Mega Cap Highs Mask Cracks Beneath the Surface

SPEAKER_1 (0:00)

Joining us, Paul Schatz, President and Chief Investment Officer over at Heritage Capital. Paul, great to talk to you on this Monday morning. I was looking back over some of our previous conversations, and you correctly anticipated the heightened risk that you called for August and or September.

Now we've got the NASDAQ up near record highs, the S&P not too far off. What is the market resilience telling you right now about where we are in this cycle?

Paul Schatz (0:26)

Good morning, always good to be with you. I think you have to be careful using that word resilient, and here's why.

NASDAQ 100 at new highs, S&P is close, we'll get there probably this week. The Russell 2000, the S&P 400 mid caps are both about 9%.

Even if they bottomed, they just went through a 9% correction and the market internals are weak. You definitely have as split a market as you've seen in several years. So this is that, the haves and the have nots. You can describe it any way you want, but look, there is some danger beneath the surface because the rising tide is not lifting all ships. I get why I'm going to all these analogies, but there is resiliency in the S&P 500 and the NASDAQ because you have the large sexy mega cap tech stocks leading the way and they dominate the indices, but beneath the surface and the average stock is down more than 20%. So again, this is not the normal healthy bull market. The bull market's older. These are part of the cracks that are going to develop and individuals can decide whether this is the golden opportunity and we're going to play catch up or there is something in the offing for Q1 of next year.

SPEAKER_1 (1:45)

So Paul, how are you looking at that then with that divergence that we have, that concerning divergence, you highlighted the average stock down about 20 percent. You mentioned the Russell 2K, the S&P 400 is down if we're looking at it standing outside of the broader group. How are you looking at that divergence?

How focused are you on this bad breath narrative right now?

Paul Schatz (2:09)

I'm looking at it gingerly and carefully and I'm trying to dance close to the door.

What you don't want to do is, you're in the fourth quarter, we're going to have tax loss selling because you have that almost every fourth quarters. You don't want to start loading up on the stuff that's corrected a lot because they're more susceptible to tax loss selling where people sell stocks to recognize the loss and perhaps buy them back in the new year. I think you have to do a lot of rentals and not a lot of long-term owns, I think you've got to take some profits off where something has melted up. We sold a little Palantir on Friday and we sold a little something else on Friday. We sold Moderna a bunch of times and I'm trying to buy stuff that's not in the basement, so we added to Schlumberger, SLB last week, Friday I think, and we added to McCormick, which is doing a deal right now. But again, I think you've got to be careful. Don't get in that value trap in Q4. The value stuff may run, but it should be later in Q4. I think you've got to surgically, tactically, thoughtfully play the momentum stocks because momentum is typically a strong factor as the bull market gets older and older and older.

SPEAKER_1 (3:32)

All right. So then let's talk about Q4 and historically versus what you're viewing now. I mean, October has a reputation for some of the market's biggest crashes, the most famous ones. But you also say you view it as one of the best months for finding a bottom. So how are you looking at October and is this October going to be more like previous historical periods are different? Because we've certainly seen us bucketing the trend throughout the summer and early fall.

Paul Schatz (4:02)

That's right. So August and September are traditionally weak months, but they're usually weaker when they begin the months in downtrends. They did not this year.

October is usually a fulcrum month where you've seen crashes in 29 and 87 and 1990 and on 98 and on and on in 2008

And that normally, that weakness into October, normally creates a phenomenal bottom and almost like a rocket ship leaving the launching pad opportunity. I don't think any of that's happened this year. I think without at least a 5 percent pullback in the next month or so, I don't think you'll have the necessary fuel to have one of those really amazing fourth quarters where everything goes up. I think if we don't get a bout of weakness to shake out, a weekend that holds and create some pessimism, I think the market will just drift higher into year end, and there's nothing wrong with that. We could see a one to three or four percent quarter, no problem. But I don't think it's going to be that all systems go, rockets clearing the tower and taking off into outer space. That's why again, I think you've got to be, I don't want to say careful because you're always going to be careful. I think you've got to be a little more thoughtful this quarter unless we get some weakness to buy pullbacks in the strongest stuff.