July 2, 2019

Colonel Phillip J. Corso served on President Eisenhower’s National Security Council and later headed the Pentagon’s Foreign Technology desk. He had a decorated career, but the reason I bring him up here is his 1997 book, The Day After Roswell. In it, Corso claims to have overseen the recovery of extraterrestrial artifacts from a UFO crash near Roswell, New Mexico in 1947. He alleges that the CIA and military scientists reverse-engineered some of the alien technology to develop products such as accelerated particle-beam devices, fiber optics, lasers, Kevlar and integrated circuits.

One would think that when a National Security Advisor to President Eisenhower tells the world that he spearheaded alien technology recovery, everyone would know about it, or at least want to learn more. But this was an instance where it required digging to discover his story – which remains largely unknown.

When I looked at the market action this past week, I thought I would be able to know what was going on right away, but something looked really strange. It didn’t make sense. I needed some outside counsel.

I decided that this market needed some reverse-engineering. After nearly 20 years on Wall Street, I’ve made a contact or two, so I made some calls to see what I could find out. I reached out to a multi-billion-dollar money manager, a head trader at a multi-billion-dollar fund and a portfolio manager and researcher.

I’m going to tell you what I found out, but first you need to know a little background in the facts, like:

1) What the market did last week
2) What my system’s data said, and
3) Why you won’t find this story in any financial news media.

The market averages last week were not very exciting, on the surface. The DJIA, S&P 500 and NASDAQ were all down slightly, off somewhere between -0.30% and -0.45%. But there was one notable exception. The Russell 2000 Index popped up 1.09% last week. Why the nearly 139-to-154 basis point difference?

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Right away, I thought that anomaly must be due to the Russell realignment. The Russell 2000 is designed to reflect the ever-changing size of stocks in the U.S. market. Due to price changes, every year they have an annual “reconstitution process” to maintain an accurate representation of the market. Breaks between large, mid and small caps are redefined. Adjustments start in May, when all the companies are ranked. Then in June, the new portfolio is communicated to the marketplace. Russell says, “Beginning on June 7, preliminary lists are communicated to the marketplace and updates are provided on June 14, 21, and 28. The newly reconstituted indexes take effect after the market close on June 28.” That’s last Friday.

What Made the Russell 2k Rise 1.1% While Most Indexes Declined?

The Russell 2000 (a small-cap-heavy index) was up 1.09% last week, but the S&P Growth Index was down 1.22%. That’s counterintuitive since the Russell 2000 is full of growth companies.

While that is weird, the most notable outliers this week were that Semiconductors screamed higher (+3.44%) while Utilities and REITs plummeted (-2.12% and -2.74% respectively.) Why is that strange?

The yield on the 10-Year note fell to 2% by Friday’s close, trading even lower during the week. That means the market sees interest rate cuts coming, so if rates are headed lower, investors look to buy stocks that have higher yields. Those are typically REITs and Utilities – the two worst performers last week.

Then I checked the data. It echoed what we see in the index performance table above. But there was also a loud-and-clear selling signal in REITs. (A reminder: We look at 5500 stocks every day, but only roughly 1400 on average can be traded by big institutional investors without making a huge impact on price.)

Look below and you can see that 93 of those “institutionally tradable” stocks are Real Estate. Look to the right. Last week saw 45 R.E. sell signals. That means just about half the Real Estate universe was sold. Wednesday was the largest selling day for REITs in 2019, with 30% of our universe logging a UI sell.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Now – with all that background – I got on the horn to find out what my friends, the insiders, thought.

The first couple of phone calls were surprising. My contacts noticed what I noticed but didn’t necessarily have a ready reason. After we talked it through, though, here was the consensus from my industry friends.

REITs and Utilities got pounded in a “sell the news” situation. Why? These groups have been the ones being bought by smart money for a while now, in anticipation of a rate cut. That expectation is now fully priced into higher-yield stocks as Main Street investors now think that it’s time to buy REITs. That’s when smart money sells the long positions that they made months ago.

The real question is: “Is this bullish or bearish for the market?”

Rates are likely headed lower. There is a smart money rotation out of higher-yield safer stocks into small cap stocks. The 10-Year note’s yield is 2.0% before taxes, versus the S&P 500 dividend yield of 1.88%. Looking at the chart below, we see that after taxes (with bonds taxed at ordinary income rates and dividends taxed at long-term capital gains rates), stock investors end up with more money in their pocket.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

The weak economic data released Friday suggests even more pressure to get a trade deal done.

Bottom-line advice: I believe this is all very bullish for U.S. stocks.

This summer may bring more volatility, but don’t lose sight of the big picture.

Like Simon Sinek said: “The big picture doesn’t just come from distance; it also comes from time.”

About The Author

Jason Bodner

Jason Bodner writes Sector Spotlight in the weekly Marketmail publication and has authored several white papers for the company. He is also Co-Founder of Macro Analytics for Professionals which produces proprietary equity accumulation/distribution research for its clients. Previously, Mr. Bodner served as Director of European Equity Derivatives for Cantor Fitzgerald Europe in London, then moved to the role of Head of Equity Derivatives North America for the same company in New York. He also served as S.V.P. Equity Derivatives for Jefferies, LLC. He received a B.S. in business administration in 1996, with honors, from Skidmore College as a member of the Periclean Honors Society. All content of “Sector Spotlight” represents the opinion of Jason Bodner


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