Right now, markets are entering what I like to call the “bonus level.”
The whole “bonus level” concept in old video games was meant to prepare you for the boss level – the hardest part of the game. There you could rack up health points, extra lives, and coins. Basically, it let you stockpile supplies you’d need to do battle.
The reason I say this has to do with our Big Money Buy/Sell Index (BMI) – which just crossed into overbought territory…
When the BMI busts into overbought conditions, it tends to stay there for a bit. This is when stocks can rack up “bonus points.”
The thing is, if you’re a good player, you can stay in the bonus level for a while. The BMI’s 30-year history says stocks could stay overbought for weeks, even months.
Historically, the BMI stays overbought for four weeks or so. My data says the BMI should peak around January 6, and then we should expect the market to peak shortly after.
That might sound scary to you. You might even think you should go sell all your stocks and go into cash, to avoid the volatility that’s most likely coming. But in today’s essay, I’ll show you why staying in the market for this “bonus level” will make a huge difference in your performance…
Why Now’s Not the Time to Sell
Even though I think a healthy market correction is on the horizon, you shouldn’t sell all your stocks. In fact, I am buying great stocks right now – but being choosy about it.
You see, the market is in bull mode. To preemptively sell ahead of an expected fall could be a huge opportunity cost.
For example, stocks went overbought May 6 of this year. History suggested overbought conditions would peak a month later and then the market would fall. Only, overbought conditions lasted four months, until September 2.
If you had sold out of stocks as soon as the markets went overbought on May 6, you would’ve missed out on an 855-point move in the S&P 500. It’s the difference between a 27% gain from the March low, and a 65% gain. And that’s just in the broad market. Individual stocks put up even bigger numbers than that.
That’s why I’m not a big fan of trying to time the market. I see dips and corrections as buying opportunities, not reasons to panic.
The real signal to look for the exits is when the big money has decided to leave the bonus level and take on the boss. And history shows that takes some time.
So that begs the question… what is the Big Money doing now?
Buying By Market Cap
Large and mega-cap stocks have lagged since November. Ever since the elections and the vaccine news, big money flooded into small caps and value stocks.
In fact, since the initial vaccine news on November 9, nearly 80% of all big-money buy signals have been in companies with market caps below $25 billion.
The logic is widely known by now: small-cap and value stocks have largely been battered by COVID-19 curtailing their businesses. With news of a vaccine, the world is optimistic about a reopening and getting back to normal.
The only rub is, these small-caps and value stocks still aren’t making money like they used to.
Think about it…
My guess is you’re not reading this just before you head off on a cruise, or a skiing trip, or fly to meet your family for Christmas. A vast majority of people are still being cautious, socially distancing, and staying at home.
Do you think we’ll all be vaccinated three months from now? Six months? Will masks really be a thing of the past by then?
I don’t think so. So if online travel companies, restaurants, and movie theaters aren’t doing blockbuster sales… and likely won’t be for some time… then why are these stocks acting like they are?
What this says to me is that the breakneck-speed buying is all built on lofty forward assumptions. Suddenly, earnings aren’t as important as they were all this year. (Which is why we saw tech companies and stay-at-home companies rally for most of this year – their businesses were crushing it!).
Enjoy the Bonus Level, but Play Smart
Here’s the bottom line…
Markets are seeing exuberant buying, but based on history, that should continue for weeks to come. We might as well enjoy the ride.
And when the data signals it’s time to prepare for the next market breather, I will be lightening the Palm Beach Trader portfolio to take profits and raise cash – so we can go shopping when everyone else is dumping stocks.
So, while we must keep a close eye on overbought markets, it can also be a very fruitful time. In these lofty conditions, we need not run and hide. But we should be methodical when adding risk.
My advice is the same as it always is: Buy great companies at good entries. For me, this means looking at prior outlier stocks that have either pulled back or are being held back. Many of those stocks are in the NASDAQ right now.
My data tells me that the blow-off top (a steep, rapid rise in prices and volume followed by a steep, rapid drop) will happen in January.
Until then, I expect small caps to continue outperforming large-cap stocks.
Enjoy the bonus level while it lasts. The market rarely offers them. It’s a good time to rack up gains that it’s giving you.
Just know the level eventually ends. My forecast says mid-January brings the next boss level for stocks.
By stocking up on gains in the bonus round, we’ll be ready to attack when stocks inevitably go on sale.
Patience and process!
Editor, Palm Beach Insider