My mother almost never calls me during the week. So when she called the other night and asked, “Have you moved to higher ground?”, I figured something was wrong.
Turns out we were under a tsunami alert down here on the island, and the warning system never went off.
By the time anyone reached me, they had already canceled it. The flood everybody braced for never came.
I think about markets the same way, and right now is a perfect example.
We have had some violent tape lately.
Today’s session reversed something like 900 points in the Nasdaq inside a half hour, and the headlines screamed that the sky was falling.
Traders watched a few of the giants get hit and assumed the crash had arrived. It had not. And knowing the difference is the whole game.
Here is what those people are missing.
A falling index and a selling market are not the same thing, and you tell them apart with one tool: correlation.
When a market truly sells off, everything goes down together. The strong names, the weak names, the sectors that have nothing to do with each other, all of it correlates and heads for the exit at once. That is real selling.
That is fear with nowhere to hide.
What we have been getting instead is rotation.
Money pulls out of a few enormous tech names, the monsters of tech, and piles into the smaller ones, or into financials, or into the stuff that had been left for dead.
The index drops because a couple of trillion-dollar companies are heavy. Underneath it, the advance-decline line stays green, because most stocks are actually fine. That is not money leaving the market. That is money moving around inside it.
You want to know the tell?
Look at the advance-decline line when the index is ugly. If it is still decisively positive while the headline number is bleeding, you are watching dislocation, not destruction.
There are dozens of names in there that have not been sold at all.
This matters because of what it tells you about risk. As long as capital is rotating, the market can absorb the hit.
The selling has not actually begun. The day you need to worry is the day the rotation stops and everything starts going down together, because the only thing that ends a rotation this violent is a genuine shock to the system.
Until that shows up, what looks like a crash is mostly portfolio managers shoving money from one pocket to another.
So when you see a brutal-looking tape and your gut says get out, do the unglamorous thing first.
Check whether the selling is correlated or whether it is just the giants taking a hit while everything else holds.
Most of the time, it is the second one. Most of the time, the tsunami gets canceled before it reaches the beach.
That is not a reason to be cavalier.
When the real selling comes, it will come with correlation and it will come fast.
Your job is to know which one you are looking at, so you do not run for higher ground over a wave that was never going to hit, and so you are not standing on the sand when one finally does.
To your success,
Don Kaufman
P.S. This is exactly the kind of read we work through live every morning, the difference between a tape that looks scary and one that actually is. If you have ever sold the bottom of a rotation because the headline number frightened you, come spend a session with us. Join me at Don DTE.
