The domino effect is something we're all familiar with. There are times when the domino effect can have some catastrophic consequences.
For example, take the curious case of the Cerise Mayo's Brooklyn bees in 2010. It was a wickedly hot summer and the first that allowed bee keeping in New York City. Cerise was a devoted beekeeper, raising her bees in Red Hook, Brooklyn, and giving them the best. But that summer, the normal amber bands on the bee bodies suddenly started turning bright red. The sight of late evening glowing red bees became an enchanting Brooklyn sight.
Oddly enough, their honey was red too. This offbeat problem eventually pointed to the bees "hitting the juice" at Dell's Maraschino Cherries Factory. Someone obtained samples of bee secretions and found they were amped with red dye #40 – the same used in coloring the neon red cherries that sweeten countless Shirley Temples.
Arthur Mondella, the factory's owner, hired Andrew Coté, the leader of the New York City Beekeepers Association, to help find a solution. Coté did, and that was that. But the bees at the maraschino factory attracted attention, and the DA decided to investigate environmental cases such as Mondella's.
After crossing this odd story with a few complaints of marijuana odors near the factory, Dell's was on the hitlist. Investigators stormed into the factory a few years later to find the city's largest pot farm underneath the factory. When authorities came for Mr. Mondella, he barricaded himself in the bathroom and shot himself dead.
In this ironic tragedy, a beekeeper named Cerise (French for cherry) kept red bees, in Red Hook Brooklyn, tainted by red dye from cherries, which led to a massive pot farm bust and the suicide of its owner.
The same type of domino effect was witnessed in last year's market. We detailed this in our exhaustive look into why exchange-traded funds (ETFs) caused the puke of 2018. Fear drove a lack of buying, creating a vacuum of liquidity. Algo-traders seized the moment and spiked volatility. It got too hot to handle for ETF model managers, who hit the sell button. The outflows of ETFs were monstrous and led to massive pressure on stocks that were the components of ETFs. It all bottomed out on Dec. 24.
Did someone now flip the dominoes the other way? We went from heavily oversold on Christmas Eve to overbought on Feb. 7. Leading up to Dec. 24, sellers were in so much control that it became unsustainable. Mapsignals called for a bounce, which came right on time. But now buyers took control, and in six short weeks, unusual buying has become unsustainable.
The MAP (Mapsignals) Ratio oversold signal has been very accurate and timely. The MAP (Mapsignals) Ratio overbought signal has also been accurate, but less timely and less intense. Basically, we find that, throughout history, what goes down must come up, but what goes up may not have to come down – or at least not right away.
In the Mapsignals white paper "Boundaries" published June of 2017 (found here), we went into the expected forward market returns after overbought and oversold boundaries were pierced. As you can see from this excerpt below, the forward returns were very positive for oversold and negative for overbought. Either way, the overbought signal indicated that it is a time to consider not adding risk.
We hit this rare signal again January 2018 and sent out a big update on Jan. 24. The market sank in a big way immediately after. So, when we hit it again Thursday morning (Feb. 7), as some of you may have seen, we shouted from the hilltops. The following is taken from the post that day and is essentially an updated version of the table above:
Now, we have seen points in history when the market stays overbought for weeks, but it started sliding immediately after our update. They say it's better to be lucky than smart, but all this ratio really is saying is that lopsided buying is unsustainable and that the markets should expect some selling soon. It doesn't mean the market will tank – we just expect some giveback, and as of Friday mid-day, this was unfolding in real time. Let's look at what the market was up to last week:
From Christmas Eve lows, the recovery has been massive. Small caps have led the rise, as seen in the Russell 2000, S&P Mid Cap 400 and S&P Small Cap 600 indexes. This is also reflected in the sectors. Info tech, consumer discretionary, financials, communications, real estate and energy are all up more than 15% since their Dec. 24 lows. Defensive sectors like utilities and staples have had the least animated run-up.
However, perhaps the biggest evidence of a rush back to growth is seen once again in semiconductors. Semis were smoked last year and essentially a toxic wasteland. Yet the PHLX Semiconductor Index is up 20% since Christmas – by far the best performer out there. We noticed a major repricing of semis last week with some stellar earnings and heavy institutional accumulation.
The first domino to fall may not get noticed until long after the fact. It helps to pay attention along the way and watch what the market tells us. The market has found its footing after a Montezuma's revenge incident due to forced ETF selling in the later half of last year. The usual worries still dominate, with renewed trade war anxiety stoked by Larry Kudlow last week.
In what I see, big institutional investors have been plowing into stocks at breakneck speed, and now the ratio suggests that a pause is coming. I do believe that we will just resume course higher and that the market will become narrower. What looked like a desperate suicide was really set into motion by red bees. Heed the words of Billy Connolly: "Before you judge a man, walk a mile in his shoes. After that who cares? ... He's a mile away and you've got his shoes!"
The Bottom Line
We continue to be bullish on U.S. equities in the long term but see a risk of a near-term giveback. We see the year-to-date lift in stocks as very constructive. As growth stocks gain on increasing volumes, we believe that earnings season could be better than overall expectations.
Disclosure: The author holds no positions in any stocks mentioned at the time of publication.