Broker Check

Data Beats Bias

| December 12, 2022

Investors should carefully consider the investment objectives, risks, charges and expenses of mutual funds and exchange-traded funds (“ETF”) before investing. Shares of ETFs are bought and sold at market price (not NAV) and are not individually redeemed from the fund.

As we continue to wind down 2022, we can feel how investor tensions are still quite high from a year fraught with war, partisan politics, and economic worries. Fears of a looming “recession” have impacted stock prices much worse than the actual reality of a global virus threatening human life just couple years ago.

Such is life as an investor, I suppose. But our readers know we rely on data, which can tell a different story than what we see in the media and reveal unobvious truths.

So, while fear persists, hard data shows reasons for optimism as stocks are increasingly looking upward. The funny thing is, fear leads to declarations of bullishness or bearishness. But those positions are just premonitions reflecting emotional biases. Instead, we at CFS lean on data to formulate probabilities.

A Foundation Forming?

Some good data-based news came from Federal Reserve Chair Jerome Powell’s speech nearly two weeks ago. As we thought he might, Chairman Powell telegraphed a smaller hike of 50 basis points in December, rather than the typical 75-basis-point jumps we’ve been seeing.

And while he used hedging language like “we’re not there yet,” the market didn’t care. Investors heard “relief” and stocks staged an intraday rally with massive institutional (i.e., “big money”) buying.

This language allowed the 10-year Treasury yield to settle around 3.6%. Our readers know that’s important from a discount rate perspective in our capitalized profits model because the bond market still is the tail that's wagging the equities market dog.

Why does this matter? Because the net results were some intriguing, some might say improbable, technical occurrences that flew under the radar.

One example is the S&P 500 trading above its 200-day moving average. Additionally, after the Fed’s news conference, the Dow Jones Industrial Average traded 20% above its most recent low. That technically puts the Dow in a bull market.

The data doesn't fit the narrative we keep hearing though. Perhaps those technical data points might not mean much. So, what do we do? We look under the hood at additional forward-looking data.

One of our favorites is the Big Money Index (BMI) from our friends at MAPsignals. The BMI is a 25-day moving average measuring activity from “big money” investors like institutions and pension funds. As a result of recent trading, we can see the BMI has been rising steadily to levels only previously seen this year in April and August:

The BMI can move with outsized impacts from either the buyer or seller side. For example, if selling evaporates and we only get a few buy signals, that could be enough to raise the BMI. But that's not what's happening now. Investors are buying stocks at levels not seen since February 2021:

And what we found to be the most astonishing is the enormous buying in exchange-traded funds (ETFs) from “big money” investors (the most since November 2020) and an almost complete evaporation of selling:

Another gauge to measure this rally is whether the buying was fragmented as in past rallies (i.e., focused on one or two sectors) or more evenly distributed. You may remember how earlier rallies were led almost exclusively by energy and/or staples stocks. But the recent buying spreads more across sectors:

Obviously one week doesn't make a market. But our readers know we’ve been slowly pointing out this crescendo of buying for a little while. The recent data allows us to see a clear shift in attitude this time around, especially towards tech, discretionary, and financials. That is a positive sign to be sure.

If you take all this together, it looks to us like smart investors are not buying the overly bearish rhetoric right now. They’re buying stocks and ETFs. Remember that bearishness is more of a hunch than a data discussion. We posit we're starting to see the market begin to look ahead past a potential economic recession that may or may not come in 2023.

Keep in mind, however, this does not remove the chances of another small range-bound dip, especially if we reach overbought on the BMI (80% reading or greater). That would indicate another short-term breather. And we do expect to go into overbought territory sometime later this month or early January. Still, the recent movements and positioning feel like a new foundation due to the broad sector appeal and huge ETF buying.

Speaking of ETF Buying…

It captures one’s attention when monumental ETF buying occurs seemingly out of nowhere. On Nov. 30, we saw “big money” buy 101 funds, which is an outlier when looking over the past 12 years (it was one of three triple-digit buying days in 12 years). To provide some clarity on what investors can expect going forward, when you see inflows of this magnitude, you get historically impressive stats.

Our friends at MAPsignals did some fantastic work to show what happens when “big money” buys ETFs in big order. Prior to Nov. 30, there were 32 instances of “big money” logging 50 or more daily ETF buy signals. Short-term returns of three months or less are middling. That indicates choppiness within that three-month period, like we’ve been seeing. That reinforces our theory that, once the BMI is overbought, we’ll likely have another range-bound dip.

But when looking out a year or more, the returns are historically impressive. On average, a year after huge “big money” ETF buys, the S&P 500 is up 14.6%; two years later, it’s up 24.6% on average:

Buying like this is ultra-rare and won't last. But it's also not a reason to run for the exits at this point, especially for those of us who had the wherewithal to stick through the ugliness of 2022.

Understanding this data reinforces our plan to trim risk and rebalance once the BMI breaks into overbought territory. All in all, this sets the stage for 2023 moving forward with a stronger foundation than most bearish, fear-driven talking heads would expect. We’re hoping again that data beats bias.

Securities sold through CoreCap Investments, LLC.  Advisory services offered by CoreCap Advisors, LLC.  Cornerstone Financial and CoreCap are separate and unaffiliated entities.

Investors should carefully consider the investment objectives, risks, charges and expenses of exchange-traded funds (“ETF”) before investing. Shares of ETFs are bought and sold at market price (not NAV) and are not individually redeemed from the fund.  Investment involves risk and investors may incur a profit or loss regardless of strategy selected.