ATEX - Tracking Flows Of Smart Money With JD Henning (Value And Momentum Breakouts)

2023-04-26 09:00:00 ET

Summary

• Our guest this week is JD Henning, the Founder of Value and Momentum Breakouts and the Momentum Gauges® forecast model.
• We get the inside scoop of where his models are predicting the market is headed.
• We dive into how his investing group got out early and avoided the Tesla earnings drop based on certain signals he follows.

Transcript

Daniel Snyder: Welcome to Investing Experts. I'm Daniel Snyder. In this episode, we're joined by JD Henning, Founder of Value & Momentum Breakouts and the momentum gauges forecast model. We get the inside scoop of where his models are predicting the market is headed for the rest of the year, plus we dive into how his investing group got out early and avoided the Tesla earnings drop based on certain signals.

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Let's get into the interview. So let's dive right in nitty-gritty, huge week for markets this week. I mean, we could talk about the Fed. We could talk about earnings. Let's actually start with the Fed. I mean, we've got the Fed meeting coming up next week. 25 basis points are on the docket. What's your approach? What are you feeling about this?

JD Henning: Well, I've been tracking it closely. This is supposed to be the third rate hike of the year. And that's what Chairman Powell promised for us last year. So it'll be interesting if this will be the last rate hike for the year. And typically, and we discuss this a lot in our chat rooms, it's not the rate hikes that lead to the market correction, but it's the leveling off period.

And we get a period where they hold it higher for longer that tends to lead to a downturn historically. And this particular series of rate hikes has been the steepest one that we've seen since 1977, and it usually doesn't end very well when the tightening goes on like this for the banks and for lenders and borrowers that really need the cash flow.

So we're watching a tightening effect happen here and it's combined with QT, the Quantitative Tightening, it's making it a little bit challenging for the markets and the money flows. And then one of the third, I would say, the third key element, I watch fund flows very closely. And what we're seeing is that corporate buybacks are dropping in the sharpest three quarter decline of corporate buybacks since 2008.

So when we see these outflows and these tightenings occurring, it's giving me some warning signals. And those warning signals are things that I wrote up in the Seeking Alpha competition to sort of guess where the market would end at the end of the year. And I have a target of 30 to 40 ((Ph)) for the S&P 500, but I don't consider myself any great forecaster of the year ahead. There's just too much that we can't predict.

So, those are some targets I'm looking for. The main thing that I'm seeing is a distortion this year in the FAANG stocks. And what I mean by that is we're seeing a very large crowding into, say, the top 5 or the top 10 largest market cap stocks in the S&P 500 Index. And what that does is it gives us a very low VIX Volatility Index and people are saying, I've seen a lot of articles out there saying that, "Oh, look, the VIX is broken. It no longer works."

But what I think is actually happening, and this is my working theory that I kick around with a lot of members in the community, is that this crowding into the largest cap stocks is offsetting a lot of the smaller cap stocks that are hard hit. And we've seen, I think, I saw somewhere that the 10 largest NASDAQ stocks have accounted for 88% of the gains in the NASDAQ. And at some point, that could burst. So I'm playing a cautious swings using the momentum gauges this year.

Daniel Snyder: So how are you positioning for the pullback in the market this year?

JD Henning: Well, like I said, I don't claim to know what the future holds, but I rely on a system that I developed in my doctoral research, which was the momentum gauges. And basically, they are forecast of money flows and they help me see where investors and large institutional traders are moving their money. And so in a way I'm a fast follower, and it's really worked out well that we've never missed a major downturn.

And just to give a in a nutshell how the momentum gauges work. After 30 years of trading, I thought, you know what, there's so many models out there that are forecasting price change using price change whether that's Bollinger Bands or Elliott Wave theory or technical analysis, they're very heavy emphasis on prices.

And what that creates is a momentum hoarding or herding effect, where people just chase stocks going up, and they react to just price movements. And I thought, why don't I study variables other than price change to forecast price change? And so, long story short, I tested over 75 variables, back tested it to 20 years with a team of advisors and educators that helped me.

But what we found was there are key variables that can explain upwards of 74%, 75% of market direction without using price change to forecast price change, and that's where the momentum gauges came into play. And that the term momentum is a little bit misleading because it's not just the price momentum movement, but it's actually looking at fundamental variables, behavioral variables, and technical variables, and it pulls on which ones are the best.

And over time, I've - members of my community have encouraged me to break out momentum gauges for sectors, for the S&P 500 ( SP500 ), for the overall market. I look at 7,500 stocks and see how that direction, that money flows is heading. And currently, as we start this very busy week of earnings, I think, there's 576 stocks reporting this week. We started a negative signal. And last week, I've been in bear funds going into this week.

So that's kind of how I do it. I don't pretend to know what the future holds, but I follow the major flows and it hasn't done us any - had any problems yet. So we'll continue to, especially in this very volatile year, there's a lot of chop and the folks that aren't using timing indicators, they're finding that they're just getting pummeled and swung back and forth. And I think it's very helpful to have indicators when you have this many reversals in the market.

Daniel Snyder: So you have this systematic approach to the markets. What are the results so far?

JD Henning: I'm happy to share that. As we're talking, my active ETF portfolio is up over 14%. Last year, it beat the market by 34% in one of the worst markets since 2008. And I also have in addition to the active ETF, I have the momentum gauge ETF model, which just swings back and forth in a group of ETF funds following the momentum gauges.

The last signal we had 25% gains on the - on NAIL, the homebuilder fund. There was a buy on LABU , on the biotechs. So it just - it moves now and switches bull bear right now, like I said, we're in a bear fund. And leading bear funds right now are the China YANG 3X Bear fund and BNKD or B N K D, which is the 3X Big Bank Index. I'm still pretty bearish on banks and semiconductors are also negative. And I think those are in a high overbought position led by very good stocks like NVIDIA ( NVDA ), AMD , but they've seen a lot of crowding in the first quarter.

Daniel Snyder: So you're watching these ETFs, but you're also diving into the indexes and individual stocks. And I think this tees it up pretty nicely for - you're talking about the FAANGs. You're talking about everybody overcrowding with the flows. It's earnings season. This is the week. Everybody is looking at the top five. What are you expecting from them?

JD Henning: Well, I can't predict what the earnings will be or the reactions will be, but the probabilities are pretty high that these stocks are priced to perfection. And when I look at a lot of different indicators, I see these say the five mega caps, the biggest stocks in the S&P, I see them priced to perfection with well above average price-earnings ratios and price to sales ratios. And I think that's part of a safety trade that I've been monitoring for a while.

And what I mean by that is I look at the number of times that the S&P 500 has swung more than 2% in a trading day. And what's really fascinating is it's alternating every years in very sizable differences from 2018. And 2018 was the last year we had Quantitative Tightening, and it spiked with a lot of events in that year. And then in 2019, it came down to very low volatility. And then, of course 2020, it spiked again with COVID, and we had a lot of daily swings over 2% on the S&P.

And then again, 2021, it calmed down, it was very low. But 2022 went up to 45 events, over 2%, which was one of the highest volatile years that we've had since the financial crisis. And yet, like this is the - my point is that we're extremely low. We've only had two events greater than 2% on the S&P this year. And when - last year, we were having four of these events a month. Here, we are into the fourth month of the year with only two of them.

And the only way I can explain the so-called low volatility even though the market is swinging, is that people are packing. And I say people, it's hedge funds, investors, retirement funds and institutional investors, are really overcrowding these large FAANG stocks, which keep volatility low and cause people to think that the VIX is dead.

Daniel Snyder: Low volatility, yields are climbing in the bond market. Money managers have to keep their keep. So why shouldn't investors just keep piling into the FAANG stocks?

JD Henning: Well, that's a good question. And I think one of the reasons is that the banks, number one, they suffered a little bit of a run on some of the small banks and it scared the small bank investors. And we saw something that was kind of a too big to fail move where the small investors changed their deposits over to the big banks, and the big banks saw tremendous gain of new investors or new accounts, but that's not the kind of organic growth that you want to see in financial sector. That's the kind of herding for fear, which is similar to what we're seeing in the FAANG mega caps.

So when I see people herding into the biggest banks, that's a smart move for safety, but it's not a sign of a healthy market. And then related to that, there's a lot of discussion about the commercial real estate loans that are coming due in the large amounts. And because we've had the steepest rate hike since 1977, we're seeing people looking at almost 5% increases on their loans that they have to refinance and year-over-year, and that's just a shock to the budget for a lot of these companies.

And I was just reading the other day that the companies that have started construction loans usually, the construction loan is a higher rate than the 30-year mortgage. But they're finding that the construction loan that they started with is a better rate around 4% and they're extending those loans out to four and five years and hoping that the 30-year drops again, so that they can kind of afford it with their budget.

But there's a lot of indicators out there with commercial real estate going vacant in the cities, not a lot of foot traffic, a lot more online activity, and a lot of this is just COVID changed some behaviors. So you combine that with higher interest rates and tighter margins and outflows from the market and fewer corporate buybacks and quantitative tightening, and it makes for a challenging market for a lot of these businesses to sustain their share price.

Daniel Snyder: I was just looking at the Russell 2000. I mean, it's still up 1.5% year-to-date. I think S&P 500 is up 8% as the time of recording this. They're both positive. It seems like are we in a tale of two economies? Or is this just too much fear mongering? What's the take here?

JD Henning: Good question. This is something I kick around in my investment community. We've got a lot of really bright people there, and I lean on them for ideas and things that they've come across in the market. I think, and some of them have noticed this that there's some similarities to the 2021 chop.

And what I mean chop is that the indexes are staying relatively positive, but under the surface, we're seeing very high sector turnover and a lot of rotation. And that rotation is basically people chasing from one sector to another looking for gains, they're looking for green shoots. And every time something goes up, they all rush over to that and you see other sectors go down. And it's kind of causing this swirling effect where the markets look good on top, like you said, the S&P 500 is positive, the Russell is not so bad.

But below the surface, the sectors are just every week, a leader, a lagger, a leader, a lagger, and the investors are kind of getting beaten up by it. And so that's where again, the timing indicators matter. It's very important to look at the sector gauges.

And one of the most important sector gauges that I use in my momentum model is the technology sector gauge, because it's - the technology sector by far is the largest sector in the marketplace. You've got three stocks there that are larger than four other sectors in the S&P 500. So, as a bellwether, it's been negative for April. Even though other sectors are moving higher, it's been giving me a warning signal into April after a really nice run in March.

And so I've just been sitting on Bear funds kind of like FNGD, and BERZ, B-E-R-Z; and then like you said, I've been looking at some of the Russell small caps. We had some good gains in the biotech sector, which is a really fund small cap sector that can have great gains in short periods of time. And a lot of those stocks make it onto my weekly MDA breakout lists.

And I can tell you that the weekly MDA breakouts, they're up over 50% this year on weekly selections. It's not a standard portfolio, but every week, I'm picking four new stocks for members, and they continue to get double-digit returns. Last week, IMCR got - gave us 16.5% returns in a week. A week before that, we had BBW , the Build-A-Bear Workshop, they - a good defensive stock, gained 10.4%. A week before that, ATEX 11.6%.

So we just have a pretty consistent gains with weekly breakouts, but you have to be careful not trading against the negative momentum conditions, because we are seeing the outflows. And related to that, when I said the similarities to 2021 were being observed by many of our members, that chop was when we got our biggest monthly negative signal in November, late November of 2021, and it didn't turn positive for 9 months.

So we - following the monthly momentum gauges, we could've avoided all of 2022, but we stay also with the weekly to look for any bear bounces and get opportunities on the way. So there's a lot of ways to trade it, there's a lot of ways to use the gauges. But I suspect come about August, we could start seeing a little bit more weakness in the market, a little more chop and potentially another leg down as this choppiness starts to settle on a direction.

Daniel Snyder: So, say, I'm a long only investor. What sectors should I be focusing on right now?

JD Henning: Well, that's a good question because, again, I don't try and forecast way out. I do what I call conditional monitoring and I look for money flows to sustain for as long as possible in different sectors. One of the sectors that has a lot of potential is the basic materials sector. There's a lot of talk about the U.S. dollar weakening and moving further into decline and maybe moving away from being a reserve currency, I don't know about all that speculation.

But I do know that as the dollar weakens, it's great for gold, it's great for silver, typically helps oil and many other commodities that are priced in dollars. And so maybe even if the demand for oil is slipping, the decline of the dollar will continue to keep the price higher. So there's a lot of factors in play, but basic materials is a pretty strong and solid long-term move if the market continues lower.

Daniel Snyder: So JD, let's take it back a second talking about the VIX, the Volatility Index. A lot of people have been looking at it. It's been sub-20 for a while now. Most people looked at it as a sell at 20, buy over 30, that was kind of the game plan for last year, if you will, is the mix broken now. What's the take here? What do investors not know or think about of the VIX at these moments?

JD Henning: Well, yeah, we touched a little bit on that. I think it's the overcrowding into some of the biggest FAANG stocks. It's causing a dampening effect in the VIX, because the VIX is based on derivatives of options of the S&P 500. And close to 25% of the S&P 500 capitalization is found in those five largest stocks. So they can really dampen volatility. And I'm frankly surprised that we've only had two moves in the S&P this year greater than 2%. And I think that's well below average of what I've been tracking.

So I expect sometime later in this year that we're going to see a reversion to the mean where it's going to pick up and we're going to see a lot more VIX movement. I don't think that the VIX trade is done or it's dead by any means. I also think that it's probably going to happen around the August timeframe because there's a lot of things converging. We have the debt ceiling standoff going on. They're just talking about forecast, I think, someone from Goldman said that the treasury would essentially run out of cash in late August that they would need some sort of agreement for a CR or a budget resolution.

But that also corresponds to the Fed's target that they - Chairman Powell said in March of last year that they were going to reduce the balance sheet by a $1 trillion. And that was tracking at about, I think, $90 billion a month. The trajectory that they're on right now is that it would be around the end of August that it hit the $1 trillion balance sheet level, and the Fed hasn't - it hasn't pivoted from that.

And I think the banks did see a rescue. I think it was about $400 billion in emergency loans that they could access, but that was mostly to prevent a run on the banks that that consumers knew that they were backed up. But what it - it doesn't address is the emergency loan program is different than the quantitative tightening program, which is - it's the open market action for domestic securities.

And I - from all my studies of QT that it's actually the Fed investing in domestic securities that has a bigger impact on the markets. The emergency loan tends to be more isolated for the banks, and because the Fed is still reducing to a $1 trillion off the balance sheet, I think, that there's going to be another issue, I say another because this is a similar program as 2018, and then we saw a big drop in Q4. And it wasn't until December of 2018 that the Fed had to give up entirely on QT, and they cut rates, they stopped tightening, and the markets recovered.

And in that sense we have a similar pattern evolving towards the August inflection point. But the big difference is, of course, inflation, and they keep insisting they're going to hit their 2% inflation target. And I think that's debatable. That's going to be a real challenge because inflation is going to be sticky. It doesn't come down as quickly as we would like.

Daniel Snyder: Before we get out of here, I can't thank you enough for your time today, but I got to ask you, there's the rounds going of how you and your investing group got out of Tesla, didn't take any positions really before Tesla earnings. We saw the massive 10% drop. What - can you walk us through, like, what happened kind of in real-time? Was it the momentum gauges? What was the insights there that you saw ahead of time?

JD Henning: Oh, yeah, I'd be happy to go into that. There's a series of variables that I look at related to money flows, and some of them are technical and some of them are behavioral. And what I basically saw and this comes out of the momentum gauge model, I pull out a few variables that I can use in real-time just to check how stocks are doing rather than running a whole MDA analysis on, say, Tesla.

And what I saw at the beginning of April was that some of these indicators, like, I use MFI indicator, which is a Money Flow Index. You can also use, I think, it's Chaikin Money Flow Oscillator. There's a lot of proxy indicators for money flow. And it was dropping pretty sharply and it turned negative. It was showing outflows really into the second day of April, and that was a first warning sign for me.

And then I apply whatever models can work, and I found that technical analysis has some value. And I saw that it was breaking support levels around 188, and combined with continued market outflows, continued with losing its technical support level, it was just at a higher risk. And so I was telling people, let's be cautious. None of these models are foolproof. But when you use the probabilities to your side, sometimes you really avoid some painful experiences.

Daniel Snyder: Yeah. Really incredible what you did there with the group and the team. All right. Let's go ahead. And before we end the episode, if people want to get more of your data, your momentum index looks, your weekly picks, the four weekly picks you talked about, where can people find you?

JD Henning: Well, I'm on Seeking Alpha, JD Henning. And the name of my service is Value and Momentum Breakouts. You can find me on Twitter and a lot of other locations. And I'm - I try and stay very engaged with my members. We have a fantastic community. I'm really proud of the people that have signed up and the dialogue that we have. And I think that's one of the best features of my service is just quality of people and the camaraderie. It's a great place to go through difficult markets.

Daniel Snyder: Just a reminder, anything you hear on this podcast should not be considered investment advice at times myself or the guests, my own positions and the securities mentioned. But this is for entertainment purposes only, and you should seek advice from a licensed professional before investing, and we'll see you next episode. But also just to remind you, please leave us a rating or review. It greatly helps.

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