by Jason Bodner
May 12, 2020
Someone (thanks, RSC) recently reached out with a great question: He said, “The melting-up markets are an enigma to me. You say they are ‘overbought,’ yet they continue to go higher. I’m curious. When looking at your BMI signals, when does a ‘hold’ become a ‘sell’?”
Ordinarily, I don’t answer questions in an open forum, but this question was perfect. The enigma is that I don’t get it more often. Everyone wants to know when markets turn, better yet… before they turn.
For a refresher, I believe big money dictates markets. I want to buy the best quality stocks when big institutions are buying them. I monitor what big money does by looking at unusual trading. That activity generates buy and sell signals. These are added up and smoothed over a 25-day moving average ratio, which is Mapsignals’ Big Money Index (BMI). When it’s below 25%, as it was in mid-March, the market is oversold, and we expect a rise. When it’s over 80%, it’s overbought, and we eventually expect a fall.
It just reached 87.6%! People, we reached VERY overbought in a VERY short time.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
It stands to reason that big money investors pull the tides along, like the moon’s gravity. Everything else just follows along. Riffing on that analogy, think of this: Being much smaller, the moon has much weaker gravity than Earth. Many know that you weigh 1/6th your earth weight on the moon. Even with that, the moon’s gravity pulls entire oceans and even steals some of Earth’s rotational energy. The moon’s gravity causes our planet to slow down by about 1.5 milliseconds every century.
As for the stock market question, it’s like the moon and gravity. It’s all about riding the wave. A surfer can’t ride the board just by counting the seconds between waves. A skilled surfer must react to how the wave unfolds. To a novice, all waves may look alike, but to a surfer, no two waves are the same.
The market is a wave. The BMI went overheated (above 75%) then overbought (over 80%) very quickly. The BMI is still trending higher. We aren’t going to fight that trend.
The historical key is to ride the wave until it crests. Once the data shifts (that is, the BMI begins to level off and fall) we should think about either protecting or reducing our long exposure. I often find (and write about) a “key divergence,” such as when the BMI starts falling but the market goes up! That would be a great indicator that things are changing under the surface. As the data confirms and reinforces that thesis, with protected or reduced long exposure, we wait until the data shifts again, giving us an all-clear to buy.
It may sound overly simple, but who said market investing has to be overly sophisticated? Either way, the beauty is that it’s all data driven. There’s no guesswork. Data has enabled this method of analysis to be spot on. That can help drive superior navigation through the markets.
With that said, can we get any idea of when this overbought market will roll over?
Right now, we are very overbought, but we can stay very overbought for weeks. The key is to watch for when the data changes, not when it just sits in overbought territory. It may lie there and not leave! When the data changes, the wave crests and it’s time to hop off and prepare for stocks to pull back, not before.
To get an idea of what to expect, I looked at the last few times this happened. Here’s what I found: Staying overbought for a prolonged period of time tends to happen when markets flip from being oversold to overbought in a matter of just a few weeks…like now.
The last two times that felt similar to now were in March 2016 and February 2019. Both periods had a lengthy overbought period of seven and eight weeks, respectively. So just because we hit overbought doesn’t mean it’s time to sell yet. It’s like getting off the wave before it crests, because a surfer is worried about a wipeout. That is all fine and good, but the end of the ride might be the best part. We never know.
As for what is driving this rally, it continues to be tech and healthcare. I’ve been highlighting that move ever since we came out of the chasm in late March. April saw capital fly into these sectors, and it’s still happening. In fact, last week we saw big health buying for the first time since February. That sector flashed yellow, meaning more than 25% of stocks in Healthcare that I monitor were bought in a big way:
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
Consumer staples stocks unsurprisingly are not far behind. Perhaps the most notable thing is the near absence of selling. That’s what we’ll watch for next. When the big money starts selling, it’s usually before the indexes drop. They tend to know beforehand, so I watch there for clues. For now: nothing.
I’ve used Laird Hamilton’s great surf quote before: “Surfing is one of the few sports that you look ahead to see what’s behind.” This week it seems appropriate to add a quote from Bethany Hamilton (no relation to Laird). She is a pro surfer who survived a 2003 shark attack, losing her left arm. She returned to surfing and when asked about why, she simply said: “My passion for surfing was more than my fear of sharks.”
Also In This Issue
A Look Ahead by Louis Navellier
How Fast Will These “Record Low” Statistics Return to Normal?
Income Mail by Bryan Perry
Today’s “Tale of the Tape” is a Technology Workplace Paradigm Shift
Growth Mail by Gary Alexander
Cash is King, but This King is Scared
Global Mail by Ivan Martchev
This is a Different Type of “V” Shaped Stock Market Recovery
Sector Spotlight by Jason Bodner
When Does an “Overbought” Market Become a “Sell” Signal
View Full Archive
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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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