Wildfires burn between 4 million and 9 million acres per year in the United States. That seems like a lot, right? But is it? It turns out that there are 2.3 billion acres, with 375 million alone being in Alaska. That means only 4/10 of 1% of the United States burns by wildfire each year. But wildfires are destructive and life threatening. Just look at California's 2018 Woolsley and Camp wildfires, which killed 86 people and leveled 18,000 structures.
Goats are apparently quite helpful at preventing wildfires. If you want to rent some goats, why not head on over to rentagoat.com for all your goaty needs? If that's not your bag, there are controlled burns. These smaller controlled fires torch the dry brush so that it doesn't build up waiting for a lightning strike to start the next CNN headline.
Wildfires are a lot like market volatility. Low volatility is often followed by wild swings in market prices, like a forest with no controlled burning. Brush builds up (low volatility) as the market grinds higher. Then the market hits highs. And the longer we go without a catalyst, the more dry brush builds up. When something hits, the market becomes a tinderbox.
The truth is, occasional turbulence is good and healthy for the market. It's less likely to lull investors into false senses of security. So maybe a controlled burn is in order from time to time. Now, I'm not saying it was his intent, but I do find it a conspicuous coincidence that Trump tweeted about China trade right as the market hit highs. Maybe it was a controlled tweet!
The volatility came unexpectedly, fast and hard. Sometimes you have to turn off the negative news when you see red price action. But remember, the news media thrives on fear. They love stuff like trade wars, Middle East skirmishes and political unrest. Conflict and turmoil get clicks, and more clicks equal more advertisers.
On Friday, May 3, the S&P 500 closed just off all-time highs made April 30. The next Sunday, Trump's tweet kicked up a dust devil that rocked stocks. But investors just bought the dip again. Each day from May 6 through May 10, the market started dropping but closed off its lows, meaning that investors bought it up. That's a sign of underlying market strength during a period of weakness.
With the trade war rhetoric, this is interesting: for the past year, on the original 10% tariff, the prices of Chinese goods didn't rise – they actually fell according to some economists. This is because China just devalued its currency while the U.S. dollar strengthened. That effectively offset the tariff. Now that tariffs have increased, it will be interesting to see what happens.
Last week saw a spike in sell signals. But digging deeper, I saw a simple picture. Selling was in info tech, health care, materials and discretionary stocks. But looking at subsectors, selling was fairly even. Consumer selling was in autos and retail. Materials selling was in chemicals as well as metals and mining. Info tech selling was all hardware, but closer inspection showed that it was centered in telecom equipment and semis. Health care was the only focused selling, as it was all biotech. To me, this simply means that, after a huge run-up since the year began, an excuse to take profits was exploited.
The following chart shows the unusual institutional (UI) buying and selling signals by sector, highlighting the the top five and bottom five industry groups.
Monday's puke was unsettling. But once stock prices fall, the market must rebound. The S&P 500 dividend yield is around 2%, while 10-year Treasuries yield 2.4%. What's important is the way each of these assets is taxed. Dividends are taxed at 23.8% – long-term capital gains. Bond income is taxed as ordinary income – the maximum federal rate of 40.8%. So, the wealthiest investors will do better owning stocks than owning bonds. Look at the table below to see how you end up with more money owning stocks at current yields.
Another reason not to worry is that bad market Mondays are usually good for forward returns. Bespoke Research said that, since the bull market started in March 2009, there were 15 prior Mondays when the the SPDR S&P 500 ETF (SPY) fell 2% or more. On 12 of those 15 occasions, the SPY was higher the next day, with an average gain of 1.01%. One week later, the SPY was up 14 of 15 times, with an average gain of 3.2%.
Our data said something strikingly similar. Remember, the MAP Ratio tracks big buying versus selling. The higher the ratio, the more buying – the lower the ratio, the more selling. Since 2012, we saw 12 overbought periods (MAP ratio of 80% or more) that then fell below 60%. To go from 80% (heavily overbought) to 60% requires a decent sell-off, like now.
Below is a table of these 12 times. "Retreat From High" shows how far the SPY fell from its closing peak. Look at the one- to six-week returns after the ratio falls to 60%: the returns are very strong. The ratio just fell below 60% last week.
Lastly, U.S. companies are strong. According to FactSet, for Q1 2019:
- 90% of S&P 500 reported earnings.
- 76% beat earnings.
- 59% beat revenues.
- The blended sales growth rate for Q1 2019 is 5.3%.
This means: buy the dip. Search for great stocks to own, and buy them on sale. Great stocks bounce higher and faster than regular stocks, and the duds thud.
The media needs to make money! Literally: buy into the fear. Like Ram Charan said: "Drama starts where logic ends." Logic says the U.S. is the place to be. We have the strongest economy and the best companies growing sales and earnings. Owning stocks is more attractive than bonds. Don't let the bears bring you down.
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. We expect unusual selling to slow in the coming weeks, thus creating a buying opportunity.
Disclosure: The author holds no positions in any securities mentioned at the time of publication.