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I’ve been warning folks that we’re in a market bubble for a couple of months. Now cracks in the five-month rally are starting to appear.

(Yesterday, I shared some signals that could trigger a pullback.)

I’ve remained deeply concerned about the market’s unsustainable levels, so I’ve kept my trades thin on the ground. And the reason for that is simple…

There’s no point standing in front of a relentless wave of buyers that keep pushing stocks ever higher. Their enthusiasm has reached even higher levels now that a rate cut is on the table when the Federal Reserve meets next month.

All the same, I haven’t been sitting idle. I’m looking for clues on what could trigger a downturn…

The Trading Trap

It can be difficult to sit on the sidelines. But patience separates the pros from everyone else.

Take bear markets. The easiest trap to fall into is buying a stock just because it’s irresistibly “cheap.” After all, it could be cheaper the next day… and the day after that. There’s a reason they call it “catching a falling knife.” It often ends badly.

It’s the same when stocks are caught up in a relentless rally – just as we’re witnessing now. In this case, we have to avoid the temptation to short a stock just because we think it’s trading at absurd levels. Stocks can surprise to the upside even when it doesn’t make sense…

Nvidia (NVDA) fell to $86 in April before sailing right up through $130, $140, $150, and all the way past $180. Those who shorted the stock at any of these levels watched their money go up in smoke.

Anyone who traded against Palantir’s (PLTR) relentless rally experienced the same. PLTR more than tripled from its January low.

We might be “right” that stocks are dangerously overbought. But the market usually needs a catalyst to set off a reversal.

And I’ve been busy scouting for catalysts as this bubble keeps growing out of control…

The Fed Is Under Pressure

The single biggest takeaway from the meeting in Jackson Hole is that the Federal Reserve finally caved to the White House. The Fed now expects a rate cut when it meets next month.

That comes despite signs of producer inflation jumping dramatically earlier this month. That’s typically a precursor to consumer inflation also ratcheting higher.

But while Jerome Powell has put a rate cut on the table, the market is unsure about how big that cut will be…

If the market starts factoring in a 0.5% cut (which is now possibly in the cards), we could see a sell-off if the Fed goes with a lesser 0.25% cut. Or an even bigger down move could be in store if the Fed abandons its rate cut plans, however unlikely.

Remember, there’s almost a month until the Fed makes its decision… and there’s plenty of economic data coming down the pipe.

The next core Personal Consumption Expenditures (PCE) data is due out on Friday. And another Consumer Price Index (CPI) reading comes just under two weeks after that. Plus, there’s a range of jobs data as well.

Additionally, NVDA is due to announce earnings on August 27. As a major driver of the rally and the world’s largest stock, those earnings carry enormous weight.

A minor earnings miss and/or a softish outlook statement could lead buyers to flick the switch to selling mode.

Just as NVDA was the engine room of the market’s huge rally, it could also be the catalyst that brings it down…

Regards,

Larry Benedict
Editor, Trading With Larry Benedict