The market always reverts back to the Big Line eventually:
That’s the trendline going all the way back to 1932.
- At the market bottom of 1942, prices were the same as they were in 1901.
- At the market bottom in 1974, prices were the same as they were in 1959.
- At the market bottom in 2009, prices were back at 1996 levels.
When I say market “crash” I’m talking a decline of 50% or more.
I’m talking about a secular bear market, or sideways trading for multiple years like we saw in the three above cases. I think we’re due for something like that soon.
The March 2020 Covid “crash” wasn’t a true bear market, in the sense that we didn’t see a fundamental shift in the long term direction of stock prices. It was more like a really bad correction, akin to what happened in 1987. It was a massive correction in the context of a longer term secular bull market.
Bear markets last longer than a month. They are fundamental shifts in market price action: lower lows, lower highs. Bull markets are higher highs, higher lows.
Look at the bull market from 1942 to 1973, for example. You will see higher highs and higher lows consistently. The bull market was over when the market stopped making higher lows, which ended up being in 1974, but you can only see this with hindsight:
It’s fair to say the bull market actually ended in 1970 because it made a lower low than it did in 1966, but it also made a higher high in early 1973 so I’d consider the bull market as ending in early 1973.
That’s what a bull market looks like. It’s a clear, consistent and defined up-trend.
A bear market looks like this:
I know there’s a lot going on there but all you have to pay attention to are the higher highs and higher lows on the left side, and the lower highs and lower lows on the right side. The bear market ended in late 2002, but we only know this with the benefit of hindsight because the market made a slightly higher low in March 2003 and then that confirmed the beginning of a new bull market.
So what are we in now? It’s a strange situation. Have a look at the chart:
We’re getting higher highs, but we’re also getting lower lows.
The market right now does not fit either definition: it’s not a bull market because we’re not getting higher lows, but it’s not a bear market because we’re getting higher highs.
It’s an anomaly.
Fortunately, I was able to find two other instances in the past where the markets moved in a similar pattern. Here’s the more recent one, from about 1966-1980:
As you can see, markets made higher highs and lower lows from about 1966-1974, and then after the big crash in ’74 it started making lower highs and higher lows before breaking out into a massive, long-term up-trend.
The market basically trades in a rhombus pattern.
There’s another instance of the markets trading in a rhombus pattern. It in the run up to the Great Depression and afterward:
Now, this one was not as clearly defined in “higher highs” but it did make higher highs over the years. It also made lower lows, and then–this is the key–after the One Big Crash, it started making lower highs and higher lows. Then the markets broke out into a new, massive long-term bull run.
So what does this mean for us right now in 2021?
Well, it means we’re going to have a massive market crash at some point, and I’d wager soon. Maybe this is it already and we’re in the start of it, I don’t know. Or maybe the markets rally and go even higher.
But what I do know is that if the market follows the rhombus pattern it followed in those two past examples, the next crash will be even worse than the Covid Crash. And since the Covid Crash was -36% in the S&P, this one will be in the 50%+ range.
It sucks to say we’re heading for a major crash in stock prices, but we kinda need it. Valuations are unbelievably high right now. Have a look at the Shiller P/E ratio, which shows market valuations going all the way back 150 years:
We’re higher than we were in 1929. The only time valuations were ever higher than they are right now was during the final stretch of the Dot Com bubble of the late 1990s.
It’s possible the market blasts even higher from here and we again reach the insane valuations of the late 1990s. It’s possible the market even goes higher than that. After all, the market had never been over a Shiller P/E of 30 until the late 1990s. There’s no iron law that prevents markets from being even more overvalued than the Dot Com peak. But I don’t think we’ll get that high. The economy of the late 1990s was roaring, and in way better shape than it is right now.
Plus, the higher the market goes, the greater the next crash will be. Remember the first chart: we always revert back to the Big Line sooner or later. The further above the line we go, the bigger the crash it takes to get back. It took the markets 13 years to regain the highs from 2000.
I think it’s going to happen soon. Monthly RSI on the S&P is 66. The MACD is ridiculously high. Valuations, as we just went over, are ridiculous.
B of A’s gauge of Wall Street Analyst bullishness/bearishness is now on the verge of reaching “extreme bullishness,” which if taken as a contrarian indicator, is a sell signal:
Now, I get that interest rates are low and the Fed is supporting the market. These are major factors in why markets are resilient and why I could be wrong about an imminent crash. Something in the current environment has to change in order to compel people to pull their money out of the market in droves. High valuations alone do not cause market crashes. If high valuations alone killed market rallies, then the Dot Com bubble would’ve ended in like 1996. It wouldn’t have even turned into a Dot Com bubble, actually.
Look, I don’t want it to happen. I want stocks to go up forever. I’m not a short seller, I don’t even buy put options.
But you have to take what the market is giving you. That’s the cardinal rule of investing. Pigs get slaughtered; the worst thing to be in the markets is greedy.
Right now, the market is not giving us many good values. Everything is pricey. I’m very worried about being all-in on equities right now. I think we will see a snap-back rally soon after this recent bout of selling, as markets are hitting oversold levels. Maybe things rebound tomorrow, maybe next week. But if and when the snap-back rally happens, watch closely: if we fail to make new highs, look out below. Use the snap-back rally as a selling opportunity to close out your long positions.
Again a final disclaimer: I don’t know what’s going to happen with markets. It could be that we trade sideways for a while. Or we could have a massive breakdown. Or, hell, markets could go up for years. I don’t know. That’s why I call this blog “Uncharted Waters,” because every single day, we are in uncharted waters when it comes to the market. You can never be certain what’s coming next.
All you can do is use the information available to you to make your best guess. And my assessment is that the party is just about over.