January 15, 2019

We are capping off another strong week. Weakness on Thursday morning was met with strong buying. On Wednesday, Bespoke Investment Group put out a report saying the S&P 500 has staged a very rare comeback. To summarize their findings:

  • After declining over 19% in less than three months, the S&P 500 came roaring back for a 10% gain in just 10 trading days.
  • Since WWII, there have only been 12 other declines of 15%+ within the span of three months that were followed immediately by a 10%+ gain in 10 trading days or less.
  • After those previous 12 instances, equity returns were generally positive. In half of these prior sharp bounces off of 15%+ declines, the S&P 500 never made a lower low within the next year.

This fits very nicely with what we have been saying here. The MAP ratio went oversold in October and I said, “Expect a bounce.” A +7% rally succumbed to wicked selling, pushing us oversold again. “Expect a rally,” we said. Now, after 12 trading days since the Christmas low, the S&P 500 closed Friday up 10.4%.

Info Tech, Energy, Consumer Discretionary, and Real Estate were last week’s big winners. This makes sense as they were heavily punished for so long. It also fits with the theme of small- and mid-caps seeing notable buying. The Russell 2000 outperformed significantly this week, as did the S&P Mid Cap 400 and Small Cap 600. Either way, it’s both refreshing and eerie to see this much green. I would expect a give-back and Friday set up for a modest correction, but Friday recovered ground through the day.

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

When we run our models, we scan 5,500 stocks a day. We find that only about 1,400 of those can absorb institutional-sized orders without a major impact on price. Out of these, the model gets “tripped” by stocks that trade on above-average volume and volatility. At Mapsignals, we look at those “trips.” The last 5+ years show us an average of 500 stocks per day (that means that roughly 35% of institutionally tradable stocks trade on larger-than-average volume as the norm). Don’t confuse “trips” with actual buy and sell signals. Trips just mean that a stock is trading unusually. In order to get a buy or sell signal, the stock also has to break above or below a recent technical high or low. So, what are the “trips” telling us?

Below is a 29-year chart of the S&P 500 with days of trips (unusually-traded stocks and ETFs) which were twice the daily average or more noted in red. You will typically notice that extreme selling days yield a lot of trips. This is logical, but as noted in the past several weeks, extreme lows tend to also coincide with big ETF signal days.

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

ETFs are the “Tail that Wags the Dog”

We have been postulating that ETFs are the tail that wags the dog, that is, ETFs became the directors of market direction – through massive asset gathering and allocation – especially under periods of uncertainty and heavy pressure. This lends even more credence to the thought that the fourth-quarter sell-off began with uncertainty over rates, trade, and the global growth slowdown. This took buying pressure out, which paved the way for high-frequency traders (HFTs) to profit off of thin liquidity and high volatility. The pressure of that condition led to ETF model management reaching sell-triggers. Then, liquidations of ETFs caused a massive dislocation in the market.

One stock can be present in many ETFs. For example, according to ETFdb.com, Facebook (FB) is present in 138 ETFs, totaling about 200 million shares. A redemption of hundreds of ETFs on the same day, as seen by the orange spikes above, representing heavy selling, amplifies volatility in a big way. And when markets are down, ETF spreads tend to blow-out, which also affects stock bid/offer spreads.

It’s clear to us that ETF passive management gobbling up retail assets for decades has reached a tipping point. The ETFs move stocks, not vice-versa. A larger study is almost concluded which will go into much greater detail, but I’ll state the clear conclusion here: We believe 2018’s horrendous finish was caused by fear vaporizing buying. Then, as soon as the decline got too uncomfortable for retail managers, ETFs caused a monstrous cascade of selling.

Navellier & Associates does not own FB in managed accounts and or our sub-advised mutual fund.  Louis Navellier and his family do not own FB personally.

So, when Financial Advisors (FAs) who spent a decade-and-a-half gathering assets and plopping them into passive management vehicles (namely, ETFs) have their model managers say to “hit the sell button,” the FAs all rush for the exits on the same day. This is what happened this past fall.

As of now, our Mapsignals ratio is increasing and currently sits at 31.8%. For the last few days, we are seeing more buys than sells in stocks. In fact, the last five days has averaged 85.4% buying (that means that our data says that 85% of our buy and sell signals in stocks are likely buy tickets). Homebuilders, Health Care, and Info Tech are starting to get bought. (The ratio has a low value because it’s a 5-week moving average and the prior four weeks favored selling.)

As noted in last week’s study, when the ratio pops back above 50% after being below 50% (meaning, sellers in control) for 40 days or more, forward returns should be strong from 1-12 months out. We have 2 weeks so far of positive action for the market. Small- and mid-caps lead the rebound and the market is being re-liquified. Pension funds, mutual funds, and assorted other institutional managers are deploying capital and bringing liquidity back into the market- something we noted should happen (in prior weeks).

We continue to be bullish on U.S. equities. We believe the trade stand-off will be resolved. The Fed is now being apologetic and walking back their language. Fourth-quarter earnings are upon us and we believe we are in for another strong earnings season. We look for a more selective phase of the bull market for 2019.

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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