Broker Check

Transition in Market Thinking

| April 03, 2023

It’s the first trading day of a new quarter and we’ve been researching. We recently completed our systematic quarterly rebalance and shift in allocation. But wouldn’t it be nice if there was an early detection system to indicate when markets will move, sort of like a market radar?

There is (we often mention it). It’s the trusty Big Money Index (BMI) from our friends at MAPsignals. The BMI is a 25-day moving average of “big money” investor buys versus sells. It tracks the daily actions of market-moving professional investors. The BMI helps us understand when markets reach cyclical transition periods.

For weeks we've been tracking the precipitous drop in the BMI since it left overbought territory on Feb. 15. That decrease signals heavy “big money” outflows. But we’ve also mentioned higher highs and higher lows. There was a bit of a plateau in the BMI around the turn of the year before hitting overbought. That shows a higher floor than in October 2022:

It seems something similar could be occurring now. Interestingly, the BMI so far has bottomed out at 29%. As of this writing, it’s at 32.9%. The BMI stalled a bit right before oversold territory due to selling drying up:

The recent deep red sell bars are a bit higher than average. But they’re moving closer to zero. And they’re not as deep as some of the selling we’ve seen in the past year:

Overall, this action could be indicative of a higher low than in December 2022 (and noticeably higher than in October 2022). We’ll have to keep an eye on this, as it might just be a short pause. But if not, it would be a great indicator of a higher market floor.

Of course, it would be great to know when the BMI could go oversold because that usually indicates a strong reversion buy signal. Recently, the 25-day average of “big money” daily buys is 30 against 111 daily sells. Should that continue, the BMI could go oversold on or around April 5 if selling picks back up again in a worst case scenario.

As MAPsignals’ sector ranks show, there is still strength in technology, discretionary, and industrial stocks. The weaker areas are those more sensitive to interest rates, like financials, utilities, and real estate:

Don’t forget the market is a forward-looking machine. We think “big money” investors are looking ahead nine months to a year and thinking about technology and discretionary companies showing solid financial performance. The world may seem bleak now, but “big money” is betting that won’t be the case in a year (when interest rates may be falling, which would rocket stocks upward). Obviously, data can change, and unforeseen events occur. Still, this is what we’re seeing now.

Let’s reflect more on the stock market in 2023 so far. Despite banking blowups, geopolitical tensions, and interest rate hikes, this chart shows the significant outperformance of tech and discretionary winners versus more rate-sensitive companies:

Tech firms account for four of the five best-performing stocks in the S&P 500 this year. That’s quite a turnaround for the sector after a brutal 2022. Investors may be thinking the sector was hammered too hard last year and are buying up value. But something must also be said for many tech firms’ new focus on efficiency and costs.

This transition in market thinking indicates a demand for growth sectors and a distaste for rate-sensitive sectors. We've been pointing out this growth sector transition for the last two months. It comes on the heels of the recent Federal Reserve decision to raise interest rates by 25 basis points. While our readers know we would have preferred no hike, which would have likely brought an aggressive market rally, it can be argued that the 25-basis-point increase is right in the sweet spot – not too hot, nor too cold.

That said, the Fed’s Jerome Powell did cause concern when he proclaimed, “There are costs to getting inflation under control.” But we continue to think those are yesterday’s problems.

The estimated terminal rate is now 5.1%, with the Fed’s target range of 4.75-5.00%. This indicates the hiking is basically done, save for perhaps one more small mistake of another 25 basis points.

Despite Powell’s hawkishness, the market rallied initially. But that was short-lived. Once Treasury Secretary Janet Yellen walked back her earlier comments on deposit insurance increases (while Powell was speaking), markets turned red. This is a great example of the real-time “foot-in-mouth disconnect” between the Treasury and the Fed.

What this means for stocks is that interest rates are plateauing. Remember, economies change based off momentum. They rarely do what they did during the height of the pandemic, when free money, stimulus, and liquidity provided a huge (artificial) boost meant to save us all.

See, breaking addiction is tough and time consuming. People were used to the “free money” days, but those are effectively over. We’re now working through that change in landscape.

The best-case scenario is that the Fed realizes that rate hikes aren't its only tool for restrictive policy, especially when the hikes are used like a blunt object rather than a surgical knife. The banking crisis and resulting tougher borrowing environment will be more effective than any of the Fed’s interest rate actions when it comes to curbing inflation:

In other words, the banking crisis did what the Fed couldn’t. The more restrictive environment confirms our belief that we're closer to the end than the beginning, which brings much more clarity. The Fed must walk a tightrope, but barely avoiding a full-blown crisis was a bit too close of a call.

Surely the Fed wants to avoid further damaging a fragile economy. Thus, we envision only one more hike of 25 basis points. We also think lagging data will quickly begin to show mediating inflation, especially in areas like shelter. The Fed futures market reflects this too (notice the shift from month-old forecasts in light blue):

Rates easing will further benefit tech and discretionary stocks, making the “big money” transitionary moves seem even more prescient. Heck, we may even see a rate cut at some point. So, in a weird way, failing banks were a great remedy to the Fed’s “fixes” and will likely keep the central bank from falling on its own sword.

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