January 8, 2019

If it wasn’t official before, it’s official now. Apple CEO Tim Cook’s letter to investors managed to shave-roughly a half-trillion dollars off of U.S. stock-market value with Thursday’s -2.5% performance in the S&P500. Imagine English author Edward Bulwer-Lytton’s face if he saw that. (He was the guy who coined the phrase, “The pen is mightier than the sword.”) Cook’s letter was just such a mighty pen.

All seemed misery and despair for most of last week. Conversations I had last week felt like emotional capitulation, which mimicked the price action. Major indexes took a nosedive after enjoying the first fruitful rally from Christmas lows, because Apple’s fall confirmed the world’s fears.

Navellier & Associates owns AAPL, in managed accounts and or our sub-advised mutual fund.  Jason Bodner does not own AAPL in a personal account.

The global slowdown is not only real, but it’s affecting the U.S. far more than originally thought. When the world’s first trillion-dollar company says that China’s slowdown affected them more than expected, things get spooky. This raises questions about Trump’s game of “chicken” in the trade war. At what point does policy aimed at constructive American economic strength harm more than help?

After nudging into the positive, the Russell 2000 about-faced and finished the day down nearly -2%. Market volatility, we hoped, would fizzle in 2019, but it roared back on this serious news.

After the storm, the flowers bloom – they say. Friday morning, sure enough, cheer returned. In a Jekyll and Hyde move, the market took back what it gave away on Thursday, plus a little more. The NASDAQ finished +4.26%. The U.S. labor force added 312,000 jobs vs. the median forecast of 182,000. This strong news could also be considered negative if it reinforces the Fed’s view of a heated economy, but Fed Chair Powell calmed investors’ nerves by saying the Fed would quickly adjust its policy as needed, essentially submarining any likelihood of rate hikes this year. This comes after market bond rates collapsed. The 10-year yielded 2.55% on Thursday. With S&P 500 dividends yielding 2.13% and taxed at a lower rate, this is bullish for stocks. That leaves trade wars, and China, with trade talks resuming this week.

Now, suddenly, the market feels much better. But that doesn’t erase the killer volatility. When the market gyrates this wildly, and everyone is looking for answers, I ignore the noise and dive into the numbers.

A Happy Ending for a Sad MAP-IT Ratio

The MAP-IT ratio is the 25-day moving average of unusual institutional (UI) buying over selling. It is essentially a barometer for how overbought or oversold we are. Below 25% is oversold; currently it’s at 28.9%. Buy-the-dip has been the mantra for many years, but what happens when the market sustains a period of unusual selling? This was our question, so we wanted to look at other periods like today.

Below is a table of the 16 periods when the MAP-IT ratio stayed below 50% for a duration of 40 or more trading days going back to 1990. It looks complicated, but I’ll draw your attention to the bold entries. For instance, the longest consecutive-day period of a ratio below 50%, was 128 days: June 24th to December 30th of 2008. That period also had the highest total number of UI sells (16,483), unsurprisingly so, given the state of the late 2008 market. The highest average daily UI sell count, more surprisingly, came from December 10th, 2015 to February 29th, 2016. It was a relatively short period of 53 days with a ton of sell signals. This supports our hunch that ETFs are the “tail that wags the dog.” More on that in the future, but for now, just know that ETFs have an ever-growing effect on market movements.

Now let’s look at forward returns of the Russell 2000 for all 16 instances. To the right, you see returns: 1-month, 2-months, etc… out to 12-months. The highest return was +61.5%, 12-months after April 1st, 2003. The monstrous drawdown of -50.7% occurred 11-months after April 8th, 2008 – again understandably so as the trough of the financial crisis was March of 2009. Interestingly, the Russell was positive 93.7% of the time 5-months after the last day of the ratio below 50% each time for an average return of +12.2%.

The peak average return was +18.9% 12-months out. Bottom line: we are amid the 16th time in nearly 30 years when the ratio stayed below 50% for 40 days or more. At 61 days, we are around average duration but close to the highest average daily UI sell count.

No matter which way you look at the data, it bodes well for forward returns once our ratio crosses back above 50% after a sustained depressed stretch. All periods from 1-12 months out have a high likelihood of positive return for the Russell 2000. Significant double-digit returns kick in from four months onward.

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

Each downdraft was painful and prolonged, but each preceded a massive rally. Most times it paid to “buy the dip.” Most times also “felt different,” like “the bull market must be over.” But most times it wasn’t.

So, what about now? This study does not mean I’m saying we will rip higher immediately, but it points out that we can’t go higher until we start to see a return of unusual buying. Immense rallies, like Friday, certainly help, but I’d like to see that ratio perk up. If it does, we should to see equity prices lifting.

As for sector leadership rotation, let’s talk about energy which is having, and will have, the best earnings growth out there. This is partly due to some pretty-sad comps a year back. A low hurdle isn’t the best yardstick for strength, but don’t forget the lag effect for forward earnings: As oil’s price has been decimated, I suspect energy leadership will be short-lived. This could also pressure an already-embattled financial sector. Energy debt tied to higher oil prices could spell disaster and rekindle the spirit of 2014-15 and its spectacular energy-to-financials domino-effect.

As seen below, Energy was #1 last week but remains worst for three months and 12 months.

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

Next-best earnings are expected with Specialty Retail and Health Care, but let’s not forget that all sectors have been punished. Bear action has been immense and damaging. But should we continue to see selling abate with good and confidence-inspiring news (like last Friday), the markets should stabilize. A 4+% one-day rally is always fun to watch, and it is a solid step forward.

Finally, Q4 earnings season is about to begin. I suspect growth rates to slow, like the poor Apple outlook showed, yet we should still see sales and earnings growth. How bad is the slowdown really and how deeply will it affect us?  No one knows, but the market looks forward. Likely most of the damage is done after the reset. We are looking for unusual institutional buying to put money to work as the year begins. Capital needs to be deployed, and bonds offer unappealing returns compared to equities.

Again, this is bullish for U.S. equities, so let today’s fears gradually subside, and let the market do what it usually does. Let it rain and let the flowers bloom. As for when, only the wind knows…

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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