Big Money Index Signals That Markets Will Pull Back

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I asked my 15-year old how he felt New Year’s Day. In teenage blasé, he said: “Earth just completed another orbit around the sun. Yay.” That’s my boy.

I’m not a fan of New Year’s either – it’s just another day. Another rotation of our home: a dust-ball with water and carbon-based life forms. Probability says that there are billions like it scattered through the universe. My and Earth’s birthdays are meaningless. Other planets have totally different years. I feel better knowing I’m 24 on Mars as opposed to 45 here, because a Martian year is 1.88 Earth years. So, if you want to stay young, just quote your age on other planets. I’m four on Jupiter. That’s my New Year’s gift to you.

Markets are dynamic day-to-day but subject to human years. Take the January effect. It’s a perceived increase in stock prices during January. Analysts think it happens after December price drops due to tax selling. For 2019, the market was up 30%-plus, so there was little to sell at a loss! The sell-off prompted by tax-loss harvesting to offset capital gains never happened in 2019. Maybe investors used year-end bonuses to buy stocks, because 2020 is up-up-and away so far.

I’ll be the party-pooper: the market is overbought. Mapsignals’ Big Money Index measures unusually big buying against selling in U.S. stocks. On 5,500 stocks, big-money signals happen roughly 100 times daily – usually 60 buys and 40 sells. The measurement smooths on a 25-day moving average, and 60% is a healthy ratio. Anything under 25% is oversold, foreshadowing a market rip. Anything over 80% is unsustainable and precedes a pullback within days or weeks. That’s where we are now. 

Here’s the thing: it doesn’t matter what month it is. The tale of two Decembers tells that perfectly. December 2018 and 2019 couldn’t have been more different. Don’t fixate on the time of year. Seasonality is real, but I think of it more like a derivative. Meaning this: it doesn’t matter when we are. What matters is what Big Money is doing. Are they buying or selling? What is the balance of money flows? How long can it last? I believe that the answers to these questions hold the keys to the market’s next moves. 

For stocks, buying persisted right through the end of 2019 into week one of 2020. Heavy buying happened in energy and info tech. Keep an eye on energy, as it was so depressed last year. We are starting to see big capital plow into those stocks. Last week, 30% of the energy universe (91 institutionally tradeable stocks) logged buys. Look for fundamentally and technically superior energy companies. Tech companies saw software stocks getting some love.

Buying was even across the board. I believe that money managers must put new money to work. As bond yields remain low and perceptions of recession wane, it’s risk-on for equities.

Maybe most interesting is the mammoth exchange-traded fund (ETF) buying. The last time we saw buying like this was January 2018. That prefaced a volatile year for stocks.

That’s only one data point so I don’t necessarily expect the same for 2020. Below is the chart measuring ETF big activity since 2005, the year ETFs took off in popularity. I wrote a white paper on how I believe that’s when the tide turned. ETFs began to dictate markets, not react to them. You can find that paper prepared for Navellier & Associates here

The circle to the right is now. Notice that ETF buying is good longer term. This makes sense: big buying pushes prices up. But when buying stops, the market has to pause, drop, and reset. Red spikes are when everyone freaks out together. They throw the babies out with the bathwater, including the financial crisis of 2008 through 2009. That’s when to buy. Remember Warren Buffett: “Be fearful when everyone is greedy and greedy when everyone is fearful.”

Remember, we’re overbought. All we need is some volatility to nudge stocks into corrective behavior. As managers invest into the January effect, it lures investors. When they stop buying and there’s a volatility catalyst (an airstrike on Iran?), the market could get cranky. But that’s when to have your shopping list ready.

Like I said, now isn’t the ideal buy time. It’s likely better to take risk off or do some hedging. The opportunistic buyer does not want to buy the high. To be fair, as Milton Keynes said: “Markets can stay irrational longer than you can stay solvent.” That means we can stay overbought for a while. I still think we will start to see faltering equity prices within a week or two. That’s based on my 30 years of data, not just a hunch. But nothing is set is stone. 

There’s one key exception though: TAGU. When you buy great companies, over time they all go up. It’s our mantra at my research shop. It’s the basis of Zombie investing. It’s the key to wealth over time. Don’t focus on your age, or Earth’s age, or the time of year. Focus on where big money is going, and when you can buy TAGU stocks. It works whether you’re 4, 24, 45, or older…

The Bottom Line

We (Mapsignals) continue to be bullish on U.S. equities in the long term, and we see any pullback as a buying opportunity. Weak markets can offer sales on stocks if an investor is patient. 

Disclosure: The author holds no positions in any stocks mentioned at the time of publication.

Source: Investopedia

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