- The recent rally off the March 23rd lows has astounded almost all market participants. The quick snapback has created serious FOMO.
- Sentiment is polarizing depending on who you ask. It's either "we're entering the greatest bull market of all time!" to "a worse decline is coming, a lost decade for stocks".
- Labels won't help you make money in this market. Stick to the highest probability outcome.
The S&P 500 declined 35% in 1 month - from the February highs to the March lows. That is the fastest decline of that magnitude on record! If you annualized every bear market's returns, then only October 1987 would be worse given the size of the move in just one day.
Since bottoming, the S&P 500 rallied ~39% in just over 2 months. This too is one of the fastest moves on record! While extraordinary, this type of market behavior has "rhymed" in many other bear markets. I say rhyme in reference to the quote, "history doesn't repeat itself but it often rhymes." - Mark Twain.
The media makes it very hard for retail investors to understand current events in context. The touted definitions of a bull and bear market being a rally or decline of at least 20% are completely misleading. Many bear markets have 20%+ rallies after the initial selloff. Retail investors may not realize this because the indexes don't usually make a new high as the NASDAQ has during this market cycle. Math can prove that a 20% decline would require a 25% rally to get back to the highs. This normally doesn't happen - hence the current environment being extraordinary.
For example, between May 2001 and September 2001 the S&P500 fell ~28%. From the bottom in September 2001 to the highs of January 2002, the index rallied ~25%; and that was just one cycle in a 3-year bear market. The S&P500 fell a further ~35% after peaking in January 2002. Is late 2001 ever considered a bull market by anyone? Nope!
Now let's think about the great rally of 2020. Will this be the start of a great new bull market, or a bear market rally? From my perspective, it doesn't matter! How you handle it to make money is the only thing that matters. Whether or not the NASDAQ making a new high constitutes a new bull market or not, is irrelevant to making money going forward.
I wouldn't be surprised if we get one more sizable decline across our US Indexes before a continued uptrend. Unlike what the naysayers think, it shouldn't be anything more than 15-20% depending on how high this rally takes us. There's also a time component of a correction that could mean the pullback is less than that but takes longer to complete. This would be a healthy pullback in the high flyers, maybe coupled with a retest of the lows in Energy and Financials (this could even happen before tech pulls back). Therefore, I think the best course forward is to have a watchlist of stocks you like for the long run and buy them as they fall into longer-term support. Believe it or not, this plan works well all the time! Patience over FOMO!
The way I look at the market today is the same way I look at the market all the time - a market of buyers and sellers constantly acting on information. This could be a new way to see the market for you and to put things into perspective:
As you can see from the chart above, every piece of information is either reacted to in a positive (bullish) or negative (bearish) way. It is then over-reacted to, efficiently reacted to, or delay-reacted to. Evidence of this is in every stock price fluctuation across all time frames. Every pattern and trend is a combination of all information being reacted to, differently, at all times.
It's actually mind-boggling to think about given how much information is available. That's why financial firms spend billions of dollars on algorithms and technology to process it all for them. I believe that the market discounts all available information at any given time. Day trader's, swing trader's, retail investors and professional investors are all interacting with each other over time to determine the price of a stock.
In the short term, any reaction or combination of reactions can happen. Humans and computers alike need some amount of time to process each piece of information, and while they're processing, new information is constantly coming out. That creates the short term market, which is often called "noise" because of the short amount of time available to process new information. In the long term though, price should move toward its intrinsic value based on the long term prospects of the company. If you don't believe that, then investing wouldn't really work in your world - would it?
From this tangent, the most important thing to take away is that information is reacted to in one of six ways (see picture above).
Over time, these reactions create patterns of varying degrees that show up on price charts. This is the basis of the Elliott Wave theory. "EWT" is a method of technical analysis that looks for redundant price patterns related to persistent shifts in investor sentiment and psychology. EWT is what taught me to look at the bigger picture when things didn't make sense in the short term -
"When in doubt, zoom out!"
This is because markets are fractal; meaning similar patterns recur at progressively smaller scales, describing partly random or chaotic phenomena like the stock market.
"History doesn't repeat itself but it often rhymes." - Mark Twain
So true, Mark! Take a look at these charts of the DJIA:
Pic 1 - DJI 2017-2020
Pic 2 - DJI 2017-2018
Pic 3 - DJI 2001-2009
You don't need to know anything about EWT to see that all these charts look eerily similar. Yet, they all happened over different lengths of time and at different points in times. History repeats and markets are fractal!
To summarize this little lesson:
1. Information is reacted to in one of six different ways
2. Market participants are processing all information at any given time. Their reactions to information are what creates price patterns. Emotions are often reacted upon
3. Markets are fractal, and the processing of information over short and long time frames creates rhyming price patterns at different degrees
We can see the outcome of 2/3 charts above. In both cases, the DJIA rallied pretty substantially before pulling back. We're currently in the midst of a substantial rally - so what seems to be the most likely next big move? 2/3 examples suggest that the market's next sizable move is down. The odds that the market goes up another 40% without some sort of pullback is very small based on prior examples from history.
If you're a day trader, the time frames presented above don't matter as much to you. That said, you've probably seen these patterns happen in daily stock prices too!
For most investors with months to years timeframes, you don't want to bet on a huge further rally right now. It makes sense to wait and buy your watchlist stocks as they come into support always, but especially right now as speculation is rampant and sentiment is all over the place.
The US markets have likely already put in a major low. If that's true, then downside risk is limited, while upside is theoretically infinite & unknown. Betting against higher prices for all of history has been a bad bet. I encourage readers to also check out this post I wrote in 2018 regarding market cycles based on Sammuel Benner's market theory. Sometime between now and next year should confirm we've put in a major low. Patience is a virtue.
Right now there is certainly risk in the market. Speculation is very high and there's a lot of unknown not being priced into the market. What if it's war? Regulation? Inflation? Deflation?! Overvaluation? Political risk? The only thing we know for sure is it's probably a bad idea to buy an asset at a 30x P/S 2050's sales... In the 70s and early 00s, the prior 3 year run-ups were completely wiped out. This is because even the best stocks (say, Coca Cola or Phillip Morris in the 70s and Cisco and Intel in the 00s) were just too overvalued and eventually needed time for their businesses to catch up to their valuations. Today, no one wants to miss out and banks are re-rating and revaluing stocks to fit this "new" regime of low interest rates and money printing. Are you buying at any price to not miss out or are you buying because of a sound opportunity?
"Value" stocks could play a key role if we are in a new major uptrend. Because Growth has rallied so much, it wouldn't take a huge rotation of money to out of tech to prop the Value stocks up. I hate the term "Value" but I think most readers know what I'm referring to. Stocks in this category have been the most susceptible to the Covid economy. It might take the economy to bottom out before these stocks get any sympathy.
This all said, we are still in the midst of probably the best secular bull market of our lifetimes. Tech is changing the world which is why these companies are able to make so much money. Low interest rates and money printing is why Wall Street is justifying paying any price for them. Still, buying with no care for price or time horizon will always lead to losses in the short term. Invest safely!
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