They say you need to be in the right place at the right time, but even that's not a guarantee for success.
For instance, there was a horse named Sham. He was a fast horse. In fact, he was the fastest by measure of almost any Kentucky Derby. He ran it in just under two minutes (1:59.90). His time was good enough to win any Kentucky Derby past or present – except the one he was in. In that race, he lost to the legendary Secretariat by about two and a half lengths.
Timing in stocks seems like it’s everything too. Only it's not. In the long run, it makes a huge difference if you buy outlier stocks at tops or the bottoms. But regardless, outliers outperform all else. Or so says 100 years of history. Dr. Hendrick Bessembinder's paper "Do Stocks Outperform Treasury Bills?" found that only 4% of all listed stocks account for 100% of stock market gains above Treasury bills since 1926.
So, in the long run, you can feel good buying an outlier stock any old day, whether the market is up or down. That may be true, and feeling good about the far future is all well and good, but getting near-term timing wrong can be really aggravating. Many traders must feel that way this long weekend.
So how can us everyday investors in outlier stocks refine our timing to get better entries on great stocks? It helps to take the temperature of the market. Looking at stocks on Wednesday of last week versus Friday would have given very different readings.
The truth is, the indications have been here for a while that a healthy pullback was in order. I've been writing about overbought conditions in stocks for months. In fact, when I called a market bottom for March 20 and missed by one trading day (March 23 was the actual bottom), the buying started and really hasn't stopped since.
That said, the Big Money Index has been steadily falling from its recent peak. The latest period of 84 days was the longest overbought period in 30 years. Finally, we fell out of overbought:
The peak buying may have finally come … Wednesday saw immense buying. It was so large that my research company wrote about Animal Spirits. That's when emotion takes over in place of logic and drives behavior, according to John Maynard Keynes in 1936 (when he coined the phrase). We felt that Animal Spirits were driving the buying behaviors of market participants.
Prior to Thursday and Friday's respective selloffs, investors were high-fiving as many accounts were at all-time highs. The news has no shortage of stories talking about the fantasy-land disconnect between the stock market and the COVID economy. But debates don't matter – prices do.
And when buyers want to buy, they buy. But indications roll around when things become unsustainable. One great indication of a blow-off top is when exchange-traded fund (ETF) buying gets crazy. I'll say it right up front: there is a clear inverse relationship between heavy ETF trading and future market prices.
Let's examine what I mean. Below you see a chart of ETF buying (green bars) and selling (red bars) overlaid against the S&P 500 index. Two things should jump off the page:
- When there is immense selling, it typically lines up with market troughs.
- When there is immense buying, it typically lines up with market peaks.
In case you're wondering, Wednesday saw immense ETF buying. In fact, there have only been 10 trading days in 30 years with 70 or more ETF Big Money Buy signals. Wednesday was one of them.
So, if huge ETF buying means lower prices ahead, what does that look like? I took all 10 times when there were 70 or more ETF buys in a day. I plotted the forward returns of the S&P 500 index out to one, three, six, nine, and twelve months. It's worth noting that September 2012, January 2018, and June 2020 accounted for seven of those days. So, it may be a stretch to rely on this as any real indication. In any event, the forward returns were negative for one and three months.
Lastly, heading into Thursday morning, there was "shock and awe" level buying in stocks. Of eleven sectors, eight (nearly nine) saw noteworthy buying, as highlighted in yellow below. That buying stopped Thursday, which brought out some sell signals, mainly in energy and communications. The monster selling in big tech that we saw hasn't created much in the way of sell signals because the stocks were at such lofty highs. We need to see lower prices pierced to see big tech sell signals.
This is what I think: this selloff was a much-needed return to earth move. Stocks got crazy as day traders saw riches, and sellers were nowhere to be found.
When it looks like stocks all drank Willy Wonka's Fizzy Lifting Drink, they have to burp – otherwise they get shredded by the big fans, just like in the movie. It's healthy to see some red in a sea of green. The longer things go one way, the uglier the come-down will eventually be.
There are bubbles popping with nosebleed price-to-earnings (P/E) valuations. Hopefully, many get hammered back down. But earnings reports are still working great on outlier stocks. They are the ones you want to bet on in both up and down markets.
Back to timing – the Big Money Index is falling, sell pressure is showing up, and stocks are correcting. The last time we saw a swift fall like this was in June, and no one really had time to "buy the dip." If you've been waiting on the sidelines, patience pays off to deploy cash as this epic buying finally takes a pause. Deals will surface, and having a buy list ready of the best outliers (waiting for a sale) is a great way to refine timing.
As for what comes next? In the wise words of Wonka: "The suspense is terrible. I hope it'll last."
The Bottom Line
We (MAPsignals) are bullish on high-quality U.S. equities in the long term, and we see market pullbacks as areas to pick up great companies.
Disclosure: The author holds no positions in the securities mentioned at the time of publication.