It’s never happened before. It’s totally unprecedented. A mere handful of stocks, six to be precise, are driving equity markets to higher all-time highs.

And it’s happening while COVID-19 still threatens the country and the economy, while the country’s struggling to climb out of the worst, deepest recession in history, and while 15 million of the 20 million Americans that lost their jobs since March remain unemployed.

However, none of that matters to the stocks powering markets higher, or the investors and analysts who say they’re going higher because they’ve benefited from lockdowns.

They’ll continue to benefit from paradigm shifts in how we live, work, and play.

The narratives surrounding these companies and their stocks are all one-sided; they’re all positive.

The problem with that is, that positivity has turned to irrational exuberance – or, misled over-positivity. And that’s dangerous.

Here’s how far these stocks have come, why they’re vulnerable to a selloff, and what levels to watch on all of them to know when it’s time to take profits (and maybe short equities)…

What Bear Market?

To be clear, I’m not a “bear.”

I’m still bullish on this market, precisely because these crazy-hot stocks are driving benchmark indexes higher, and that’s bringing sidelined money, into the whole market, not just into these rocket-riders.

Because as benchmark indexes go up, investors and mutual funds and ETFs that track them have to buy all the stocks in the indexes, or that underlie ETFs. That lifts indexes, which draws more attention to them making new highs, which draws in more sidelined money.

What’s most important to understand about the six stocks is that, except for the Dow Jones Industrial Average, which is price-weighted (higher-priced stocks have a bigger impact on the index), all the other indexes and most of the ETFs they’re in are capitalization-weighted.

That means as the price of those six stocks goes up, their equity capitalization (price per share times number of shares outstanding) goes up, and their impact on the much broader indexes and ETFs they’re in goes up significantly.

For example, because of the capitalization weight of the Big Five (what I call) “FAAMG” stocks – Facebook.com (NasdaqGS:FB), Apple Inc. (NasdaqGS:AAPL), Amazon.com Inc. (NasdaqGS:AMZN), Microsoft Inc. (NasdaqGS:MSFT), and Google – these five stocks account for 25% of the valuation of the entire S&P 500.

That’s five out of 500 stocks.

Any movement in any of them impacts the S&P 500, which is the most watched, followed, traded, and important stock market measure in the world.

The Bigger You Are, the Harder You Fall

For starters, the Dow Jones Industrial Average, which, as of Monday night, was less than 4% from its all-time highs. It then rose a stunning 54.11% off its March 23, 2020 lows as of the end of August and is now only 0.03% away from being positive year-to-date.

The S&P 500 rose 56.78% off its March lows and, at of the end of August, is up 8.4% in 2020.

And the Nasdaq Composite, which shot up 70.47% from its March lows, is up 31.23% this year.

All the indexes owe their gains to the FAAMG stocks and Tesla Inc. (NasdaqGS:TSLA).

Facebook powered 99.51% higher off its March 18, 2020 lows and is up 42.8% year to date as of August 31, 2020.

Apple jumped 130% off its March 23, 2020 lows and is up 75.77% as of August 31, 2020.

Amazon leapt 105.8% off its March 12, 2020 lows and is up 86.78% year to date.

Microsoft shot up 65.85% off its March lows and is up 43% year to date, as of the end of August.

Google (Alphabet Inc. (NasdaqGS:GOOGL) if you prefer) ran up 54.66% off its March 23, 2020 lows and is up 22.22% year to date.

And then there’s Tesla, the sixth bellwether stock. Tesla blasted off 589% from its March 18, 2020 lows and is up an insane 495.5% since the beginning of this year.

If that’s not irrational exuberance, nothing is.

Again, just because there’s a lot of hot air blowing these stocks up, doesn’t mean they can’t get blown up more, a lot more.

Alan Greenspan, Fed Chairman in 1996, famously described the buildup of the dot-com bubble as irrational exuberance. It took until March 2000 for the bubble to pop, which drove the Nasdaq Composite down 78% before it was all said and done.

As mentioned on Monday, in July 2007, Chuck Prince, Citigroup’s CEO at the time, famously said of the subprime mortgage buildup, “As long as the music’s playing you’ve got to get up and dance.”

The Financial Crisis, spawned by a grossly inflated bubble in mortgage and mortgage-backed securities and related products, blew up Wall Street and the country 15 months later, in spectacular fashion.

That’s when we discovered that America’s biggest banks, who were all insolvent, had to be saved.

Big doesn’t matter. The bigger you are the harder you fall. That goes for the bellwether six that are driving investors to party like it’s 1999.

What to Do Now

Enjoy them inflating, but don’t sell them. Just use trailing stops to protect your gains as the get pumped up.

And keep these “levels” in mind, meaning mark them on your graphs and on your brokerage statements. Because if these stocks break down through the proprietary levels I’ve calculated below (which are close to technical levels traders are going to be watching), that will be the ringing sound of for whom the bellwether tolls, and you don’t want it to be you.

Up, up, and away is all good. But if Facebook backtracks to $278, take some profits; if it backtracks to $258, take some more. If FB heads quickly towards $225, you better hope it stays there, otherwise it’s time to take your profits and see how low it can go before you buy back in.

If Apple backtracks to $118, take some profits; if it backtracks to $99, take some more. If AAPL heads quickly towards $88, there’s a good chance it will test support at $82. You better hope it stays there, otherwise it’s time to take your profits and see how low it can go before you buy back in.

If Amazon backtracks to $3,245, take some profits; if it backtracks to $3,085, take some more. If AMZN heads quickly towards $2,886, you better hope it stays there, because if it can’t, it’s time to take your profits and see how low it can go before you buy back in.

If Microsoft backtracks to $217, take some profits; if it backtracks to $200, take some more. If MSFT heads quickly towards $187, you better hope it stays there, otherwise it’s time to take your profits and see how low it can go before you buy back in.

If Google backtracks to $1,543, take some profits; if it backtracks to $1,462, take some more. If GOOGL heads quickly towards $1,398, you better hope it stays there, otherwise it’s time to take your profits and see how low it can go before you buy back in.

If Tesla backtracks to $400, take some profits; if it backtracks to $320, take a lot more off the table. If TSLA heads quickly towards $273, you better hope it stays there, otherwise it’s time to take your profits and see how low it can go before you buy back in.

As bellwethers, you want to be watching each of these stocks and their support levels. One or two breaking down will likely let you know there’s trouble ahead.

If they all start breaking down at the same time, just take all your profits off the table.

And we’ll jump back in when it looks ugliest.

Sincerely,

— Shah

Source: Total Wealth