Almost four weeks ago, it seemed the world was ending. You couldn't open a website or walk past a headline without seeing the words "bear market" everywhere. People were goading me, saying things like, "Are you still bullish?" and "I am guessing you're just as bullish as ever." My usual response was that, while it was hard to be bullish when everyone is decidedly not, I had to go with my data. And the data said to be bullish – this will pass.
If I were a doctor making a dire diagnosis, it would not please me to be right. But I'm not, and I was making a prognosis for a swift recovery of the market. So, I can tell you, it pleases me to be right. Since Dec. 24, 2018, the four major indexes have rocketed higher with massive gains in less than a month.
It doesn't really surprise me that the sectors enduring the most punishment are remarkably resilient in this new 2019 year. Energy rallied more than 18% since Dec. 24. Consumer discretionary, littered with growth stocks, shot up 17.1%. In fact, eight out of eleven sectors were up more than 10% in less than four weeks.
The laggards, (if you can call their performances "lagging"), were defensive sectors. Real estate vaulted only 9.3%, staples were up 7.5% and utilities gained 3.1%. After writing for weeks and inserting charts that were only red, it's a welcome change to be seeing green.
So yes, I'm still bullish. Now that's not to minimize the damage that was done. The sheer scale of the slide we all witnessed was colossal and fearsome. Over here, as we've been saying, we are pretty certain that exchange-trade funds (ETFs) caused the chaos. We just completed a study of 20-plus pages on this, but the 30-second version is as follows:
ETFs rose in popularity from one ETF in 1993 to currently over 2,200 with $5 trillion of assets in them. Many of the passive vehicles were directed by model managers – outsourced fee-based strategy managers. They had sell-stops that were triggered by a lack of "dip buyers" starting in the summer of 2018. Algorithmic traders took advantage of low liquidity and shorted heavily. Sell triggers were hit, and model managers told their financial advisors to sell. When you only have a few hundred liquid ETFs to trade out of the 2,200, and one stock can be present in almost 200 ETFs, you get "ugly." A watermelon is quickly shoved through a keyhole, and all stocks get abused because they must absorb the impact of sell-hedging from tens of billions of dollars in outflows in a few days.
The fact that we are seeing a swift recovery doesn't surprise me – nor does seeing buying pick up in growth names. We are seeing previous growth champs rise to the top of our 20-buy list again – and just look at how the Russell 2000 is regaining ground faster than any other index above. This is an encouraging sign here. A drop-off in unusual sell signals, replaced by slow and steady buy signals, rotating from defense into more growth names – all with a major drop-off in volatility – is a good sign. Add to that our MAP-IT ratio steadily climbing, and you get a great sign.
In the past weeks' essays, I offered studies about what to expect after sustained periods of a depressed ratio. I also went over what to expect after oversold conditions. Both were very bullish in the near term and the medium to long term. This week, I decided to take a trip into, well, "trips."
Out of 5,500 stocks, we find that 1,400 on average can absorb institutional trading without major impact to price. A stock that flags our scans for unusual volume and volatility indicates potential unusual institutional trading. Each day, when we run our models, we get an average of roughly 500 stocks that "trip" the model for this type of unusual trading. From those 500, we get approximately 100 unusual buys or sells – stocks breaking out above a high or below an interim low – with 61 buys and 46 sells on average each day looking like this:
Looking at data from the past has provided us with important insights about what to expect. So far, these insights have been spot on. So, I wanted to know what happens after monster trip-days. When I look at our model and see 1,000-plus stocks tripping the model on one day for unusual institutional activity, I need to take notice. That means over 70% of our institutionally tradeable universe is trading on above-average volume and volatility. We now know that situations like that occasionally occur with big up days in the market, but they usually coincide with big down days in the market. So, what should we expect after they happen?
This week, I did a study to find out. I went through our data from 2011 on and pulled out days when we found 1,000 or more stocks showing unusual activity – that's 70% or more. I then calculated forward returns one to twelve months out for the four major U.S. indexes. Let's look:
From 2011 until today, there were 64 instances in which 70% or more of our 1,400 institutionally tradeable stocks flagged unusual activity on the same day. The average for those 64 times was 1,133 per day, which is closer to 81% of the universe flagging unusual activity. As you can see below, the forward return profile was very positive. For example, the forward three-month return of the S&P 500 was positive 75% of the time (48 out of 64) to the tune of +2.7%. To the right, you see that, on average over all periods, the return was +4.3%, 68.5% of the time. The Russell 2000 showed slightly stronger results.
To be fair, I wanted to present the data including 2018. The end of 2018 greatly skews returns downward due to the monstrous sell-off late in the year. Even still, seven out of ten ain't bad. When we remove 2018 and survey 2011 through the end of 2017, we get a much more bullish picture. The S&P 500 was positive 100% of the time three months later for an average return of +6.5%! The average 12-month return for the S&P was +14.9%, while the average 12-month return for the Russell was +16.3%.
Again, no matter which way you look, the data is bullish for this post-washout period. When things get hairy and uncertainty is as high as a giraffe's ears, pessimism reigns supreme. That's the time to dig into data. The data said, "Be bullish," even though everyone was prepping their bunkers. The data now is even more bullish. So, if someone says to me, "I bet you’re just as bullish as ever," I'll say, "Yes I am," until the data says otherwise.
The Bottom Line
We continue to be bullish on U.S. equities. We see the lift in stocks year to date 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 the securities mentioned at the time of publication.