Markets Are Becoming Far Less Forgiving

Editor’s Note: Tonight, our colleague Jeff Brown is diving into the details of the current state of the biotech industry, including the historic convergence happening in the sector… and how, after four years of biotech winter, the “golden age of biotech” is here.

It’s a long-awaited shift after years of rising interest rates, weak investor sentiment, and limited access to capital.

And Jeff has just the strategy to play this golden age. He’s kicking things off at 8 p.m. ET tonight. You. Can go here to add your name to Jeff’s guest list with one click.

For much of the past two years, it felt as though the market could do no wrong.

Every dip was bought. Every pullback was brief. And seemingly every company that mentioned artificial intelligence (AI) was rewarded with a higher share price.

It became a momentum-driven market…

Investors weren’t just buying businesses with strong growth. They were buying whatever had been going up. And in many cases, that momentum became self-fulfilling. Rising prices attracted more buyers, which pushed prices even higher.

But over the past month or so, I’ve noticed something changing. The market is becoming far less forgiving. Investors are no longer willing to pay any price simply because a company has an AI story to tell.

And if folks ignore this subtle shift, they risk being left holding the market’s most expensive stocks just as fundamentals begin to matter again.

Because the one thing I know from over four decades in the markets is that the wheel always turns…

Market Cycles

Whether it was the dot-com boom, the housing bubble, cryptocurrencies, or today’s AI revolution, the pattern is remarkably similar…

In the early stages of a major investment theme, almost everything moves higher together. Investors become increasingly confident, capital floods into the sector, and valuations continue to soar. The cycle feeds on itself as everyone scrambles to get on board.

But eventually, investors become more selective…

At first, investors simply want to know if a company is involved with AI. But later, they want to know if it’s actually making money from it – and whether those profits can justify its lofty valuation.

And if not, then all that easy money starts disappearing.

For now, it doesn’t necessarily mean the broader bull market is over. Nor does it mean that AI won’t transform the economy over the coming decades.

But what it does mean is that investors will need to become more discerning.

Another reason I’m paying attention to this shift is what it means for market volatility…

When Momentum Stalls

One of the major characteristics of the rally has been the dominance of momentum-based trading. Many algo strategies are designed to buy into strength and add to winning positions as trends develop.

That creates a powerful feedback loop during rising markets, which helps keep pullbacks shallow and makes recoveries remarkably quick.

But momentum works both ways…

If enough leading stocks begin losing their upward trend, those same strategies can quickly become sellers. And instead of reinforcing the rally, they begin reinforcing the decline.

That’s often when volatility returns much faster than investors expect. And for option traders, that’s particularly important.

Periods of extremely low volatility can make it difficult to find trades with attractive risk-reward characteristics. Premiums become compressed, forcing you either to accept less reward or take more risk than you’d ideally like.

Neither is a viable nor a sustainable way to trade. Eventually, the odds will catch up with you.

But if volatility begins returning as momentum weakens, option premiums should steadily increase and become more attractive again.

That creates the kind of opportunities we’ve been patiently waiting for. It’s about waiting for the odds to swing back in your favor.

After such an extended period of low volatility, the good news is that those odds may finally be improving. And that’s going to set up an interesting – and potentially very lucrative – second half of the year.

Regards,

Larry Benedict
Editor, Trading With Larry Benedict