OVERVIEW
Money Continues To Rotate Out Of Equities

The U.S. equities market has closed out 2024 on a disappointing note, leaving the seasonal rally we usually expect from December to January nowhere in sight. It’s a sharp contrast to what was otherwise a remarkably strong year for stocks, driven by a relentless surge in artificial intelligence trades and the dominance of the "Magnificent Seven." This momentum even spread to other areas of the market as the bull run gained broader participation.

However, the past two weeks have taken a turn, with investors locking in profits from some of the year’s top performers. Concerns over rising interest rates have also weighed heavily, dashing the hopes for a euphoric combination of a Trump presidency and the prospect of easing monetary policy—conditions that typically fuel asset price growth.

Understanding Market Rotation

Market rotation typically refers to the shifting of capital between asset classes or sectors, driven by changing economic conditions or investor sentiment. Right now, we’re seeing a major rotation out of equities and into bonds, driven by rising bond yields, particularly in the US 10-Year Treasury (US10Y), which is holding above 4.5%. As yields rise, investors move away from riskier assets like stocks and seek the stability that bonds offer, especially in times of uncertainty.

This market rotation is very different from a typical rotation within equities, where money flows from one sector to another based on seasonal trends or economic conditions. For example, during periods like November and December, money often flows into consumer cyclical stocks as consumer spending picks up ahead of Black Friday and the holiday season. In this scenario, specific sectors benefit from rising demand, and we see a clear shift in capital within equities. However, right now, we are witnessing a rotation from equities to bonds, which signals a more cautious, risk-off environment where investors are seeking safer, more stable returns.

For us swing traders, this is a challenging situation. In a typical sector rotation, we can position ourselves to capitalize on the growth in specific sectors like consumer discretionary or tech as money flows in. But in the current rotation driven by rising bond yields, equities as a whole are facing pressure, and the usual momentum-driven trades we rely on become harder to execute. Stock prices are less likely to exhibit the strong, sustained moves that we need to find profitable setups. The usual "buy the dip" or "ride the trend" strategies become less effective when the broader market is dominated by a rotation out of equities and into bonds.

Nasdaq

The Nasdaq is reflecting the prevailing weakness in the market, with a second failure on Tuesday to attract any demand near the declining 10- and 20-day EMAs, which once again acted as resistance. The QQQ, typically one of the strongest indices in the US equities market, is now testing its 50-day EMA for the third time during this sell-off, which coincides with the Point of Control (POC).

It cannot be overstated how critical it is for the market’s overall health that the QQQ holds this POC and 50-EMA level. A failure to do so could significantly increase the risk of the broader market entering a deeper correction.

There’s potential for a bounce here, possibly setting up a double-bottom formation, which would be the most bullish and attractive scenario. However, given the intensity of the selling pressure and the widespread deterioration across sectors, we can’t rely on this outcome.

Attempting to time any bounce at this stage could be costly, as the market remains fragile and unpredictable. Patience is key—waiting for confirmation of a reversal is a more prudent approach than trying to jump the gun on an uncertain recovery.

S&P Midcap 400

The midcaps faced their own rejection as they attempted to inch closer to the declining 10-day EMA once again. The MDY has continued to chop sideways around its Point of Control (POC) at $570, with very little action from buyers.

We’re starting to see a sideways range develop, which is the first step toward a potential reversal. However, there’s still a lot of work to be done before we can feel comfortable entering. While the range-bound action is a positive sign, patience is required as we wait for clearer indications that a move higher is on the horizon.

Russell 2000

The small caps are in a similar position, having faced rejection at the declining 10-day EMA. Like the midcaps, the Russell 2000 is barely holding onto its POC level, which is the only thing preventing it from making a sharp move toward the rising 200-day EMA. If this support level fails, we could see a deeper pullback, but for now, the POC is acting as the key line in the sand.

DAILY FOCUS
Too Early To Long, Too Late To Short

We’re currently seeing bear flags forming on all three major indices we’ve evaluated, which emphasizes the importance of understanding price cycles and market structure at this juncture. According to Wyckoff's principles, we could be witnessing the tail end of a buying climax, where the market has reached its peak, followed by a failure to sustain strength and demand at higher levels. This is often characterized by a low-volume rally that fails to attract enough buying interest to sustain upward momentum. As a result, the market appears to be weakening, and the potential for further downside is growing.

In Wyckoff terms, what we’re observing could be the final stages of distribution, where smart money is unloading positions as prices rise, anticipating an upcoming correction. The failure of the market to push higher with conviction signals that the demand needed for a recovery is simply not there. Importantly, we have not yet seen a selling climax—this is a critical point. A selling climax typically occurs at the end of a downtrend, where there’s a sharp and heavy volume sell-off that signals exhaustion of the sellers and sets the stage for a potential reversal. As of now, we have not seen that type of sharp, high-volume selling. Without this, it suggests that the current decline could have further room to run before any meaningful recovery takes place.

However, if we start to see more consolidation at these levels, with the failure to make lower lows and the daily 10-EMA across the indices no longer declining, this would signal a potential shift. If the 10-EMA is overtaken and sectors and relative strength-leading stocks stop breaking down, instead starting to tighten up and break out, that would be a clear indication of a change in market structure. At that point, it could be time to shift from a cautious stance to a more active one, but until then, it’s hands off. The market will need to show us confirmation that the selling pressure has exhausted itself before we can begin looking for opportunities again.

WATCHLIST
The Relative Strength Leaders

AMBA: Ambarella, Inc.

• AMBA has continued to be one of the stronger names in the market and in the semiconductor space, with a multi-week long bull flag forming on the daily chart.

• The characteristic higher lows and lower highs indicate a contraction in volatility, alongside a drying up of volume, while still holding its daily 10 and 20 EMAs and failing to break lower.

ERJ: Embraer S.A.

• ERJ is in the aerospace and defense sector (XAR), which has been one of the relative strength leading industry groups during this most recent sell-off. In fact, we saw FTAI in the same industry group have a major breakout on Tuesday, against all odds, dramatically outperforming the entire US equities market.

• We have seen higher lows on ERJ as it bounced on ascending support, taking out its 10, 20, and 50 EMAs in the last several sessions as it starts turning back up.