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My 10-year old son has recently discovered 80’s music.  As I grew up listening to a lot of 80’s music, some of the tracks he has been streaming in the car or on our Sonos brought back a little nostalgia.  In college, I moved into my dorm room about a week earlier than most and quickly was introduced to Byron, a neighbor across the hall who was playing the Clash at many decibels louder than what I am sure was probably permissible.   

One of the Clash’s most famous songs is “Should I Stay or Should I Go” which now, thanks to my son, is stuck in my head on auto-repeat.   

I hate it when that happens.

But as I began to write this update, I realized that the song title does a pretty good job of asking what is on surely on the top of mind for investors.

After a spectacular run since the March lows, being in the market has begun to feel a bit like musical chairs. I know this is a shocker to all the new investors who have joined the party post March…but, wait for this…

…the market can go down.

September gets a bad rap for being a crumby month for stocks.

And rightly so…

According to Yardeni Research, September has generated the worst returns (-1.0%) in the S&P 500 Index since 1928:

And this year, September has certainly lived up to its notorious reputation.

The S&P 500 declined -3.9% for the month, the worst September since 2011.

It also happened to be the first down month since March, breaking a five-month winning streak.

On top of that, September turned out to be volatile.

After the S&P 500 made a new all-time record high on September 2, stocks turned tail. The index posted four consecutive weekly declines.

The conditions were ripe for a corrective action. After all, the Nasdaq had been trading nearly 3 standard deviations above its 50-dma, as we entered September.

The S&P 500 declined 10% from the peak and found a tradable bottom last at a key level of technical support from the summer (June/July).

At the heart of the reversal was the correction in technology stocks, most notably the so-called FAANG stocks. Between September 1 and September 21, all five of the FAANG stocks suffered double-digit declines.

That said, some perspective is in order. Technology is still by far the strongest asset class in 2020.

Comparative Performance

Now we move into the “scary” month of October. Add the election in 30 days that has the potential to be the most contentious since the Civil War, and a new surge in Covid-19 cases that now includes POTUS and the First Lady, and it’s understandable why investors would be nervous.

Additionally, Investors have been led to believe that October is all about doom and gloom.

Epic meltdowns that occurred in the month of October — such as the stock market crash of 1929 and 1987’s Black Monday — are ingrained into the investor psyche.

And while those events were dark days for investors, the reality of the situation is that October is a month that investors should embrace.

First of all, the month of October has generated a positive average return (+0.4%) since 1929 (Yardeni Research).

And second, more bull markets were born in the month of October than any other.

You see, all the historical weakness in September opens the door to opportunity in October. But clearly, this year has been unlike any other. So rather than speculate, let’s look at the market through the lens of “what is”.

First, our Market Timing Indicator (MTI™) provided us a well-timed sell signal on Sept. 4 (always updated on the Member’s dashboard).

Now, one of the key data points that used by this indicator is the NYSE Bullish Percent Indicator (“BPI”). (I will be hosting a webinar to discuss this in greater detail- stay tuned). Developed by Abe Cohen in the mid-1950s, the Bullish Percent Index was originally applied to NYSE stock and measures the percentage of stocks on the NYSE that are in bullish control. When it’s rising its plotted in “Xs” and when its fallings it’s plotted in “Os”. A more in-depth article can be found here.

In a healthy market, we typically will see more than 50% of the stocks in bullish control and increasing. In a weak, bearish market, we see the number falling and below 50%.

The MTI™ uses this data in a precise way with a set of established rules that creates the specific buy and sell rules.

Understanding the “True Market”

The reason that I think it is important to pay attention to the BPI is that it gives us a clearer picture of what is actually taking place “in” the market. Currently, five stocks account for 25.3% of the S&P 500’s performance.

In the previously displayed “Comparative Performance” graph, one can see that the equal-weight S&P 500 (RSP) is actually negative for the year. By looking at the cap-weighted S&P 500 index that is the investment industry benchmark, we fail to see what is taking place beneath the surface among the majority of stocks.

To put it another way, the aggregate cap-weighted return for the 495 non FAANG stocks is -2% YTD.

The BPI is like having an x-ray to stock market, not distorted by the effects of cap-weigthing.

We can also take this one step further and do the exact same type of analysis at the individual sector level.

Let’s take a look at this year’s worst performing sector – Energy.

Energy stocks have been under intense selling pressure. Here we can see that within the energy sector only 13.25% of the stocks within that sector are controlled by the bulls.

And the performance (or lack thereof) speaks for itself. Energy (XLE) is down a whopping 48.62% YTD!

Now this is where it gets fun. And once you see the market this way, you will never look at the market in the same way again.

The Industry Bell Curve – Your Guide to the Stock Market

The following charts are what I refer to as “industry bell curve” or “sector breadth charts”. Here is how they work.

  1. We first divide the “market” into 45 industry groups.
  2. Industries with rising BPIs are color-coded blue.
  3. Industries with falling BPIs are color-coded red.
  4. The scale along the bottom is the percentage or level of the BPI. So an industry that had a reading of 50% on the BPI chart would be dead center.

We now have a means of looking at the market in a new and visual way that can not only tell you the general health of the market, but also, what is working and what is not.

Here are a few snapshots from 2020:

At the end of January, just before the market peaked, there were 20 industry groups bullish and 25 bearish. The distribution was pretty normal with the groups distributed fairly evenly on both sides of 50%.

By February 27th, EVERY industry group was red and the internal BPI readings were plummeting as evidenced by the left-hand skew of the chart.

On March 16th, one week before the market’s “official” bottom, the industry curve displayed historical levels indicating an extreme washed out condition.

One day later…evidence of buying began to show up.

And just a few days later, EVERY industry group was being bought.

If we fast forward to the beginning of September we see that more than half of the industry groups were controlled by buyers and the curve was slightly right-hand skewed.

But how quickly market conditions can change. In three short weeks, just one industry group remained blue.

And now today.

Over the last week, we are seeing more industry groups turn to blue. This is telling us that buyers are stepping into the market.

And this notable improvement has begun to show in the broader markets.

The S&P 500 gained +1.5% during the past week, snapping a four-week losing streak and the price-weighted Dow Jones Industrial Average gained 1.9% during this past week.

The technology-heavy NASDAQ Composite also gained +1.5% during the past week, adding to the +1.1% gains of the prior week.

But the “blue ribbon” for outperformance is awarded to Small caps–the S&P 600 gained almost +5.00% and the Russell 2000 gained +4.36%.

So, while the news of the day may be confusing or even scary, the only thing that really matters is that buyers are stepping back into the market based on the empirical evidence of the Industry Bell Curve.

Some Closing Thoughts

The credit markets are signaling “risk-on” as High yield bonds are a top holding in the Drawbridge algorithmic models for October.

The QQQ’s are again above their 50-day moving average as has the SPY’s.

That said, I will watching the 3425-3450 region on the S&P closely as that level was touched twice during the September correction and acted as resistance. A close above that “line in the sign” would set the market up for another run to new highs.

In closing, remember that when you look at the “market”, that you consider the “true market” and not just the popular averages. The real story is always found digging deeper.