Patient: "How bad is it, doc?"
Doc: "I have some bad news; you're really sick."
Patient: "Can I get a second opinion?"
Doc: "Sure – you're ugly too."
It's a classic – so bad it's good. We all need a little levity right now. Bad news has us all crawling out of our skin: "Global epidemic of a deadly novel virus."
Epidemics are real, and so is fear causing panic. Shelves are empty where once hand-sanitizers were plentiful. History showed similar fear during the Holocaust. Polish doctors Lazowski and Matulewicz actually saved 8,000 Jews by creating a fake Typhus epidemic. Germans quarantined the area instead of risking outbreaks by sending them to concentration camps.
Fear right now is gripping the market. Epidemics keep people away, and businesses slow. Life may grind to a halt. Italy is quarantining 16 million people. China did the same. Results were good for containing the spread of COVD-19, but the economic impacts could potentially hurl the globe into recession.
So how bad is it, doc? How long until the market gets better? Like any doctor would say – "It depends." For a scientific approach, let's look into the data and check the lab reports.
Sector Lab Work
Ordinarily, I spend time on leading and lagging sectors. That's fine in a normal market. But when fear hits, sector correlations dissolve. The broad picture reflects what we'd expect in a modern unprecedented health scare.
Defensive sectors outperform. Utilities and real estate see less selling. Investors look for haven and yield. As the Fed cuts rates, high dividend payers collect capital – collect being relative as they are seeing less intense selling.
Health care and consumer staples are also relatively hanging in there. Health companies naturally benefit from sick people. It's a sad and undeniable truth. Imagine the one-day soaring stock price of a company announcing progress on a coronavirus vaccination.
Financials are hurting due to rate cuts, with likely more to come. Lower rates hurt bank stocks. Also, as many events and travels face cancellations, insurance companies will see more claims.
My 15-year-old is bummed that Miami cancelled the Ultra Music Festival. The event averages 60,000 attendees per day for three days. Local businesses will get creamed, as many wait for this event each year. Possible insurance liability lists seem endless: artist contracts, vendors, trucking, production crews, security, etc.
Huge selling is obvious in discretionary stocks. Leisure companies like cruises and hotels are getting punished.
Lastly, selling is just plain ugly (second opinion) for energy stocks. Oil cratered on Friday, down as much as 10% intraday. Crude oil closed at $41.57.
Market Breadth Lab Work
Friday, Feb. 28, saw huge big money signals: 1,571. The only other time in the past five-plus years that happened was Dec. 24, 2018.
So, are we out of the woods? No, not yet. Selling on Friday, March 6, was ugly, but not at December 2018 levels. The chart below shows each time the aggregate big money signal count hit twice the 25-day moving average. To simplify, this shows huge volume. The takeaway: generally massive volume coincides with local market troughs.
Looking back since 1990, Mapsignals data showed 139 times this occurred. Average Forward returns were mostly positive but were near-term below average.
The thing is, we haven't hit that level yet. We likely will soon, but not yet. This fits a narrative of probable further downside over the next two weeks.
Market Comp Lab Work
How close to a market bottom are we? Of the past nine trading days, seven saw a daily Big Money Index (BMI) reading of 5% or lower. That means 5% or less of all signals were buys on a given day. That's extreme selling.
This chart shows the 339 times that has happened out of 7,601 days going back to Jan. 1, 1990. Notice again: the instances line up with troughs.
Big Money Index Lab Work
Mapsignals measures huge buying versus huge selling daily. The BMI is a 25-day moving average of these results. Readings above 80% are overbought: markets likely fall soon after. Readings of 25% or lower are oversold and historically have been a buy indicator: markets typically recover sharply after oversold conditions. The BMI currently reads 44.8%, meaning that 44.8% of all signals have been buys on a 25-day moving average.
The first day a market goes oversold is not always the same as the last. Just 276 days out of 7,602 have registered oversold readings. While it's rare, it can last a while. There were 16 oversold cycles in 30 years. Each cycle lasted between one and 49 days. The average cycle was 15 days. Here are the forward returns from both the first day and last day of oversold. Both are very promising.
Again, we are not yet oversold. This supports the narrative of more downside to come. Our estimate to hit oversold conditions is another roughly two weeks.
How Much Longer Until I Feel Better?
Revisiting a week ago, our data indicates a market trough 21 days from when selling was eight times the 50-day moving average. The results are an average dating back to 1990. The lab work says that Friday, March 20, is when we will reach a washout bottom.
Data strongly suggests more downside coming. We are not yet oversold. We likely must retest lows until we can construct a base to rebuild upon. We lag China by a few weeks.
China is successfully climbing back and battling coronavirus. And if the country's market is any indication of what's to come for us, it's a good time to be buying great stocks on sale. According to FactSet, the China Shenzen A-Share index is up 19% from its Feb. 3 low of 1,683.17.
Final thought: don't fear recession. While it may not be fun to live through, the market damage usually precedes a recession as the market is forward thinking. Post-recession returns are just lights out.
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 long positions in Walmart, Costco, and CVS at the time of publication.