by Jason Bodner

February 28, 2023

Some things don’t add up. For instance, Adolph Hitler was nominated for the Nobel Peace prize in 1939.

And now, after a massive run since last October, we see that market volatility is back. With it comes anxiety and worry over news headlines and stock prices. But in this week’s entry, I will discuss why it’s happening, how we expected it, and what to plan for in the upcoming weeks.

Stocks went officially overbought according to the MAPsignals’ Big Money Index (BMI) on February 8th. Since that day the SPY (the S&P 500 ETF) has fallen -3.94% as of this writing and the BMI spent only seven days overbought. Since 1990, the average overbought duration was 22 days over 70 prior instances. This time was significantly shorter. With the market suddenly on shaky ground, the question arises:

Should we worry about why the recent overbought condition ended so soon?

Well, I have bad news and good news for you.

The bad news is this: There will always be bad news. Inflation, interest rate fears, politics, the threat of World War, and disease epidemics continue to dominate our daily headlines. I have other bad news for you: When these stories lose their appeal, newer and different anxieties will replace them. It’s natural to want to blame the market’s gyrations on bad news. But – and I believe this wholeheartedly – the news does not alone a market make. More on that in a moment.

The good news is that, according to my 32+ years of historical data, we have nothing to fear but fear itself. The forward returns after an overbought market can indeed be choppy in the near-term, but in the longer term, the returns are promising after 1, 3, 6, 9, and 12 months:

BMI Overbought S&P 500 Table

With that historical survey out of the way, we can breathe a sigh of relief.

Now, about the news. As I write this, the latest PCE report came out Friday. The Personal Consumption Expenditures (PCE) price index is the Fed’s favorite inflation yardstick. It rose 0.6% in January. It also rose 5.4% year-over-year. Removing volatile food and energy components, “core” prices rose 0.6% for January and 4.7% from last year. Consumer spending also rose 1.8% from December.

In worse news, the December CPI report was revised higher, and now January is worse than expected. Basically, these numbers say inflation isn’t falling fast enough. That boosts fears that the Fed has more damage – er, I mean work – to do. Still, I should remind you that we are well past “peak inflation.”

In normal times, this is good news, indicating a strong consumer with robust finances in a growing economy. Of course, too much of any good thing is a bad thing. These days, all eyes are on inflation as the Fed governs our lives. More inflation means “tighter for longer” to most investors.

The reaction to the PCE walloped stocks and lifted Treasury yields. The broad indexes were off last week:

  • S&P 500 sagged 1.05% Friday and -2.67% last week.
  • Dow Industrials -1.02% Friday and -2.99% last week
  • NASDAQ -1.69% Friday and -3.33% last week
  • Russell 2000 -0.92% Friday and -2.87% last week

While stocks sank, the 10-year Treasury rose to 3.95%, edging closer to the October highs of 4.21%. That’s ugly and disconcerting, for sure. But before we attribute an unwinding market to a bad PCE – let’s think about what a bad PCE gave the market – it gave HFTs an opportunity to do what they wanted to do. 

It may seem counterintuitive to hear me say that – but hear me out… Let’s start with the BMI:

BMI Index Chart

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

As you can see, market lows in early October brought about big buying. It eventually intensified into relentless buying, which ripped both the broad indexes and the BMI higher. January brought a breather, but then buyers stepped on the gas and lifted us into overbought territory. Suddenly, buying started to dwindle. We can see this in the daily unusual buying of stocks and ETFs. You can see clearly that the green bars tailed off after a big spike. And you can also see that red is starting to increase as well:

Big Money Stock Buys-Sells Chart

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

That increase in selling alone is not enough to slow everything down, but coupled with less buying, the BMI started to fall.  Now, the buying pressure is just not there the way it had been since October. This is a form of liquidity drying up. (Buying and selling pressure shouldn’t be confused with volumes).

This chart (below) shows unusual trading volumes – different than what you see on a typical stock chart with volume. These amber bars are the number of unusually large and volatile trades on a given day:

Big Money Trading Activity Chart

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

We can see that the volumes are still decently strong. But the buying liquidity dried up. And as buying fades, selling grows, and volumes stay constant. That’s a setup for sellers to come in. Who are these sellers? Didn’t we just have historic short covering since January?  Shouldn’t that spark natural buying?

The answer is yes. However, nothing moves in a straight line. When buying pressure fades, and bid offer spreads on stocks widen, that offers opportunity to short sellers, but not necessarily activist investors, or research houses like Citron or Muddy Waters. I’m talking about algorithmic and high-frequency traders (HFTs). They love environments filled with bad news and fading buying pressure. They can come in and muscle around stocks that have wider price spreads and lower liquidity.

The truth is, they lie in wait, constantly testing liquidity up or down until a tipping point comes and they can monetize their strategy in a few volatile days – ugly days in which they can pop champagne bottles in the lounges of HFT firms after the market closes. They make big money on our scary (volatile) days.

A quick scan of the sector buying and selling shows weakening buying across the board:

Discretionary vs XLY Staples vs XLP Charts

Energy vs XLE Financials vs XLF Charts

Health Care vs XLV Industrials vs XLI Charts

Technology vs XLK Materials vs XLB Charts

Real Estate vs XLRE Communications vs XLC Charts

Utilities vs XLI Chart

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

We see industrials, tech, and discretionary as continuing strong sectors. Health care, communications, and utilities remain the weakest. It is good to see growth leading the charge – even if the market is pausing.

Sector Rank Table

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

The market is tanking on bad PCE numbers. Or is it that the PCE report gave a perfect excuse for HFTs to sell into lighter liquidity? Time will tell, but it doesn’t really matter. History says future returns look bright after being overbought. So don’t get too hung up on reasons and focus on the details.

As Sanford Weill said: “Details create the big picture.”

All content above represents the opinion of Jason Bodner of Navellier & Associates, Inc.

Please see important disclosures below.

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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