Goldman Sachs Touches on the Cats and Dogs Trade

They call it the laggards to leaders, in any case, it's not exactly the phenomena I have noticed in the market over the last 10 years and that is, just before the market rolls over from a bull move/rally, there's a rally in what I call the Cats and Dogs, Goldman calls them the laggards.

The premise of my version of the C&D trade is that the market is above all manipulated, but also an emotional creature. I have often encouraged students, members and readers of my sites to try to view charts in an emotional light. When you see more the moving averages and you can see emotions, which include mania's, fear cycles, greed cycles, etc (for instance, we are in a mania/greed cycle- when the SPX dropped on March 5/6th, it stopped out a percentage of the longs who had bought over the last 21 days, nearly 1 trading month stopped out in 2 days-this is why I have been saying being long the market is like "Picking up loose change in front of a steam roller" and certainly some longs got steam rolled this month), back to the point, when you can recognize these emotions, you get a lot more information out of a chart.

Why do I say this is a greed/mania cycle? Look at breadth alone and if you think market breadth is meaningless, give it some time, you'll be able to look back and say, "Wow, breadth was warning big time". The longs don't care, as usual, "This time it's different", that is until it isn't- as always.

In the greed/mania cycle, people who saw the new October lows left the market and it probably took several months of rally to get them feeling like they missed it or are missing it, so they enter the market, but being most stocks followed the market higher (until recently as my breadth post proved last week), they don't want to pay for quality so they look for the Cats and Dogs, stocks that haven't rallied yet and are usually under $3-$5. Wall Street knows they'll be shopping and sets up some nice looking charts in the C&D trades. The thing is, they pop and pop hard, often with double digit gains, but they fall even faster, guess who is left holding the bag? This is why when we trade the Cats and Dogs, I recommend taking at least partial profits on any 1 day double digit gain and trail the rest with a tight stop. I have noticed for years this happens just before the bull move ends.

Here's Goldman Sachs version of the Cats and Dogs from ZH...

This year has been characterised by a dash-for-trash as the flood of central bank liquidity sent the marginal dollar into every down-beaten, over-shorted, unprofitable, over-leveraged, illquid stock it could get its hands on. As Goldman notes today, however, this laggards-to-leaders strategy is starting to underperform in the last few weeks. Buying the trailing 12M laggards and selling the trailing 12M leaders had returned an impressive 7% YTD but since mid-February (which notably was when credit started to underperform equity markets more directly) performance of this 'pair' has lost almost 3%. It seems the liquidity-floats-all-boats mentality is indeed leaving the market and with a refocus on growth(that this likely implies) we suspect correlation will pick up once again to the downside.

Chart: Goldman Sachs