Massive ETF Buying Was a Bearish Signal Again

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I have a nasty habit. Everybody knows driving barefoot is illegal. Yet, I can’t help it; I drive without shoes. I’ve heard that many race car drivers preferred driving barefoot: they could feel the car better. I’m no Andretti, but is it illegal?

It’s an urban legend; driving barefoot is not illegal in the United States. No states have laws that require footwear while driving. Some states even recommend driving barefoot over high heels, flip-flops, or boots that add extra pressure to the gas pedal.

Humans are habitual. Once something is in our heads, it usually stays that way despite contrary evidence. I’ve been warning of a market pullback in the second half of January for many weeks now. I felt that the January effect would lose steam. Pension funding and new annual investment would give way to something else: the market was heavily overbought. The data said so.

But many I talked to saw no signs of slowing. Every dip was bought. Every headline was shrugged off. Last week, the cracks in the “Buying Dam” finally gave way, and sellers came rushing in.

So, what’s to come? As always, I look to the data … There are a few key points to consider:

  • The Big Money Index (BMI) is falling. Until buyers show up, we will see selling pressure. For weeks, the market was one-way buying. We highlighted it constantly. When big money investors move stocks in an unusual way, I get signals. To simplify: the top of a price range is a buy signal. The bottom is a sell signal. We saw virtually only buy signals for many weeks. The BMI measures these signals over a 25-day moving average. Above 80% is unsustainable buying. As you can see, the meter was in the red for a while. But when it falls, look out below!

On Jan. 21, the BMI peaked at 87.6, meaning 87.6% of signals over the prior 25 days were buys. The next day, I published a white paper for Navellier & Associates detailing how volume data called for lower markets in the near term. You can find that here.

  • Today the BMI is 74%. Selling only started recently. We won’t revisit overbought anytime soon. Looking at the BMI another way, the next chart looks at net buys vs. sells. More buys than sells means a green stick. More sells than buys means a red stick. Notice that, from October, there was only green? Markets went straight up. But when red sticks come, markets sag. Sellers take control. It may be short term, but this spells turbulence ahead. Look at how suddenly red shows up:
  • Exchange-traded fund (ETF) buying also plummeted. For weeks, we highlighted how abnormally high ETF buying is a contrarian signal for near-term market prices. Look at the chart below and note how selling suddenly picked up. After weeks of green, here comes the red.
  • Sector selling has been brutal for energy. Almost everything got hit last week, but energy was really beaten up. There hasn’t been a single buy signal in the entire sector in six trading days. Keep an eye on it; energy is not yet oversold, but if selling continues, we will be well on the way. Should there be retaliation by Iran for U.S. airstrikes weeks ago, we could see a major spike in the price of oil putting a bid into energy stocks. The exception for buying was notable in utilities. This is a classic risk-off trade and a clamor for yield as equity risk suddenly comes out of favor, if even very short term.

So, I said that there would be lower markets by the end of January, and I got it in under the wire. But what lies ahead? We are waiting to buy stocks. Here’s why:

  • Friday’s selloff was certainly a healthy pullback, but it wasn’t capitulation … it was orderly. We are making plans for a further drop to scoop up great stocks on sale.
  • China’s coronavirus outbreak is spreading to the U.S. private sector. Several companies like Apple Inc. (AAPL) and Starbucks Corporation (SBUX) are closing locations. Any economic fallout from the impact of the Wuhan outbreak will actually strengthen this country’s standing in the trade negations. China will be at even further economic disadvantage. 
  • U.S. stocks are still beating sales and earnings forecasts, and analysts are forced to revise their estimates higher. Of companies reporting fourth quarter results, 73% beat earnings, and as of last week, according to FactSet, 67% beat sales.
  • Rates collapsed. The 10-year Treasury yield is at 1.52%. The dividend yield on the S&P 500 is 1.81%. So before taxes, you win with stocks. But because bond income is taxed at ordinary income rates, after taxes, you end up with 53% more money in your pocket holding equities. With the two-year yield at 1.32% and FOMC rates at 1.5% to 1.75%, the market is looking to force a rate cut.

This is all bullish for stocks. Don’t let coronavirus scare you too bad. While it’s serious, the ordinary flu is way more fatal so far. Stocks went up too far too fast and need a reset. It’s healthy and here. Health scares are a convenient excuse to sell when Middle East tensions and impeachment hearings don’t raise an eyebrow. Right now, watch and wait, because selling should continue. But when it stops, the rush into stocks should be swift and fun to watch. Even better to take part in!

Sun Tzu: “He who is prudent and lies in wait for an enemy who is not, will be victorious.”

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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