Painful for Stocks, Great for Crypto

By Michael Salvatore, Editor, TradeSmith Daily

In This Digest:

Three types of pressure bearing down on stocks…
This big semiconductor stock almost always falls in August…
How far can crypto run in the next three months?
Why a tripling from here is not out of the question…
It’s not too late to take profits, but we’re getting close…

My gut tells me you want to turn bearish right about now…

I didn’t mince words last week on my big bear call. And I won’t mince them now.

The data continues supporting the view that the next two months will be painful for those buying stocks at these levels.

We see it in the seasonals, the momentum, and even in those intangible signs of exuberance that we tend to see around local tops.

Let’s quickly go over the most pressing signs. Chief of these is the seasonality chart of the S&P 500 – the most important market benchmark in the world.

This dataset covers the last 15 years. Based on the average price action of these years, we can see the S&P 500 peaked around July 22, chopped around until July 29 – forming a lower high – and then spent the next two months heading lower with some counter-trend rallies in between:

On average, the S&P 500 lost -1.8% of its value during this period. On down years, it lost about -4.1%.

In the next chart, we can see that this period has seen some pretty significant drawdowns in the past. Even 2023, the year that started the current bull market, saw a drawdown of more than 5%.

As always, we need to couch this in the fact that this isn’t enough to make a rock-solid forecast. Seasonality just gives you a little piece of evidence to work with.

Another piece of evidence is the state of market momentum. Take a look at this chart of the S&P 500 along with its Relative Strength Index (RSI). The S&P 500’s climb to new highs throughout July came about amid a period of slowing momentum (purple shading below):

This series of lower highs on the daily Relative Strength Index – along with a cross below its 14-day moving average – could be seen as a warning… or just a simple cooling off period after the huge upside momentum of the past two months.

Either way, the odds seem stacked against continued upside momentum at least in the short term.

Then we can get into the sort of strange market stories that tell my gut to keep taking profits.

One is the mini meme stock mania we saw on Tuesday. Kohl’s (KSS) became the target of a short squeeze which took the struggling clothing retailer nearly 100% higher from the previous session before giving a big chunk of those gains back.

This kind of rampant speculation isn’t the kind of thing you see in healthy markets. It’s what you see when latecomers start chasing what can in a brief moment look like a quick payday.

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So, assuming stocks have found their highest level for the next couple months…

What then?

Well, one thing we can do is use seasonality to target stocks with general weak periods coming up.

TradeSmith’s software makes this pretty easy. We can set up a screener to look for stocks with a track record of falling more than 80% of the time, for average losses of -5% or more, with these periods starting in the next 30 days.

That filters the thousands of stocks we track down to just eight from across large and mid-cap areas of the market:

At the top of this list is Lam Research (LRCX), which has a pronounced bearish seasonality period coming up. For all but two of the last 15 years, LRCX has traded down for an average loss of nearly -6% from July 31 to Aug. 25:

And the chart below shows us that four of those years saw drawdowns of worse than 10%:

Think about what you could do with this information:

If you’ve been eyeing LRCX as a semiconductor play, you could wait out the bearish seasonality period before you buy.
If you already own the stock, you could sell short-dated covered calls against it throughout August.
And if you just want to speculate on the stock’s direction, you could trade put options to profit as the stock falls.

Of course, if you subscribe to TradeSmith’s services you can explore all the other bearish seasonality plays I highlighted above. (Click this link to access those screener settings directly.)

If not, we’re opening the doors for our seasonality service, Trade Cycles, specifically because our CEO Keith Kaplan wants this tool in as many of our readers’ hands as possible BEFORE the big market turning point that’s coming. Click here to watch the replay of his free webinar to see what he has in mind.

Meanwhile, the speculative side of the crypto trade is going full bore…

Check out these two charts of the level of bitcoin market cap dominance (above, BTC.D), and the relative performance of #2 coin by market cap Ethereum (ETH/USD) against bitcoin:

At the exact same time bitcoin dominance broke down from a long-term bullish channel, ETH has broken above a long-term bearish channel.

This moment represents the start of the more speculative, frothy era of the crypto cycle. Ethereum, in the simplest terms, is a kind of machine for people to create other altcoins. So, when we start to see it outperform bitcoin, we know that the risk appetite in the crypto sphere is growing exponentially.

But just how high can the crypto market run?

In past issues, we’ve established a timeframe of about six more months before we see the top of this post-halving cycle for bitcoin, after which we’ll see another yearslong bear market.

Now that altcoins are finally starting to wake up, it’s time to start thinking about where the entire market could land.

And I have an idea that may seem audacious but could well be where we wind up... and very soon.

Let’s look at a chart of the total market cap of all cryptocurrencies in logarithmic scale:

A logarithmic scale is useful for things like new technology, which experiences exponential growth. It smooths out the price action over time to show a more linear progression.

The red lines in the chart above are the previous bitcoin halving dates, while the yellow lines connect the highs and lows of previous cycles.

As we can see, in both the 2016 and 2020 cycles, the total crypto market topped out exactly 77 weeks after the halving. That’s different from the cycle lengthening dynamic we’ve observed in the price of bitcoin.

If that were to happen this time, we could expect the entire crypto market to top out in late October of this year. Again, this conflicts with the pattern of bitcoin price cycles lengthening and reinforces the idea of bitcoin’s relative strength and longevity compared to the rest of the market.

However, the appreciation of alts during the next few months could be monumental. In the 2017 bull market, the entire crypto market cap gained $684 billion from the halving to the peak – a rise of 1,664%. In the 2021 bull market, it gained $2.7 trillion, or 1,521% growth.

As it stands today, the crypto market cap is at $3.9 trillion. And if it’s going to revisit that top resistance line again, it would more than triple to $9.4 trillion by October.

Am I saying we’re going to see exactly this? No, and I’m also not saying we won’t.

But once you realize that the S&P 500 has gained about $5 trillion in value since March, it starts to not seem so impossible that crypto will see a similar multi-trillion-dollar influx during its most rabid period.

Suffice to say, the time to buy altcoins is right now. Ethereum should be at the top of the list, along with other coins in breakouts like Ripple (XRP/USD), Solana (SOL/USD), Chainlink (LINK/USD), and others that have stood the test of time.

How about seasonality in crypto?

Well, normally to give you a proper analysis we want at least 15 years of history. None of those have that. You’ve also got to factor in those bitcoin halvings every four-ish years that are essentially tectonic events for all of crypto.

However, as Andy Swan argued in Sunday’s Daily, the best “proxy” stock is, in fact... Tesla (TSLA).

That’s a ticker we can work with. In its 15-year history, TSLA has been choppy through the stock market’s seasonally sketchy period in August – then has had a nice pop in September.

TSLA looks especially strong as October turns to November and December, with 11% average returns followed closely by 7.7% returns:

In fact, plenty of other big-name stocks start looking like great buys around that time.

Another interesting idea might be something like Block (XYZ). This is a big payments processing company, responsible for the Square point-of-sale terminals and its popular Cash App. It got a big boost recently for joining the S&P 500 after Hess got acquired by Chevron (CVX).

The company also happens to hold quite a bit of bitcoin on its balance sheet, with 8,584 bitcoin at last filing.

This would be one of the larger so-called “bitcoin treasuries” for a company that isn’t either:

A bitcoin miner,
A company directly involved in crypto, or
A company whose entire business model is buying bitcoin.

XYZ is right about at its seasonal peak for the year… that is, until November, where we might expect bitcoin to top out:

From Oct. 24 to Dec. 3, XYZ has gone up in 89% in its last 10 years as a public company, for an average return of 14.4% during this span.

But from now until then, the stock has historically floundered sideways, losing -1.5% and being down more than half the time.

If you wanted to trade XYZ, you might want to hold off until mid-October when it tends to see this big surge.

Keith talked all about seasonal patterns in his webinar yesterday – and even shared a strategy you can use in the meantime to exploit the summer volatility for quick profits.

Painful for Stocks, Great for Crypto