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Don’t Get Seasick Now, Such Action Has Been a Strong Reversion Signal

| October 02, 2023

The ocean is no place for people with weak stomachs. Equities markets aren’t much different right now.

We’ve written many times how August and September are historically the worst months of the year for stocks. That was true this year (so far), and it probably feels like we're in the eye of a storm at sea right now.

Interestingly, studies have shown that people prone to seasickness can get sick merely by thinking about it. Many investors might look at the recent volatility and have the same nauseous reaction. That’s understandable given recent selling:

Stocks are splashing around like a hurricane. As of this writing, we saw the tech-laden Nasdaq Composite Index drop 3.5% and the small-cap heavy Russell 2000 fall almost 4% in the last week.

But the good news is that market sickness, which is fear-driven, isn't a given like seasickness, which is a medical condition. When data is our guide and we look farther out over the horizon, it seems like everything will most likely be fine.

For some context on this capitulation, remember that markets are still up significantly from their October 2022 lows – and growth stocks led the way:

None of this is obvious to most people from just the past few weeks of equity performance. The capitulation selloff started with the technology, discretionary, and industrials sectors. They’ve been joined recently by the staples, health care, and real estate sectors (i.e., more “conservative” sectors).

However, there are teachable moments from previous periods like this. While it sounds contrarian, spreading capitulation is typically a strong indicator of the washout coming to an end. The data is littered with the theme of extreme selling preceding rises in markets, exchange-traded funds, and individual sectors (we will likely produce a blog post on this topic in the coming months).

But what does that mean right now?

Let’s start by saying (yet again) that August and September are historically the worst performing months of the year for stocks. And while those months were tough this year, October is here, and it begins the historically best time in the calendar for stocks (the fourth quarter).

Recent selling pressure, especially in tech and discretionary, has drawn those two leaders back to the pack enough that the only sector currently performing – energy – was able to jump ahead and snatch the top spot (see below). As discussed last week, this is direct result of the 34% price rise in crude oil since June.

So, we’re ending the seasonally worst time of the year with lots of negative news headlines swirling around. But if we examine the fearful narratives, we may come away with a different viewpoint.

  1. Potential government shutdown – is that really a bad thing?
  2. Inflation fears – when underlying data shows it’s dropping like a rock?
  3. Interest rate hikes – even though the Federal Reserve just paused indefinitely?
  4. Automotive strikes – don’t strikes end at some point?
  5. “Exploding” bond yields – this is the true cause of the capitulation.

One of these things is not like the others, and it’s the bond yields. But, as has happened every time this year, inevitably bond yields will come back in line with the market:

If bond yields are the reason for decreasing stocks, why is this taking place? Investors sell bonds in anticipation of higher yields associated with higher rates. Most often we see bond yields rise higher and equities run higher with them because people sell bonds to buy equities. But right now, bonds are being sold and equities are facing headwinds.

According to government figures, as of Sept. 9, 2023, there is almost $6 trillion now in money market accounts. But if you look beyond the horizon, it’s inevitable that these money market funds will come back to the market via equities and bonds once uncertainty dissipates.

To summarize, we have a weak time of the year coinciding with bonds and equities being sold. It’s the perfect recipe to tease up stock capitulation.

This is further reflected in the activity of big money” professional investors. MAPsignals’ Big Money Index (BMI) is a 25-day moving average of stock buys versus sells by “big money” investors. It fell to 35.7% as of this writing:

It’s possible this capitulation has already occurred in some corners of the market. We’ve already experienced heavy-to-extreme selling in both stocks:

And exchange-traded funds (ETFs):

But don’t get seasick now, such action has been a strong reversion signal, historically.

Also, history and data indicate that the eye of the storm is already passing. So we must keep an eye on the horizon – like we’re in a rocking ship – to navigate through the volatility. As former U.S. President Franklin D. Roosevelt said, “A smooth sea never made a skilled sailor.”