When Will The Stock Market Stabilize?

The short answer is: maybe not for a long time.

But I want to go into a bit more detail on some of the main reasons I believe the stock market pain is not over and will likely continue, possibly for the foreseeable future.

1. Investors Are Still Bullish on Stocks

There is still a decent “buy the dip” mentality out there right now, and there will be until the strategy no longer works.

This might seem like a bullish factor that means the market is likely to bounce back and resume the bull trend, but in reality what it means is that the market has still not fallen far enough to offer decent value relative to the underlying fundamentals of the economy as well as the current state of both monetary and fiscal policy.

Once dip buyers get punished, and the markets really go into free fall, then we might be able to start talking about a potential bottom.

But people still see corrections as opportunities to buy, and until they no longer do, that means this market still has not fully priced in all the headwinds and negative developments that are causing so much volatility right now.

Sentiment still is not bearish enough to indicate a bottom:

Compulsive dip-buying just for its own sake is what’s keeping stock valuations elevated.

Capitulation is the point where even the most devoted BTFD’ers give in and dump all their stocks. They do this after they buy the dip and then proceed to get crushed even more on the next leg down.

That’s when the market may be nearing a bottom: when the bulls give up and admit defeat, and the bears fully take over and drive stock prices down to a point where they are once again attractive.

2. The Bubble Has Already Popped

When you consider that many high-flying stocks that went up so spectacularly in 2020 and the early part of 2021 are now down massively—and have been going down for the better part of a year now–then it becomes clear that a bear market has already begun.

Do not be fooled by the fact that the S&P is only ~9% down right now. The overall market is extremely unhealthy. Of the nearly 800 stocks I track, 44% of them are currently in a bear market right now. 44%! One in ten of them are down more than 50%!

The market is being supported right now by the biggest and strongest companies—Apple, Microsoft, Google, etc.

FANG is done. Facebook and Netflix have already gone down.

Even Amazon has long since plateaued and begun its downtrend. Amazon popped on its earnings recently because of an accounting gimmick from their sale of Rivian.

Right now it’s basically just MAG holding up the market—Microsoft, Apple, Google. Them, plus Tesla and Big Oil. They’re like Atlas holding everything up.

The analogy I use to describe how stock market collapses unfold is the tide at a beach. All the companies trading at sky-high multiples (or that don’t even have any earnings at all), the small caps that are more susceptible to economic downturns—these are the stocks that are closest to the shoreline, meaning they get taken out first when the tide (recession) comes in. The further you go inland from the shoreline, the larger and more sound the companies you find. Your Apples and Microsofts are the furthest away from the shoreline, meaning they get hit last, and they don’t get hit quite as severely. They’re the least fragile.

The tide has already started to come in. The weakest and most fragile stocks have already been decimated.

What we’re seeing now is multiples get slashed—stocks that were trading at 150x earnings are now trading at just 75x earnings after their prices have gone down by 50%. They went from ludicrously overvalued to just quite overvalued.

But again, these high flyers are always the first to get whacked. And they will continue to fall as the broad market buckles, with many of them, by the time this is all said and done, losing probably north of 80%-90% of their market value. Many of them will simply go tits up altogether and be acquired for pennies on the dollar.

The tide is already coming in.

When you look at the overall health of the stock market, it becomes clear that this current selloff is no mere blip on the radar. It’s likely just the beginning of a way bigger and more drawn-out collapse in stock prices. In other words, we’re in a bear market, not a correction.

At the very least, we are in a very different market environment than the one of 2020-21. The euphoria of the bubble has worn off, and the default state of markets being green is no longer in effect.

3. Multiple Compression Will Get Worse When Earnings Start Declining

The recent phenomenon of stocks getting absolutely massacred after earnings reports is a sign that investors are no longer delusionally optimistic about future growth prospects, and those stocks that exploded during the bubble phase are now being brought back down to earth.

The second investors see any hint of slowing growth—usually in the form of reduced or disappointing forward guidance—these stocks are getting hammered.

They’re going down by eye-popping amounts in a single day, and it’s because investors now suddenly care that they’re all overvalued. And why’s that?

Because the moment investors start feeling pessimistic about the future, they have a hair trigger on the sell button for a lot of these growth and tech names.

We just recently saw Facebook go down 26% in one day. It’s now down close to 50% in a few months. Facebook’s $900 billion market cap is now $560 billion. Meaning over $340 billion just got vaporized in the course of a few weeks.

People don’t understand how Facebook got punished so harshly when it’s a well established company that generates obscene amounts of cash and trades at a fairly decent multiple.

But there are growing concerns that Apple has essentially killed Facebook’s ad revenue business model, Facebook has zero appeal to young people, and that TikTok is eating Instagram’s lunch, along with the serious doubts that Zuckerberg can pull off… whatever it is he’s trying to accomplish with “the Metaverse”.

What I’m saying here is that Facebook may be trading at a decent multiple relative to earnings currently. But the market has punished Facebook so harshly because it believes its earnings are heading lower in the future. The future growth outlook for Facebook looks poor, and so when earnings start declining, the stock price will chase them lower.

This multiple compression we’re seeing—this general repricing of stocks down to more reasonable valuations—is only looking at the price aspect. In other words, it’s not taking earnings into account.

When earnings are constant, PE ratios fall when price falls.

But if price is constant, PE will rise when earnings fall.

We’re looking at a lot of these stocks and their valuations, and we’re seeing valuations come down and thinking, “okay, it’s fairly reasonably priced now. Why is the market so down on this stock?”

Because even though the PE ratio might look good to you now, remember we’re seeing peak earnings right now. Fiscal stimulus has dried up, interest rates are going to rise and the Fed is ending QE. Plus we have inflation which is inflating earnings reports—making it look like companies’ revenues and profits are exploding when really all they’re doing is just charging more. Some companies are genuinely seeing surging sales, but it’s tough to tell the difference. Plus a lot of buyers are stocking up on goods because they expect even higher prices down the road.

So if PE ratios look good now, just wait until earnings actually start falling. The price will chase earnings lower.

Again, if price is constant and earnings fall, the PE ratio goes up and the stock is more overvalued—even though the price hasn’t changed.

So when you see a stock that has gotten slaughtered lately and it’s trading at what appears to be a fair multiple, you have to understand that the market probably expects the company’s earnings to decrease going forward. In other words that stock is not nearly as cheap or “fairly valued” as you think it is.

The market is faster than you. It is driven largely by algorithmic trading programs that instantly scan and process companies’ earnings reports and automatically make buy and sell decisions before you even get the notification for the earnings report on your phone. Algos do this with Fed statements—basically any sort of data release or news headline that affects the stock market, it’s immediately read and processed by programs that make buy/sell decisions in a matter of seconds.

When you couple this with the fact that the firms using these algorithms are mostly giant hedge funds and other professional investors that are buying and selling massive quantities of stock, these highly sophisticated algos moves markets.

They’ve already processed every bit of news and made buy/sell decisions accordingly before you even know about the news story in question. Say a biotech company reports promising test results for a potentially revolutionary new drug and it appears likely for FDA approval—by the time you hear about the news, read the headline and go to check the stock price, it has already skyrocketed. This is the algos at work.

What I’m saying here is that these stocks that have gotten crushed have gotten crushed for a reason. It’s not an overreaction.

The overreaction was the move up in stock prices over the past two years, which was based on extremely optimistic growth expectations. What’s happening now is the market is coming back to its senses. There’s a reason they call stock declines “corrections.” They represent stock prices correcting to a more appropriate valuation.

4. The Fed is About to Send Us Into Recession

I said earlier the bear market has already begun. How do I know this for sure?

It’s simple: because not only is the Fed done easing, the Fed is literally going to cause a recession and pop the asset bubble deliberately. This means both stocks and housing will come down.

The Fed is going to withdraw accommodative policy and begin tightening because it has to get inflation under control. It has to. It’s part of its mandate. It has to get inflation under 2%. This is not a choice the Fed can make—it is their mandate.

But the thing is, what the Fed doesn’t say out loud is that it tames inflation by causing a recession. Recessions are deliberate. Obviously the Fed can never admit this.

So people still believe the party can keep going without Fed easing and zero-bound interest rates. As I’ve gone in depth to show, this is extremely unlikely. The stock market over the past 13 years generally only goes up when the Fed is easing and interest rates are at rock-bottom. The only exception was from November 2016 to February 2018, when the Trump tax cuts sent stocks skyrocketing despite rising interest rates no increases to the Fed balance sheet.

But the economy currently is not nearly strong enough to support current stock valuations and propel stock valuations on its own. The market in 2022 needs Fed easing in order to go up. Once the easing stops, the market will go down, until easing resumes.

These are my main reasons for believing the bear market has begun:

  • Sky high valuations
  • Persistent unmerited bullishness among investors
  • No more easing
  • No more stimulus
  • Fed mandate to stop inflation will cause a recession
  • Commodities spike

The party is over. For many stocks, it has been over for a long time. This is not just some blip on the radar selloff. This is the beginning of a larger bear market that will take valuations way down. How far? It’s impossible to say. But my guess is that stocks won’t bottom out until the Fed starts easing again, and that may not be for a while.

People lose money in bear markets for two main reasons:

  1. Because they’re reluctant to sell when they’re already down, and they’re waiting for a rebound that never comes. Sometimes cutting your losses is better than holding. In other words, it’s better to take a 25% loss and preserve capital than it is to take a 50% loss because you were waiting for a rebound that never actually comes.
  2. Because they buy the dip and it turns out to be a bear market rally, or a bull trap, and the market promptly heads down to fresh new lows.

None of this is to be construed as financial advice, it’s just me giving my two cents. But I would be remiss if I didn’t send out a warning based on the things I’m seeing right now.

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