Stocks Are Facing Overhead Supply – February 23, 2023
Markets ebb and flow like waves in the ocean. Eventually there’s a crest, which prefaces a downward pull.
That’s where we are in the data. Stocks are facing overhead supply.
Just 2 short weeks ago, our rare overbought signal triggered. It’s an indicator pointing to extreme appetite for stocks. It rarely lasts and often forewarns of a healthy expected pullback.
The last few days have shown a different character in our data. Certain groups of stocks are under pressure, highlighting a slowdown in overall buying.
Today I’ll walk you through the MAPsignals landscape and showcase the areas dragging on markets. Odds are, there’s more downside ahead. For patient investors, that’s a gift.
Stocks Are Facing Overhead Supply
In early February, stocks were officially overbought. Our Big Money Index (BMI) pierced through 80%, the first time since mid-August.
There were signs of extreme buying that often suggests lower market prices are around the corner. Since then, the BMI has fallen quickly to 73%.
Below I’ve circled the pullback and August’s BMI downdraft:
Now, a 6% pullback in the BMI could send off alarm bells in investors heads, but it shouldn’t. After a massive rally in January, there’s a need for a healthy reset of expectations.
Markets don’t go up in straight line. Air pockets hit when we fly to elevated levels. Our daily buys and sells reveal that after extreme buying (large green bar), a reversion (pullback) is often ahead.
Notice how buying slowed dramatically after the surge in demand. These “forced buying” episodes often lead to near-term market weakness as highlighted in last week’s piece.
Below I’ve drawn arrows at the local crest points. Buying tends to dry up soon after and selling increases. This is supply and demand 101:
After a rally that left many investors scratching their heads, stocks are facing overhead supply. Fears of an earnings slowdown and higher interest rates have taken a toll on investor sentiment.
Whatever narrative you want to create, the fact is data tells the true story. Caution is warranted when we hit overbought levels.
Now, let’s zero-in on the pain points responsible for the pullback.
Two areas facing the brunt of the selloff: Healthcare and Energy stocks. Notably, these were both strong performers last year. The Healthcare Sector ETF (XLV) fell 2% last year while the Energy Sector ETF (XLE) gained 64%.
Those returns easily outpaced the S&P 500 with a -18% return. Investors were heavily overweight those areas so it’s natural for those trends to take a breather.
Health Care stocks are seeing the most selling all year:
Many of these equities being sold are big dividend-rich pharma names. Much of this is likely due to the group coming in overbought last year. There was a scramble for yield and safety in 2022.
Energy stocks have felt the pain too. Profit taking has hit many dividend-growth stalwarts as you can see below:
I’ve highlighted this week’s red and pointed to prior similar instances. Get your shopping list ready as these pullbacks tend to snapback… which is my belief.
Both of these areas are the primary drivers of the falling BMI. This rotation should be used as a time to pick your spots on high-quality names on sale.
Let’s wrap up.
Here’s the bottom line: The BMI is under pressure mainly due to the selloff in Healthcare and Energy stocks. Prior “safety” trades have come under attack, signaling a healthy rotation in 2023.
Most of the stocks being sold are high-quality dividend growth names. As monies flow out of these areas, growthier areas like semiconductors and software have been attracting capital.
Odds are the selloff isn’t fully over given the recent trend. But don’t expect anything like 2022 this year. Breadth readings have been strong, pointing to a healthy medium-term trend.
Buy the dips. Focus on quality!
Author: Lucas Downey