What does it mean when you hear, “Overhead Supply”? How does that help anyone?
The market is a beautiful thing. It’s driven by supply and demand dynamics, or buyers and sellers, based on reasons that we don’t need to know. I’ve noticed that the majority of market participants like to worry about the “why?“. We choose to worry about the “Where, When and For How Long?“. It seems like a much better use of our time, particularly if our only goal is to make money. We’re not interested in writing gossip columns.
For me, overhead supply is when there are an overwhelming amount of sellers relative to the amount of buyers around a certain price. Sometimes you get the smartass in the room that says, “Well JC for every buyer there must be a seller”. Yes, dummy, but there aren’t an equivalent amount of willing buyers and sellers and every price. That’s why stocks move.
The idea behind overhead supply is that it takes time for demand to absorb it before prices are able to move higher. For example, there was an overwhelming amount of supply relative to demand in the S&P500 in early 2018 just below 2900. We know that because when prices got there, they sold off. There were more willing sellers than buyers there, for a fact, not my opinion.
When prices returned to that area in September, prices broke above it, temporarily, before failing and selling off again. This failed breakout was accompanied by deteriorating breadth and momentum. Only a fraction of stocks were making new highs and only a fraction were showing positive momentum characteristics compared to the prior highs earlier last year. This break confirmed those divergences when prices failed, suggesting to us that no, demand had not yet finished absorbing that overhead supply:
Here we are back again, knocking on the door for the 3rd time. Will we finally break out? Or is this going to be another failure?
For me, I think it’s likely to continue to be a mess. We have mixed signals from what actually makes up this market – the stocks themselves.
First the good news, Technology and Semiconductors are already trying to make new all-time highs. Think about it, in order for the entire group to break out, it needs to start with one. Here is Tech back up to its 2018 highs:
Here are Semi’s already making new all-time highs. Can they hold and lead? Or will they fail? More on that in a minute.
Consumer Discretionary is testing those highs as well. If “this is it”, then I would expect Tech and Discretionary to lead the way higher. If “this is not it”, then expect these to fail up here. These are the leadership groups, without question.
When we look at the rest of the biggest sectors in America, they Don’t look like these above. They are not testing and/or breaking out above former highs. In fact, they’re no where near last year’s highs. Look at Financials:
Industrials are still well below those highs:
Energy is the worst of all of them:
We take a weight of the evidence approach. We also try and focus more on individual stocks themselves than the overall market. While it’s important to put things into context, there have been, and continue to be, opportunities at the individual stock level. If you don’t like banks, don’t buy banks. If you like Tech, buy Tech, sort of mentality.
So what’s the risk here? For me the biggest risk is all out failure up here from the leaders. If we see Semi’s start to fall back below the March 2018 highs, and even worse fall below 1430, things can really get hairy for the overall market.
I think that the lack of participation by most of the market sets up this risk factor that we need to take into account. We do not want to be aggressively long in that scenario. That would create a similar sort of setup as what we saw in early October. Maybe not to such an extreme, but downside risk nonetheless.
It’s messy out there. I think there are good setups where the risk is very well-defined and the reward is exponentially greater. That’s all we can really ask for. There are good charts and bad ones short-term. But there are huge bases everywhere long-term that we should not forget about.
So to answer the first question about the S&P500 – Is this a new breakout or just another failure? How about neither? I think we likely keep chopping around a bit in the indexes, presenting more opportunities at the individual stock level. How about that? Is that a cop-out answer? Maybe, but that’s how I feel.