Capitulation will Ignite a Violent Equity Rally – October 05, 2023
The “expect equity weakness” narrative has reached a feverous pitch.
We’re now approaching the later stages of this pullback, and that means…
Capitulation will ignite a violent equity rally.
Fear is swirling. Doom lust is rampant. The crowd is bracing for a never-ending rise in interest rates.
We’ve heard these seductive tales before. If you recall, doom-loopers prophesied in recent years that:
- Energy companies will go out of business (circa 2020)
- Homebuilders are doomed (circa 2022)
- F.A.N.G stocks are broken (2022)
Those memorable focus-on-today analyses achieved their designed goal: media engagement. I’ve learned that following the crowd rarely pays off.
What has paid off in spades is undeniable proof that extreme bearish institutional positioning prefaces monster rallies.
If you’re unable to look through the media distractions, you’ll miss the massive setup.
Stocks and ETFs See Extreme Selling
Since the end of July, institutional support for markets has faded. Big investors have been dumping stocks for months.
Our alarm bells rang loudly on July 27th as the Big Money Index (BMI) reached the overbought zone. We gave an evidence-based narrative that a summertime pullback is coming.
Since then, the S&P 500 has fallen 5.74%. The Russell 2000 dropped 11.25%. That’s quite a bit of carnage.
It’s now time to be less fearful and more cheerful.
Weak breadth has sent the Big Money Index (BMI) in freefall mode:
As a reminder, the BMI is a real-time money flow indicator. A ton of destruction has occurred under the surface. Currently, it’s inching closer to the most bullish granddaddy signal of them all: Oversold.
To get oversold, we need to see broad-based capitulation in equities and ETFs. That’s the signal that forced selling is underway.
That’s what we’re witnessing in stocks. Below plots the daily buys and sells of stocks. On Tuesday, 347 stocks were sold. That’s the most since March.
Over the past 3 years, these capitulation signals preface face-ripper rallies:
The same risk-off footprints are seen in ETFs. On Tuesday, we saw 197 ETFs sold.
Below you’ll see the relationship between ETF capitulation and forward market performance. Said simply, investors dump ETFs at bottoms:
It’s one thing to dwell on the here and now. It’s another to look out into the horizon. There’s a great chance that we’ll see a mega rally in Q4.
Capitulation will Ignite a Violent Equity Rally
Last week I told you to brace for impact. Reaching oversold conditions is fraught with equity pain and discomfort.
On average, the S&P 500 falls 3.8% in the 2 weeks leading up to the green zone. That’s the now. What comes next is most important.
In the market’s darkest hours, life suddenly emerges.
As a reminder, here are all oversold instances since 1990. The BMI navigated us during 2022, COVID, 2018 and beyond.
I’m betting it’ll do its job in 2023. Capitulation will ignite a violent equity rally.
3 months after oversold, markets rip 5%. A year later they rally 15.1%:
Don’t focus too much on today’s red markets. You’ll miss the parade.
And it’s not just an oversold BMI that sets markets up for success. Seasonal tailwinds are quickly approaching.
In pre-election years going back to 1979, November – December see the S&P 500 gain an average of 3.15%. I’ve also included the average returns the following year. Check it out:
Folks the stage is set. I’m betting that capitulation will ignite a violent equity rally. I’ve seen this playbook many times before.
It’s coming.
Once we reach oversold and the BMI starts heading northbound, the crowd will be stunned at how fast DOOM shifts to BOOM.
Don’t be scared. Be prepared.
These events are rare and offer some of the best stock picking you’re gonna get.
Let’s wrap up.
Here’s the bottom line: We’re seeing the most stock and ETF selling in months. It’s a setup we’ve seen time and time again. Media fearmongering suggests rising interest rates will doom equity markets forever.
Author: Institutional Money Flows