LULU, NVO and CHTR (all showing more strength in our signals than they or any value stocks typically do.) Even if we see a significant correction over the next couple of days/weeks (and we easily could), companies like LULU and UNH likely won't drop near as significantly as say an AMD or HOOD who have been on parabolic runs for weeks. But don't take my word for it, let's look at the returns of some of our value plays from last week. We decided to look at the average return over the last 5 trading days for our 4 value stocks compared to our most recent growth portfolio picks. Check 'em out.
LULU + 3.54%
UNH -1.74%
NVO +4.34%
CHTR +3.65%
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5 Day Avg Return: +2.45%
APP +.68%
PLTR -9.50%
HOOD -3.11%
AMD -5.11%
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5 Day Avg Return: -4.26%
Even after a strong rally on Friday our Value Stocks identified by Prospero's signals, still beat the pants off of our recent growth names. Be careful going long this week, but if you do, make sure you're choosing from Prospero's picks at the bottom of the newsletter. Or other picks that lean more towards value than growth.
Stay Smart In Your Positioning
While we still could see growth for a while, be aware that there are some really smart people growing increasingly alarmed at the state of the market. As a matter of fact, according to @daytrading, famed investors Ray Dalio, Micheal Burry and Jeremy Grantham are already positioning themselves for an impending crash. For example, Burry has a $98,000,000 short position on NVDA. Pretty gutsy. Grantham is predicting a 50% crash because of systemic failure. Now, they all could be wrong – and they certainly could be early in their prediction; but the fact remains that those guys are NOT dumb. When the music stops, and it probably will at some point, you don't want to be left holding the bag. By the way, go study the phrase "retail traders as exit liquidity" and you'll get a sense of what we're saying. Don't be afraid to take some profits on your winners. Hedge to the downside and watch those SPY and QQQ Net Options Numbers carefully. When their combined score gets below 10, that's when you need to be on red alert. Now a word from our CEO…
A WORD FROM OUR CEO
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We have had to balance the downside risk while still seeking out upside. Our win rate for our paper trading portfolio vs. SPY actually increased this week but we had a few larger losses when the market flipped fast. Overall we are happy with how we managed risk and are 65% above the market annualized with a win rate of 62% against SPY benchmarks.
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Value Judgement
Market/Macro Update w/ Cap/ Value Analysis
QQQ and SPY Net Options Sentiment
Sector Analysis
How we view the Sector performance and momentum
Portfolio Strategy
Putting it all together to make a portfolio that first controls for risks but also has upside
Longs
Adds —> Keeps —> Drops
Shorts
Adds —> Keeps —> Drops
Portfolio Summary
CAP/VALUE ANALYSIS
Small-cap stocks have seen a notable boost following the Fed’s dovish policy pivot, outperforming other equity segments which also benefited, albeit to a lesser extent. If there's a meaningful shift in rate policy, it’s likely to favor companies that previously didn’t benefit from lower capital costs—potentially triggering a rotation into undervalued areas that have been heavily discounted. That said, a broad-based rate cut should provide support across the equity spectrum.
SECTOR ANALYSIS
Energy had a standout week, an unusual bright spot for the sector overall. Real Estate clearly benefited from the Fed’s policy shift and could continue to see relief, provided the bond market doesn’t exert pressure on the USD via the long end of the yield curve. Tech and Communication Services underperformed this week, but their long-term outlook remains solid. Financials also gained from the policy pivot, and Consumer Discretionary should see some easing as well, especially if rate expectations continue to soften.
SPY/QQQ NET OPTIONS SENTIMENT
SPY NOS clearly still structurally bearish despite the shift on Friday in Fed policy, more so the market is anticipating it as a 1-time shift and not really changing broader market sentiment and momentum going forward.
QQQ net open interest remains bearish, reflecting continued caution among market participants. Fundamentally, not much has changed, growth stocks are still facing headwinds from elevated valuations, margin pressures, and a lack of near-term earnings catalysts. However, the recent shift in Fed policy could act as a momentum catalyst, potentially sparking renewed interest in rate-sensitive sectors like tech.
PORTFOLIO STRATEGY
With both QQQ NOS and SPY NOS in bearish territory despite the positive macro shift, we’re keeping a market neutral positioning this week with appropriate attention to diversity across cap spaces and sectors with a slight overweighting in some key sectors that have had positive momentum. And as we discussed, we are managing downside risk on the longs by steering towards value. You will notice our picks this week are steering away from stocks near their 52 week high. It is one of the primary reasons we dropped META after having it in our portfolio for 82 days. 8 longs, 8 shorts.
Long / Bull Moves
Long / Bull Moves – TSLA add / CRWV, LULU, UNH, CHTR, NVO, LEU and LITE holds / META, BABA and PLTR drops
Adds
TSLA was added with its perfect Upside Breakout score and good Tech Flow and Net Options. The latter especially is trending quite positively.
Holds
LULU was kept as a well-rounded Consumer Cyclical pick. UNH was kept for its near perfect Tech Flow and good Net Options. CHTR was kept for its great earnings power. NVO was also another Healthcare pick that we wanted to keep for its good Tech Flow. LEU and LITE were both holds for their Net Options and Upside Breakout scores.
Drops
META was dropped as we wanted to limited our Communication Services exposure as well as our exposure to stocks near 52 week highs.. BABA was dropped as we found better risk reward in Consumer Cyclical elsewhere. PLTR was dropped as it didn’t have strong screener performance for its market cap.
Short / Bear Moves
Short / Bear Moves – INVA, HQY, FYBR and QSR adds / IHRT, IRBT, ON and DELL holds / SLDP, AGO, TEL and SLVM drops
Adds
INVA was added with favorable Net Options for a short. HQY was added for Healthcare exposure with <10 Tech Flow. FYBR was added as a Communication Services counterbalance. QSR was a good short as a large cap Consumer Cyclical name that we needed to balance out our exposure on the long side.
Holds
IHRT and IRBT were kept for their poor earnings power. ON and DELL were kept for large cap Tech exposure.
Drops
SLDP, AGO, TEL and SLVM were all dropped as they performed poorly in our screener.
Portfolio Summary
Long / Bull Moves – TSLA add / CRWV, LULU, UNH, CHTR, NVO, LEU and LITE holds / META, BABA and PLTR drops
Short / Bear Moves – INVA, HQY, FYBR and QSR adds / IHRT, IRBT, ON and DELL holds / SLDP, AGO, TEL and SLVM drops
8 Longs: TSLA, CRWV, LULU, UNH, CHTR, NVO, LEU and LITE
8 Shorts: INVA, HQY, FYBR, QSR, IHRT, IRBT, ON and DELL
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