Sucker's Rally?

Brit Ryle

Posted May 24, 2023

I guess it’s not a huge surprise that stocks have been trading a bit lower this week. It should never be surprising to see stocks sell off some after they make a nice move higher, like what we saw last week. 

But as I  write, the S&P 500 has now given back all of last week’s “breakout” gains. And the fact that the S&P 500 rally failed right where rallies in February and April failed seems a little ominous. 

So let’s get right to the point and ask the question: was last week’s move higher a sucker’s rally? 

To answer, let’s start at the beginning of last week’s rally…

We looked at the pennant formation that had formed on the S&P 500 chart last Monday, May 15. You can check out my analysis here. But the basic point was that the S&P 500 would make a pretty strong move when it broke out of that pennant formation. The only problem is that you can’t be sure which way an index or stock will break out of a pennant until it actually does…

So the May 15 low for the S&P 500 was 4,110. By Friday, the index had broken higher and was challenging the year to date highs at 4,200. Here’s the chart we looked at Friday: 


Source: Yahoo Finance

We came into this week with a little enthusiasm that our elected leaders might actually be able to do their jobs and spare us all the worst of the debt ceiling drama. But of course, dingbats will be dingbats – there has been no progress on the debt ceiling, and the S&P 500 has given up all the gains from last week. 

It’s tempting to say that the failure to hold recent highs and the subsequent weakness we are seeing this week is solely because the debt limit debate is dragging on and on…

Frankly I think that’s pretty accurate. And sadly, the longer the dysfunction persists, the more vulnerable the market will be to further downside. 

I know – that’s not exactly earth shattering analysis, right? 

Well, hang on, I might have something a little more helpful for you…

Mob Mentality

Now, I use “top down” analysis to help inform my investing and trading decisions. We’ve probably all heard the phrase “a rising tide lifts all boats.” And we usually understand this to mean that when the tide for the S&P 500 is moving higher, then it’s a pretty good bet that most stocks will move higher, too. 

But sometimes it’s easy to lose sight of the fact that the stock market is really a market of stocks. That is to say – it is the collective price action of groups of stocks that determine at what level the major indexes are trading. 

So we could look at the recent action for the S&P 500, and think “yep, sucker’s rally.” Or we could look at the action of individual stocks that are growing their businesses in spite of what’s driving the headlines. 

Like Palo Alto Networks (NASDAQ: PANW). Palo Alto is the big dog in the cybersecurity space. I first recommended the stock back in 2017, around $50 a share (adjusted for splits). Well, last night, Palo Alto reported yet another blockbuster quarter, and the stock is up 7% to $203 today. And it’s only $5 away from a new all time high. Inflation, interest rates and the debt ceiling don’t seem to be affecting Palo Alto very much…

Microsoft (NASDAQ: MSFT) made a new 52-week high at $321 a share on Friday. The company is executing its artificial intelligence (AI) strategy very well. Sure, the stock is trading around $314 today. But do you really think investors are rethinking their decision to buy into one of the top AI plays because of the debt ceiling?

Same goes for one of the other hot AI stocks, Nvidia (NASDAQ:NVDA). It ran 9% last week to a new 52-week high at $316. It’s pulled back to $300. And given that forward P/E of 63, I can see why people might be a little nervous ahead of its earnings report that’s due after the bell. I have a pretty hard and fast rule about trading into an earnings report – the range of outcomes are wide and difficult to predict. But I bet ya that buyers step in pretty quick if Nvidia shares do indeed drop after earnings. 

Now I get it. AI stocks have done well this year. But what we’ve seen so far is just the beginning. The best AI stocks (like Microsoft and Nvidia) will absolutely trade all time highs over the next few months. 

And the gains for the smaller AI stocks I’ve discussed here will be even better. 

Did you see what Schrodinger (NASDAQ: SDGR) did on Monday? It was a down day for the S&P 500. But after rallying 10% to $33 on Friday, shares of Schrodinger jumped another 18% to $38.95. Somehow  I don’t think the pullback to $37 means that rally was for suckers… (NASDAQ: AI) is up 10% since Friday’s close. Lemonade (NASDAQ: LMND) might be down almost 7% today. But it’s still $1, or 6%, higher than it was when the S&P 500 was topping out on Friday. 

Fisker (NASDAQ: FSR) and Rivian (NASDAQ: RIVN) are both higher today, too.

Oh and if you jumped on Canadian Solar (NASDAQ: CSIQ) call options on Monday as I suggested, you’re up around 50%. 

So no, I don’t think we can call last week a sucker’s rally. At least not for those of us that buy/trade stocks whose businesses and stock prices have some momentum that doesn’t depend on the day’s headlines.  

That’s it for me today. Take care, and I’ll talk to you tomorrow. And if you have anything you want to discuss, drop me an email: 

Briton Ryle
Chief Investment Strategist
Pro Trader Today