The market is experiencing challenges as tech stocks face a steep decline. This downturn is mainly due to cautious trading ahead of Nvidia’s earnings report on November 19. Investors are stepping back to manage risk amidst lower liquidity and uncertainty. Hedge funds are shifting investments from AI stocks to healthcare, and Alibaba’s announcement of a revamped AI model has added to the market’s worries. Tech stocks are already feeling pressure from valuation concerns, further intensified by a disappointing report from Japan’s Kioxia, which caused semiconductor stocks to fall and worsened the overall market decline. Although the retail sector attempted to take advantage of the dip, the overall mood remains cautious. Many are focused on the Federal Reserve’s upcoming decisions, with the possibility of rate cuts in December looking less certain, which could influence the broader market.

Concerns Around Liquidity

Worries about year-end liquidity and funding are increasing. The market is also paying attention to the Federal Reserve’s approach to managing reserves, including potential “Reserve Management Purchases” to help stabilize the financial system as the repo market faces pressures. Additionally, Alibaba’s efforts to compete with ChatGPT in the AI space could change the competitive landscape in global AI. Given the recent downturn, Nvidia’s earnings on November 19 should be viewed as a key event for the market. The Nasdaq 100 Volatility Index (VXN) has jumped over 12% in the last two sessions, showing heightened anxiety before the earnings report. A straightforward strategy for navigating this volatility is to use options, like straddles or strangles, allowing for profit from significant price movements in either direction without needing to predict the outcome. The Federal Reserve’s strict approach is dampening hopes for a quick policy shift, directly affecting growth stocks. The odds of a rate cut in December have dropped from over 70% last month to just 45% today, according to CME Group’s FedWatch Tool. This shift makes buying longer-dated puts on indices like the S&P 500 or Nasdaq 100 a sensible way to protect against further drops in stock valuations.

Focus on Funding Markets

It’s crucial to monitor funding markets closely, as this area may signal deeper problems. The SOFR rate is trading a few basis points above the Fed’s own policy rate, indicating strain in the financial system that could worsen as the year concludes. If this trend continues, we might see a larger shift away from risk, making puts on financial ETFs a strong strategy for countering a possible liquidity squeeze. The shift from technology stocks to more defensive sectors, like healthcare, is becoming clearer. Over the last five trading days, the Health Care Select Sector SPDR Fund (XLV) has outperformed the tech-heavy Invesco QQQ Trust by nearly 4%. If market fears remain, this gap is likely to increase. A pair trade strategy—going long on healthcare calls while shorting tech calls—can directly exploit this shift. Lastly, the notion of unassailable US AI leadership is starting to weaken, thanks to Alibaba’s aggressive strategy and disappointing reports from Japanese chipmakers impacting market sentiment. This creates new risks that warrant reducing exposure to heavily invested semiconductor and software companies. Selling call credit spreads on overextended AI stocks could provide income while offering some protection if the sector continues to decline. Create your live VT Markets account and start trading now.

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