OVERVIEW
Extended Market: Defense Stocks Leading

Good morning, Traders.

The market has been on an absolute tear for the last several weeks, especially with speculative small and midcaps. We've seen a major rotation from safer mega and large cap stocks like Nvidia, Facebook, and Google into more interest rate-sensitive and speculative growth stocks like Root. If you check our reports from two weeks ago, we've been outlining how we started positioning ourselves in several of these speculative growth names.

The reason for this surge in small and midcaps is that traders are betting on a nearly 93% chance of the Federal Reserve cutting interest rates in September. Because of this, institutional investors are selling off the big tech winners of the market rally and shifting towards rate-sensitive stocks like small caps and industrials, which are likely to benefit from lower rates.

This is all great if you were quick enough and sharp enough a week or two ago to actually buy up the stocks that made the big moves. However, if you missed it and you’re currently looking for entries, you’re out of luck.

What does this mean?

If you look at the brief sector analysis provided by Finviz, you’ll see that the leading sectors last week that actually made progress are all defensive: energy and financials. The same can be said for the last month, with tech seeing a massive beatdown while the more defensive sectors led.

This doesn’t mean there weren’t good opportunities in the last month. Root, for example, is an explosive small cap stock in the financial sector that is up almost 100% in the last month. However, it does mean that as of today, the vast majority of growth stocks, which tend to be housed in the technology sector due to tech’s highest growth potential, are in a clear cooling-off period, and you should look elsewhere for potential entries.

That said, there are not too many opportunities in general, given the small and midcaps are pulling back and absorbing their monstrous moves. Meanwhile, the large caps are seeing profit-taking as money cycles away from the S&P 500 and Nasdaq and into the Russell 2000 and S&P 400 Midcaps.

Let’s analyze this further.

Nasdaq

The Nasdaq experienced a significant high-volume sell-off after gapping below its daily 10-EMA last Tuesday. Since then, it has dropped below its daily 20-EMA and Point Of Control (POC) at $479, and is now just barely clinging to the rising daily 50-EMA, which is acting as support.

We expected and even welcome this Nasdaq sell-off. Throughout the year, the only real group making moves higher has been large and mega-cap tech (which the QQQ represents). This aggressive selling in the Nasdaq has been redirected into more speculative areas of the equities market, such as small and midcaps (represented by IWM and MDY).

Here's an important point that might not be on everyone's radar: money rotating from large to small or midcaps is bullish and good to see. However, if we saw money being rotated out of the Nasdaq and IWM and MDY were also underperforming or beaten down, this would indicate that money is being taken out of the stock market entirely. This would suggest that big institutional money is bearish on the stock market and reallocating to a different asset class. Fortunately, we aren’t seeing this, which is why we are happy to see this rotation.

S&P Midcap 400

The midcaps have experienced a three-session sell-off following their massive rally, which broke them out of their multi-month volatility contraction pattern (VCP) that we were eagerly anticipating.

Don't be too worried about these last few red days; it's normal to see the MDY revert back to its mean and hover around its daily 10-EMA, which has so far acted as support.

We expect to see the midcaps trade sideways in the immediate short term and find demand at the $550 level, a significant supply/demand zone that coincides with the daily 10-EMA. If we see $548 lost today on heavy volume, this would be concerning and would make us reconsider the medium-term future of the MDY.

Russell 2000

The small caps are not only at a multi-month high but have reached a multi-year high, with the IWM trading at levels last seen in early January 2022. We are very bullish on small caps in the medium to long term. However, in the immediate short term, similar to the midcaps, we expect and want to see some sideways consolidation around the daily 10-EMA. This will allow buyers and sellers to adapt to the new IWM share price, digest this historic breakout, and form a secondary VCP, setting the stage for even higher prices.

DAILY FOCUS
Patience Pays: Don’t Overtrade

Most of the high-quality stocks and setups have already moved, as the best time to buy long positions in these types of breakouts is before the corresponding indices break higher. These setups are now either breaking below their 10-EMAs, ending their runs, or the A+ stocks are simply too extended to offer viable entries.

We don’t see any real opportunities today, so we recommend exercising some patience today and likely tomorrow as the extended names cool off and start to form secondary volatility contraction patterns (VCPs) that could allow for low-risk entries.

Remember, we don’t make money by constantly buying and selling stocks. We make money by buying at the right time and riding the momentum- quality over quantity.

WATCHLIST
The Diamond In The Rough

SLQT: SelectQuote, Inc

• SLQT is an insurance growth stock we’ve been keeping a close eye on and already have a long position in, following its breakout on July 1st.

• We’re impressed with SLQT’s fundamentals and technicals, and its sector remains resilient against broader market pullbacks.

• Currently, SLQT is forming a secondary flag pattern as it consolidates above its daily 10-EMA after its recent big move. We’ll be closely monitoring SLQT as it ideally tightens up from here.

• Given that we already hold a long position in SLQT, if the stock breaks below its daily 10-EMA and closes weakly today, we’ll consider offloading half our position. A full exit would be triggered if the stock closes below the daily 20-EMA.