The market is currently pricing in up to three rate cuts this year, which is putting pressure on Magnificent 7 stocks, defined as Apple, Alphabet, Amazon, Meta, Microsoft, Nvidia and Tesla. Due to their global exposure, heavy cash positions and positioning within the growing AI trend, they have been perfectly situated to benefit from a bifurcated and complex macro environment. Because of this, the Mag 7 has significantly outperformed the broad market, and also led it higher for nearly 2 years.

To put this into perspective, the first six months in 2023 was the biggest 6-month rally in Nasdaq history - and since then, over a year ago now, the NASDAQ has plowed through key levels to reach a staggering 72% return in a little over 21 months. It’s not only the returns we’ve seen in 2023 and 2024 that are unusual, but the fact it happened back-to-back. Tech investors can thank the Mag 7 for this spectacular outperformance.

However, we are now getting evidence that a change is happening. As excitement over reduced rates has investors rotating into beaten down small caps and consumer facing stocks that have sat out tech’s historic rally.

By not participating, small caps and other pockets in tech that are more traditionally cash-strapped are now undervalued. Optimism around the Fed could spark a continuation of the relief rally in the Russell 2000 and further rotation out of the Mag 7. Below, we look at the pros and cons of a Mag 7 rotation and how we plan to personally handle this shifting landscape.

Why The Mag 7 Worked

The complexity of this business cycle can’t be overstated. On one hand we are seeing one of the longest and steepest yield curve inversions in market history. This signal has a near perfect track record of predicting recession, which is being backed up by a weakening consumer, and a deep and prolonged manufacturing recession that is now filtering into the services sector. On the other hand, corporate profits are healthy, the job market remains relatively tight, and AI is creating a new economy that is driving historic top line and bottom line growth for the AI leader (we think there will be many more beneficiaries beyond Nvidia).

This bifurcation within the economy can be seen in equity markets. For example, markets that are dependent on a strong consumer, thrive with lower interest rates, or in need of cheap money to expand - like high beta tech, small caps, real estate, consumer discretionary - are still well below their 2021-2022 highs.

At the same time, we are seeing markets that have global exposure, flush with cash and are not dependent on the consumer, all well above their 2021-2022 highs. This is most obvious with the Mag 7, who were leading this market higher in early 2023, and continuing into today.

For this reason, we need to take a closer look at select charts within the Mag 7 to get an idea on where the market is going over the short-term, as well as the medium to long-term.

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Certain Stocks Within the Mag 7 Continue to Provide Clues

Our broad market analysis in 2024 has been focused on the relative performance of the Mag 7. Without question, these 7 stocks are the most important stocks in the current bull market. Historically, as long as the cycle leaders continue to move higher with the market, all is well. However, as stated in our March Report…

“When the cycle leaders start to underperform, it tends to mark the start of a trend change. The Magnificent 7 have been the undoubted leaders of this bull run, and we are now seeing them start to trend lower against the indexes. More times than not, the leaders on the way up, tend to be the leaders on the way down.”

This was the pattern that warned us about the April selloff, and again in July.

What followed our March report was a 6.3% drop in the broad market. However, high fliers like NVDA and META dropped 22%, TSLA dropped an additional 32% while the rest of the Mag 7 dropped between 15% - 10%.

Since then, the market has recovered and resumed the bull market higher; however, we have seen new leadership emerge from the Mag 7. Since the April 19th low, the S&P 500 is up +12%, while Apple is up 32%, Nvidia is up 64% and Tesla is up 77%. Lead Tech Analyst, Beth Kindig, pointed out on Bloomberg Asia that Tesla was simply trading too low at the time, and to look for a bounce.

What is interesting is that the same pattern that we saw from the Mag 7 in early March, was also warning investors leading into the July 16th high.

Nvidia first started making lower highs on June 10th, followed by Tesla on July 10th, and then finally Apple on July 15th. So, while the broad market continued to make higher highs, it was doing so without its leaders, signaling that trouble is likely ahead.

What The Majority of the Mag 7 is Saying Now

The divergence above within the Mag 7 stocks warned us of the coming volatility. We can use further analysis of these important stocks to help tell us what the market may do next.

Of the Mag 7 charts, Apple, Microsoft, Nvidia, Amazon and Google are the clearest. They all suggest that what we are seeing is a correction within a larger uptrend, and that it is likely that we see higher levels in the coming weeks. While Meta and Tesla can be interpreted in the same way, they are not as clear as the ones we will discuss below. For reference, the 5 stocks below account for ~28% of the S&P 500, and should have a very strong correlation on the direction of the broad market over the coming weeks to months.

Nvidia

Nvidia is the most important stock in the current bull market. Within the most recent bull market, it has gone from a top 25 stock in the S&P 500 to now the 2nd most valuable company in the U.S. due to its positioning within the new AI trend.  Our firm was the first to lay out NVDA’s path to becoming the most valuable company in the world. Now that it has surpassed Apple, we further presented how it has a clear path to becoming a $10 Trillion Company by 2030.

Since the 2022 low, NVDA has been tracing out a very large 5 wave pattern higher. Note the vertical move higher in early 2024. This was met with max volume and max momentum to the upside. This is the marker that you are in the most powerful moment of a trend, which is the 3rd wave. This is also around the halfway point of the entire 5 wave pattern.

The pattern appears to be incomplete. Even though NVDA topped early, the drop is a clean 3 wave pattern within an incomplete uptrend. We still need a 5th wave to new highs in order to complete the larger 5 wave move.

Nvidia may have one more drop into the $113 region before bottoming, but appears to be developing a bottom right now. Look at the momentum indicator below. It is bottoming in the exact same region the April low tagged, and it is doing so while price is much higher. These are the type of bottoming signals we look for when degerming a low is close within a developing uptrend. As long as any further drop holds $103, we expect NVDA to push higher.

Apple

With Apple’s push into bringing AI to the consumer, coupled with the likelihood that the Fed will lower rates soon, Apple has stopped becoming a laggard and is instead one of the leading Mag 7.

It appears to be a bit further along in its uptrend pattern off the 2022 low. While NVDA needs a large degree 5th wave, Apple is missing a smaller degree 5th wave. Like NVDA, the pattern is incomplete while giving us clear bottoming signals.

Note how the momentum indicator is making a lower low from the June low into today’s low. This is happening while price is making a higher low. This is the type of pattern we see in on-going uptrends, and supports that we should see another swing higher into late summer/early fall. As long as Apple hold over $206, we expect to see this move higher manifest.

Microsoft

Our firm recently closed MSFT for a sizable profit due to valuation concerns. While the chart does suggest it has one more swing higher, we see other stocks within tech having more upside in both valuations and technical targets. For this reason, we have rotated these gains into Nvidia, as well as other AI stocks that we have been targeting for months.

However, like Apple and Nvidia, Microsoft is a bellwether for the broader market and an important stock to cover. It is very rare to see MSFT move against the market, and when it does, it is a sign of a brewing trend change.

The below chart shows a very mature uptrend off the 2022 low. We have a very large 5 wave pattern that is suggesting it has one more swing left. This would be wave 5 of a larger 5th wave, and is estimated to be anywhere between 8 – 15%.

We are seeing similar bottoming patterns in MSFT as we saw in AAPL. Microsoft appears to be completing what looks like a 4th wave drop. As long as any further weakness holds $406, I expect a final 5th wave push in the coming weeks.

Amazon

Amazon looks a lot like MSFT and AAPL. It is tracing out a 5 wave pattern and needs the final 5th wave higher to complete the uptrend. The current drop also appears to be a 4th wave and showing bottoming signals like the above charts. As long as AMZN can hold $174.50, we expect a 5th wave bounce in the coming weeks.

Google

Google is making a lower high while it is at extreme oversold conditions. Like the above charts, it looks like it needs one more high to complete the larger 5 wave pattern. As long as any additional weakness can hold $169, it looks like it needs a 5th wave bounce to complete the bigger uptrend.

Broad Market

The broad market in the S&P 500 is signaling the same push higher that we are seeing in the above key stocks. While it appears that we have another move higher to look forward to, according to the larger pattern in play, the next move will likely be the final move we see before having to contend with, at best, a multi-month and deep correction.

The pattern that the S&P 500 is tracing off the 2022 low is what is called an ending diagonal pattern. It is the only pattern that can account for the messy, overlapping moves that we have seen in both directions. The only question is what degree of a 5 wave pattern is in play, which is what my two counts represent.

• Green - This count has the 2022 bear market as a large degree 4th wave in the secular bull market that started in March of 2009. That would put us in the final 5th wave, which is developing as a large ending diagonal pattern.
  
  These patterns are 5 wave patterns that overlap. More times than not, the 4th wave will go be so deep, as to move into 1st wave territory. The next swing higher would be the final move in the 3rd wave, which would be targeting 5850 – 6340. Once this 3rd wave ends, the 4th wave would likely be a multi-month drop and on the larger side of a bull market correction. This would set up a tremendous buying opportunity, once completed.
• Red – This count has us in a smaller degree ending diagonal pattern. It has an extended 5th wave that is playing out. The targets would be the same as above, 5850 – 6340 SPX. However, unlike the green count, we would not see a 5th wave to new highs, but instead a lower high in a much larger downtrend.

As long as any further weakness holds over 5375 - 5200, we should continue to see the bull market continue for another move higher. Below this level decrease the odds of this happening. The final support for any pattern that can take us higher would be 5,200. Below this level and the larger period of volatility will have likely begun.

Small Caps

The June CPI numbers came in softer than expected. This coupled with weakening economic data, triggered the market into a rotation based on the expectation that the FED will have to cut rates sooner rather than later. As a result, the Russell 2000 is up about 9% from that moment, while the Mag 7 are down an average of 13%. Furthermore, we are seeing an expansion of breadth into more consumer based value stocks as well as some high beta names.

As stated, it appears that the majority of the Mag 7 and the S&P 500 are supporting another push higher. This is also supported by small caps. The benchmark for small caps, the Russell 2000, for example, appears to be in a 4th wave correction, which is around the halfway point of the move higher. As long as any further weakness holds $211 (IWM), like the rest of the markets and stocks we covered, it should continue higher before putting in a more meaningful top.

The broads Small Cap Index is also suggesting that a low is being put in and we should see another swing higher. The upside pattern is incomplete and likely around the halfway point of the move higher. However, we do still believe this is a stock pickers market, so we have positioned some of our portfolio into select small cap positions that have exposure to AI. While the rotation into small caps may continue, it looks like the bulk of this rotation is complete, as the broad market is setting up the next leg higher.

Realized Volatility

Realized volatility (RV) is a measurement of price swings on a day-to-day basis. The lower RV is, the smaller swings in either direction are to be expected. Ideally, you want to see RV trending lower as price moves higher. This tends to mark a healthy uptrend.

The best way to think about Realized Volatility is as a measurement of liquidity entering or exiting the markets. The more liquidity there is, the smaller the moves we tend to see, as the market continues to grind higher. The higher Realized Volatility goes, the less liquidity is in the market – i.e., big money is raising cash, which can cause larger swings in the market.

What matters to me is how Realized Volatility is trending with the market. This is what we are seeing today. Look at the 10-day, 20-day and 30-day measurement of Realized Volatility is trending up with price. The last time RV hit these levels that we last around the April low. This is significant, as it is indicating that liquidity is leaving the markets while price is much higher.

As long as Realized Volatility continues to trend higher with price, it is a warning that liquidity is exiting. However, this also means that less liquidity can propel the markets higher up to several months.

Note the two most recent periods this happened – 2020 and 2022. Once we saw RV start trending higher with price in 2022, we only saw a 5% move higher over a 1.5 month period. However, in 2020, this trend lasted for +3 months and led to a 10% swing higher in the markets.

Conclusion

In conclusion, the stage is set for a meaningful move higher, if we can see SPX break above 5670. While less liquidity tends to mark the early warning of trend reversals, it also means that any bullish catalyst can propel the markets higher in larger than normal daily swings. This lines up with what the majority of the Mag 7 is suggesting - a 5th wave rally to new highs is needed to complete the larger uptrend.

As long as the supports listed hold, this is what we are expecting. While the next move higher could last anywhere from a few weeks to several months, it’s important for investors who are buying the dip to realize the risks involved within the larger picture. While being nimble can pay off handsomely in moments like this, not having a risk management plan can do the opposite once the market rolls over.

If you are sitting on outsized gains from the current bull market, looking to protect those positions, or interested in owning AI leaders at reasonable prices, join us each Thursday, at 4:30 EST for our premium members webinar. This week we will discuss our risk management plan, buy and trim targets for various AI positions as well as crypto. Learn more about I/O Fund’s premium services here.

Disclaimer: This is not financial advice. Please consult with your financial advisor in regards to any stocks you buy.

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