February 12, 2019

The domino effect is something we’re all familiar with. There are times where the domino effect can have some catastrophic consequences. Take for example, the curious case of Cerise Mayo’s Brooklyn bees.

It was a wickedly hot summer. Cerise was a devoted beekeeper, raising her bees in Red Hook, Brooklyn, giving them the best possible care. But that summer, the normal amber bands on the bee bodies suddenly turned bright red. The sight of glowing red bees became an enchanting sight on Brooklyn nights.

Oddly enough, their honey was red, too. This offbeat problem eventually indicated that the bees were “hitting the juice” at Dell’s Maraschino Cherries Factory, run by Arthur Mondella, the factory’s owner. Andrew Coté, the leader of the New York City Beekeepers Association, in seeking a solution to the red bee dilemma, obtained samples of bee secretions and found they were saturated with Red dye #40, the same used in coloring the neon red cherries that sweeten countless Shirley Temples. The maraschino factory then attracted attention, and the DA decided to investigate the premises at Mondella’s factory.

After comparing this odd bee story with a few complaints of marijuana odors near the factory, investigators stormed Dell’s factory and found the city’s largest pot farm underneath the factory. When authorities came for Mr. Mondella, he barricaded himself in the bathroom and shot himself dead.

In this ironic tragedy, a beekeeper named Cerise (French for cherry), kept red bees, in Red Hook, Brooklyn, tainted by red dye from cherries. That led to a pot farm bust and the suicide of its owner.

The same type of domino effect was witnessed in last year’s market swoon. We detailed this in our recent look into why ETFs caused the dual downdrafts of 2018. Fear drove a lack of buying, creating a vacuum of liquidity. Algorithmic traders seized the moment and spiked volatility. It got too hot to handle for ETF model managers who hit the sell button. The outflows of ETFs were monstrous, leading to massive pressures on stocks – which make up the components of ETFs. It all bottomed out on December 24th.

Did someone now flip the dominoes the other way? We went from heavily oversold on Christmas Eve to overbought on February 7th. Leading up to December 24, sellers were in such total control that it became unsustainable. We called for a bounce, which came right on time. But now buyers took back so much control that in six short weeks, the level of unusual buying has become unsustainable.

The MAP Ratio “oversold” signal has been very accurate and timely. The MAP Ratio “overbought” signal has also been accurate, but less timely and less intense. Basically, we find that throughout history, what goes down must come up, but what goes up may not have to come down, or at least not right away.

In our MAP white paper “Boundaries published June of 2017, we went into the expected forward market returns after overbought and oversold boundaries were pierced. As you can see from this table below (excerpted from the report), the forward returns were very positive for oversold, and negative for overbought. Either way, the overbought signal indicated that it is a time to consider not adding risk.

We hit this rare signal again January of 2018 and sent out a big update on January 24th. The market sank in a big way immediately after. When we hit it again Thursday morning, February 7th, we shouted the news from the hilltops again, as some of you may have seen.

The following is taken from the Thursday post and is essentially an updated version of the table above:

We have seen points in history where the market stays overbought for weeks, but last Thursday it started sliding immediately after our update. They say it’s better to be lucky than smart, but all this ratio really is saying is that lopsided buying is unsustainable, and we expect some selling soon.

The Semiconductor Index up Over 20% Since Christmas

That doesn’t mean the market will tank. We just expect some give-back.

Let’s look at what the market has been up to the last week and six weeks:

From the Christmas Eve lows, the recovery has been massive. Small caps have led the rise as seen in the Russell 2000 and S&P Mid 400 and Small Cap 600 Indexes. This is also reflected in the sectors. Infotech, Consumer Discretionary, Financials, Communications, Real Estate, and Energy are all up more than 15% since the 12/24 lows. Defensive sectors, like Utilities and Staples, have had the least animated run up. But perhaps the biggest evidence of a rush back to growth is seen in the Semiconductors.

Semis last year were essentially a toxic wasteland. Yet the PHLX Semiconductor Index is +20% since Christmas, by far the best performer in the recovery. We noticed a major repricing of semis last week with some stellar earnings and heavy institutional accumulation.

The first domino to fall may not get noticed until long after the fact. It helps to pay attention along the way and watch what the market tells us. The market has found its footing after a Montezuma’s revenge incident due to forced ETF selling in the fourth quarter of last year.

The usual worries still dominate, with renewed trade war anxiety stoked by Larry Kudlow’s admissions last week. In what I see, big institutional investors have been plowing into stocks at breakneck speed, and now the ratio suggests that a pause is coming. I believe we will just resume course higher and the market will become narrower. What looked like a desperate market suicide was really an invasion of red bees.

Heed the words of Billy Connolly: “Before you judge a man, walk a mile in his shoes. After that who cares?… He’s a mile away and you’ve got his shoes!”

About The Author

Jason Bodner
MARKETMAIL EDITOR FOR SECTOR SPOTLIGHT

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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