December 11, 2018

It’s important to find the bright side of seemingly cataclysmic market action. Supernovas birth all the heavy elements in the universe. The iron in our blood was born from the death of a giant star.

Last week was unsettling. The one-week change for major U.S. indexes was around -4.5%. Much destruction occurred on Tuesday, citing distrust of the China-trade resolution. When trading resumed on Thursday, it was prefaced with a massive S&P 500 futures sell program at around 7 am when news broke of Huawei CFO’s arrest in Canada. That sell order cratered futures by about -1.64%, instantly triggering 40 trading pauses on the CME. Hedge fund liquidations were blamed, and the indexes opened down by about -2%. The intraday reversal was encouraging because stocks caught a bid and the NASDAQ finished the day positive. That’s what I like to see – a high-volume reversal with buying into the close. In my research, 1,200 stocks out of 1,400 tripped triggers for unusual volume and volatility on Thursday. I felt this was bullish, but I was too early. On Friday, the carnage was ugly, and we hit new lows on volume.

Hidden in the data lies something different. The MAP-IT ratio I follow measures unusual buying versus selling. What we see is an increasing ratio, meaning unusual buying is outpacing unusual selling. Hard as it may be to be believe, my data shows that more stocks were bought unusually than sold last week. In other words, I saw unusual institutional buying activity more meaningful than unusual selling.

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

Sometimes the market catches a cold, and sometimes it catches pneumonia. Whatever it is, it’s not good. Yields continue to compress. Tuesday the market was freaking out because the 3-year “inverted” over the 5-year, that is, near-term rates yielded more than medium rates. The news seized on this as a bearish sign.

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

Some thoughts on that: I read that the 3/5 Treasury inversion is the least reliable spread indicator for a recession. With 73 instances of this happening over 64 years, there have been only nine recessions. The 2/10-year Treasury is more reliable, and it is not yet inverted. This week saw yields compress as capital flew from equities into bonds. The 10-year bond yields 2.85% taxed as ordinary income while the S&P yields 1.99% taxed as long-term capital gains. The case for equities becomes more compelling as prices recede. I think dividend-growth stocks will lead the market higher when sanity returns to the market.

Another Sea of Red Hit Most Sectors Last Week

It’s unsurprising seeing Utilities and REITs catching a bid, and they were the only positive sectors last week. These rate-sensitive stocks offer compelling yields when sellers throw the baby out with the bath water. Weak spots were Financials, Industrials, and Materials. The Financials Index posted a dismal -7.08% for the week, followed by Industrials -6.29% and Materials –5.20%.

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

I am still bullish on equities. The data is strong for a continued bull case, but emotions trump everything. Speaking with friends and colleagues, it’s clear that everyone is glum. Unfortunately, people can get overly concerned about finding the bottom instead of asking, “What stocks are selling off unfairly?” There are great stocks out there, but when the market acts irrationally, it’s easy to lose sight of opportunities.

Will buyers ever buy stocks again? Of course. Has buying on market dips been rewarded in the past 5+ years? Clearly, yes. Are we at levels where I think we should be nibbling on stocks? I believe we are.

I continue to cite the data: low taxes, record sales and earnings growth, record profits, a strong dollar, and a strong economy. Clearly, the forward worry of slowing growth and recession has gripped the wheel and shunned logic. The Q3 figures for the S&P 500 were +9.3% sales growth and +25.9% earnings growth. The forecast for Q4 is +6.8% sales growth and +13.4% earnings growth. While these are solid numbers, market volatility reflects a forward distrustful view of sales and earnings growth, perhaps a recession fear.

Interest rates cast more clouds. Dovish comments from Fed chair Jerome Powell last week were also not enough. Now we must wait for the Fed meeting on December 18-19. Likelihood of a rate hike is lower as yields crumble along with equity prices. If there is a hike, the language investors want to hear is ‘that’s it.’

Another unknown keeps appearing. The Mueller probe is front-and-center, and Trump is reportedly nervous. I constantly hear two divergent opinions: “There is nothing there” and “the sharks are circling.”

Regardless, I focus my research on finding stocks with superior fundamentals likely being bought by big institutions. This will happen even if volatility continues as investors must deploy capital. Diamonds reveal themselves in the rough when markets are choppy, as investors must become choosier.

This brings me to my final point: When markets firm up, I think we will enter a stock-picker’s market. Investors will be more selective. Unlike the “Trump-Bump,” which gave way to a widespread rally for 24 months, it likely won’t be a market where everything goes up. Only superior stocks will make the cut.

I’ve picked some phenomenal stocks and some dogs in my career. The key is to keep playing. If fear stops the process, that’s when the losing begins. Looking back, pressured markets are when consistency matters most. Stay grounded, find the sanity, and the opportunities will emerge. As Ed Seykota said, “There are old traders and there are bold traders, but there are very few old, bold traders.”

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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