March 12, 2019

Think back to when you were a kid. Remember when you used to hear all these warnings: “You’ll shoot somebody’s eyes out!” or “Sitting too close to the TV will ruin your eyes.”  Or “don’t run into traffic.” Looking back now, some of those just seem ridiculous, but some were smart guidelines to keep us safe.

Some warnings have ulterior motives. For instance, the military requested that the FDA do a study on drug effectiveness. They studied 100 prescription and over-the-counter drugs and found that over 90% of them were still effective and safe 15 years after the expiration date. That’s right, the dates don’t actually indicate that a drug is less effective once it had “expired.”

The obvious undertone is that the manufacturers sell way more drugs if you’re fooled into believing they are no longer safe and effective. It brings to mind the ongoing argument between my wife and me about food expiration dates. Either way, one mantra of expiration dates is: keep ‘em shopping for a fresh supply.

I know I sound like a broken record when I say that the media is fixated on delivering bad news to you. The fact is that unicorns and rainbows don’t get people to click, so the media needs to generate fear and loathing. That brings me to what I am noticing now. We have been talking about how the market has been overbought since the first day our ratio popped above 80% as of the close on February 6th.

The market has now been overbought for 21 trading days with the MAP-IT ratio over 80%. This happens when the number of unusual institutional buy signals divided by sell signals is more than 80% on a 25-day moving average. The ratio hit its peak on March 1st at a level of 92.6%. As the ratio has declined, the buying has been slowing and the selling has been picking up. This table delivers the daily details:

The green column is the daily buy signals while the red is the daily sells. The right-most column is the 25-Day Moving Average of this daily measure. As you can see, it’s dropping over the past few days. But when you look to the column left of it – the one-day ratio – you can see how swiftly the deceleration of buying has been in the past five trading days, a time during which the S&P has declined over 2%.

Observing this led me to ask: How does this overbought period compare with prior periods in the last 30 years of our data mining? There were 28 prior times that the market stayed overbought for 19 or more trading days. Given the power of our oversold signal timing market bottoms, we were hopeful to find the overbought signal to be promising in identifying market tops. What we found was very interesting.

Making a long statistical story short, we found the peaks of the 25-DMA ratio in each instance and then looked for when the ratio declined for at least five days afterwards. We took the average returns for one week through eight weeks afterwards. The theory was that when the ratio started falling from the peak reading, we would see lower market prices ahead. Over the 28 instances in the last 30 years that fit these criteria, what we actually found was an average 1.5% increase eight-weeks forward.

This summarizes the average 1-8 week returns from the ratio dropping from its peak (after five days):

Those are the average returns of all 28 instances. But what we see now are lower prices.

The First Week of Lower Prices in Most Sectors in 2019

Look at the market and sector performances since the ratio peaked on March 1st

Now that’s a pullback – no question. On a sector basis, we have seen a rotation from growth sectors into defensive sectors. Utilities and Real Estate saw a move higher (as of this writing) while the remaining nine sectors were down for the week. Health felt the biggest blow, down nearly 4%. Energy, Financials, Consumer Discretionary, and Info tech were the other worst performers.

This is the first week of lower prices in most sectors since the end of 2018.

As you can see below, buying slowed significantly, while UI sell signals picked up slightly.

A giveback is a healthy thing and now the worriers who fretted about going up too far too fast can begin worrying about going down. Such is the curse of the eternally negative thinker. As a result, the China trade news is now back in the headlines. The Friday nonfarm payroll report was pretty dismal, and the political headlines are (as usual) irksome. My point is that the news cycle has shifted negative again, and we can see the algorithmic selling starting to react to it, so I expect some bumps ahead.

But given the lookback we did over all prior overbought periods, our expectation has to be tempered to expect less high prices rather than lower prices. In other words, the bull market is still alive. The sales and earnings cycle is nearly complete with 96% of companies reporting earning: 70% beat their earnings estimates, and 60% beat sales estimates. So, as we exit this earnings cycle and hit a pocket of less market-intense news, I expect a near-term market burp followed by a resumption of bullish action.

The thing about market warnings is they are just that – warnings, not facts. Take heed in the warnings that come from pessimistic thinkers. The data is strong, but there will always be storm clouds on the horizon.

As Norman Cousins said, “History is a vast early warning system.”

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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