Where there's a will, there's a way.

Here's an example. In the 1980s, there were few German princesses left. One of the last, Princess Marie Auguste of Anhalt, was in trouble – she was broke. She was so broke that she started a business adopting adult men. That gave them the royal title of "Prince." They would pay for this service of course. This way, about 35 regular dudes became "princes," and in the process, she made millions.

Leasing royal titles aside, many look at this market and must be thinking that the market is willing itself higher. It should be no secret that the market is a forward pricing mechanism. The current rise of more than 30% from March lows is forecasting a swifter recovery than the media anticipated.

Whether or not the market is accurate remains to be seen. But one thing by now should be clear: the market movements and media headlines are decorrelated more often than not. It's the human deep-seated desire for reasons and stories for outcomes that drive our need to know why the market is doing what it is. We need a story … most of us can't just accept that things are.

I remember frustrating the heck out of people in an exchange like this: 

Person: "Why is the market going up?"

Me: "Because it's going up."

Man, that annoyed them … but the truth is hard to accept: There isn’t always an immediate reason available. In fact, most of the time, the reason comes after the move. 

So if we can stop trying to know in our bones why the market goes up or down, maybe we can just look at what the market does historically for an idea of what it will likely do in the future. That way we can sit back and nod our heads in a quiet "aha" moment, having been positioned correctly before knowing why.

It is counterintuitive, I admit – especially when talking about risking money. It's like asking you to sit at the poker table and giving you a playbook, only you don't know the rules of the game or how to play. You just follow instructions that say: "When you receive two aces, you have an 81% chance of winning heads-up; therefore, bet 80% of your chips." With a hefty stack of chips, you'd be happy finding out why later as opposed to being infatuated with knowing why before you bet.

So it goes right now with the market. Several people reached out to me last week certain that the market would crack. They initiated short positions. They wanted to know the moment it would turn. Indeed, the S&P 500 index did finish 1.7% lower for the week, but not without staging a 3.3% rally from Thursday morning lows – still near three-month highs … But why?!

Bankruptcies are on the rise. Airline travel is down 95%. Unemployment is monstrous. Restaurants are getting read their last rites. Reopening is being met with skepticism and reluctance. Schools remain remote. Summer plans are total question marks, and leisure travel is the stuff of dreams for next year … maybe. 

The world sucks right now, but the market is going up … why??? Here's why: because it’s going up. The real question to ask is: "What will the market likely do next?" My advice? Ask that and resign to find out why later. The best way to answer the real question is to look at history. What does the data say for situations like now.

First though – what is the current situation? When markets trend along, it's important to know the leading sectors and lagging ones. Right now, the story hasn't really changed. Tech and heath care still lead, while energy, utilities, and real estate lag. Below you can see the weekly stock buys and sells. These are the big money signals according to Mapsignals:

Table showing unusual institutional (UI) buy and sell signals by sector

There are plenty of reasons why that is. Health care stocks are seeing an obvious bump due to increased health needs and demands of the pandemic. Cloud computing life is exploding with stay-at-home orders persisting. The endlessly increasing reliance on technology is being accelerated for practical reasons.  Energy prices continue to be low and volatile. Consumer discretionary stocks are not looked on favorably, as dismal numbers were released last week. 

Sectors help in smoother markets, but when markets are volatile like this year, we must pay closer attention to the overall picture. Are we oversold or overbought?  In early March, the data looked to be headed toward being oversold. I came out and said that the market should trough on March 20. I did this by looking back over 30 years of data to provide a predictive framework. The market actually troughed one trading day later on March 23. The S&P 500 vaulted more than 31% from there. 

Now the Big Money Index (BMI) says that we are firmly overbought (over 80%) and sits above 90%. So, I did the same thing. I looked back at all overbought instances since 1990.

The Mapsignals BMI was overbought for 1,403 trading days out of 7,650 observances (18.3% of the time). This was spread across 67 periods. The longest overbought period was 99 calendar days (68 trading days). The shortest was one day. The average forward returns for the market were mediocre but positive. That means adding risk when overbought doesn't provide nearly the asymmetric payout potential as doing it when oversold.

Table showing average returns after overbought market conditions

The key is to see when the data shifts (i.e., the BMI starts falling) in order to determine possible market reversal points. We want to know that money is coming out of stocks, even if the indexes are rising. I have said that we could stay overbought for a while now. Remember, the max period of being overbought is well over three months. These are the four longest periods:

Table showing the longest overbought periods

This data says that just because we're overbought doesn't mean lower prices. The market is telling us: "Never mind the reasons – where there's a will, there's a way." It's been that way for a long time too. George Herbert first had this as one of his Outlandish Proverbs in 1640: "To him that will, wais are not wanting."

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 any mentioned securities at the time of publication.

Investment Research Disclaimer