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Postcards from the florida republic
An independent and profitable state of mind.
The emails trickled in one at a time…
Then the phone calls started.
A business-school friend – with an MBA and decades of executive experience…
A financial publisher who’d edited newsletters for 30 years…
A bartender in Washington D.C., A relative in Maryland… And readers from around the globe.
All asked the same thing about my analysis of the markets on Wednesday, August 16.
“What the hell are you talking about?”
Keep It Simple (Stupid)
Please forgive the market jargon and the argle-bargle. My wife has put up with this for years. I explain things in academic and trading world terms… She smiles and nods.
My mother did the same when she edited a riveting graduate school paper, “Executive Accountability in the Oceanic Commons…”
“I don’t really understand any of this,” she said, handing me a marked-up copy. “You also used the word ‘Complement’ wrong.”
The markets are a foreign language. They’re technical. There are many things that require definitions. I see many people asking why the markets are selling off… I try to answer them, but some look at me the same way that I looked at Swiss strangers who spoke Swiss German at me a few months ago. I’ll get better…
So let me take a step back. Let me explain my market religion.
If I don’t do a good enough job at this simple premise… please put a note in the comment section and say: “Explain this part.”
There will be a few terms ahead – but I assure you this is a simple way to look at the state of the market from 30,000 feet.
Whether you’re experienced in financial markets… or are brand new – I want you to abandon all you think you know about why equity markets rise and fall… Forget the fundamentals.
In today’s markets, I follow one metric.
It’s called Equity Momentum.
I stumbled on this subject at the University of Indiana.
A professor recommended I read a book by Grant Henning called Stocks By the Numbers. My father-in-law had also just given me a copy of the book Quantitative Momentum by Wes Grey. And I’d read another book by Gary Antonacci called Dual Momentum.
I was hooked on this subject around 2016.
Tim Melvin and I had begun analyzing how money flowed in and out of the market. That’s easy to measure with technical lines and price movement analysis on roughly 4,500 public companies.
The question was always: Why?
Why would a market suddenly plunge out of nowhere? How could you have Barron’s talking about the next Bull Market one day, and then the S&P 500 falls 20% in a month? How does the equity market drop by double digits in a few weeks – with little insight into why it is happening from the major media outlets?
There’s an answer to this…
But first, let’s explore Equity Momentum itself.
Defining Equity Momentum
First, a few points that we’ll explain through this article.
- By technical definitions, momentum is the speed of a price change in a stock, asset, or index.
- The Daily MACD for the Nasdaq 100, S&P 500, and Russell 2000 is our early signal for trend reversal leading to positive and negative momentum shifts in equity markets.
- We look at how many stock prices move at a certain speed over a certain period…
- Based on the number of stocks breaking out compared to breaking down, we can get a reading of Equity Momentum.
- If momentum is negative, we move to cash, hedge our long positions, and focus on other parts of life.
- If momentum is positive, we actively purchase equities with strong fundamentals and speculate on oversold equities.
Before we get to the definition… let’s start with a visual.
You’re standing on a snowy hill in January.
You push a snowball down the hill.
At the start, the ball crawls through the snow.
But it does pick up more snow and starts moving faster.
It becomes very difficult to stop.
I want you to think of momentum as a snowball effect.
When the trend starts, it’s like pushing that snowball.
And as more investors and traders get in, the trend gains momentum. The more people riding this trend, the more difficult it becomes to slow down.
Eventually, it will slow down due to friction. Market events, big news, or a sentiment shift can stop the trend in its place.
How do we know if that trend is coming to an end?
There are two parts to measuring momentum.
First, if you want to know if a possible selloff is pending, you can look at one technical line. Your early warning metric is called the reading on the MACD.
Don’t be intimidated by the name Moving Average Convergence Divergence (MACD). It wasn’t made in a scientific lab.
Just think of it this way.
It’s a trend line. It follows the price averages of two different periods. If this indicator turns negative (you’re about to see a black line and a red line), it could signal that the trend of rising markets is about to reverse.
Look at the chart in February. That crossover happens around February 6th. But the real damage to the market wasn’t there yet.
Momentum has a second measurement… a confirmation. It is the basis of our reading on the S&P 500, Nasdaq, and Russell 2000.
You might laugh… because it’s simplistic.
We’re looking at the number of stocks falling by very specific rates over a 2-day and 5-day period (daily and weekly reading).
If 100 stocks on the Russell 2000 are down 10% in a week, and 20 stocks on the Russell are up 10% in a week, that is a net 80 companies down double digits in a short period.
Why does that matter? Because these companies all have market capitalizations in the billions of dollars.
This is a MASSIVE flow of money out of the markets.
When more outlier stocks are in breakout mode than breakdown mode – momentum is positive. Capital is flowing into the market.
It’s the opposite for negative momentum – more stocks breaking down at percentage declines than breaking out.
That’s legitimately it.
When momentum goes negative, it’s the exact moment a trickle can turn into a hurricane.
And when it goes positive, it’s like the sun coming out after a blizzard.
The frost is about to melt, and things get back to normal.
When Has Momentum Gone Negative?
We began our analysis of momentum in mid-2018. If I went back to graduate school, my dissertation would look at the data dating back to 2008, when the Great Recession started.
We make do with what we have. There have been many short-term Equity Momentum shifts in the last five years. Let’s look at some of the larger ones.
These momentum readings went negative in October 2018. That preceded a major bond crisis and a 20% downturn in the S&P 500 in December of that year. Momentum didn’t turn positive again until after the Federal Reserve cut interest rates and started to buy bonds again.
What about early 2020? The markets rallied into February of that year, ignoring the COVID crisis hammering China.
Our reading turned negative on February 21, 2020.
What came next was a complete avoidance of a 33% decline over the next few weeks.
I’ve highlighted the date of February 21, 2020.
The reading went positive again on April 6, 2020.
What about last year?
There were multiple negative momentum events.
On June 8, 2022, momentum went negative. The S&P 500 had a double-digit decline in the next two weeks. The Russell 2000 fell almost 13%, as evidenced by the ETF chart below.
In this case – the reading of stocks breaking down was so fast that it preceded a negative turn on the negative MACD reading.
But why did momentum go negative?
We didn’t know right away. We just got out of the way.
We’d find out a week later – by looking at government data – that it was the largest selloff among large institutions (like hedge funds) in 15 years.
On March 7, 2023 – momentum went negative.
We did not know why, but markets had declined for a month. The MACD had turned negative in Mid-February, but the real selloff didn’t come until three weeks later.
If you look on Google News, search “Regional banks” from January 1 to March 7.
You will find no mention of a regional banking crisis.
But within weeks, three large U.S. banks were gone.
Something Is Wrong with Today’s Market
One month ago, market bulls discussed the S&P 500 returning to 4,800. There was talk of the next bull market. China’s central bank showered money at the start of June.
Now, people are starting to panic again. I’m on the sideline.
I do not ever know why momentum goes negative – but it typically involves problems in the broader financial system. Right now, we have three big problems facing the world economy.
1) China is facing deflation (price declines). This can cause serious problems for anyone holding debt.
2) Japan is reducing the incentives for large buyers of U.S. bonds to hold those bonds. It could cause a problem for U.S. equities.
3) The U.S. is struggling to get investors to buy long-term bonds. There is a lot of risk in the U.S. bond markets, which will take much time to sort out.
Can’t This Be Gamed by Institutions?
The question that a lot of people ask is, “How could this momentum measurement fail?”
Well, it’s fair to say that we do have periods of chop – where momentum goes negative one day, positive the next, and then negative again. Nothing is perfect. But you don’t have to marry yourself to daily readings of momentum.
We also focus on weekly momentum readings – as they help confirm a new trend. In addition, we watch the MACD closely.
A weekly reading of momentum is ideal for long-term investors.
Traders, however, are better at using a daily metric.
As I noted, I’m not a big fan of shorting the market. That means betting against the market. In that case, I’d try to profit from the markets or stocks going lower.
There’s a reason for this. One, I don’t like betting against American companies. I don’t like making money because someone just laid off half their staff.
Second, markets can and will rebound VERY sharply when there is action by regulators and central banks to shore up their economies.
If China’s central bank decided to print another two trillion Yuan tomorrow, the S&P 500 and the rest of the markets would likely rally because this would boost global liquidity – and drive money back into risk assets like equities.
This reliance on central bank easing has been the real positive driver in the global markets – since 2010.
I don’t need that headache.
I’d instead just put some cash in a money market account, collect a few percent, and then deploy that cash when the regulators print more money and pump it back into the system.
I hope this explanation helps.
If you want me to clarify anything, please put a comment in the Substack section, and I’ll respond right away.
Secretary of Finance
On Tap This Week
Tomorrow… I’ll discuss a stock I dislike with a burning passion. In a sane world, they’d ban its product and fire everyone.
Saturday, we’ll look at next week’s calendar in Republic Speak.
Sunday is a surprise.
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About the Author
Garrett Baldwin is a globally recognized research economist, financial writer, consultant, and political risk analyst with decades of trading experience and degrees in economics, cybersecurity, and business from Johns Hopkins, Purdue, Indiana University, and Northwestern.