If you pay attention to the markets, you have probably noticed the extremely odd movements underway right now.
Just when it seemed like the party was over and the bear market had begun, the market starts absolutely RAMPAGING higher. The Nasdaq index, which had been just beaten mercilessly since early January, dropping about 24% from its all time high, is now up over 16% in just two weeks.
It’s just nuts. Why would anyone be buying stocks right now, much less panic-buying them like they there’s no tomorrow? Investors aren’t just buying with both hands, they’re buying with both hands and feet.
Stocks are now highly overbought right now, but it seems like there is nothing that can derail this party.
It’s as if someone flipped a switch and started a mania. It feels like investors have done massive amounts of cocaine and all just screamed FUCK IT!!!!!! in unison, Leeroy Jenkins’ing into the shittiest and most ridiculous stocks imaginable. This chart, via Lance Roberts, shows the mind-boggling gains in the old meme stocks that were flying high back in early 2021:
Gamestop up 120%?! AMC up 90%? In TWO WEEKS? What the hell is going on?
As for the meme stocks, your guess is as good as mine. Maybe the market has gone insane. None of those moves are based on any sort of fundamentals or anything.
But as for the overall market itself shooting higher despite one of the worst economic and political backdrops in decades, I have a few theories I’d like to run through here.
The first is pretty simple: we could still be in a bear market, but bear markets are not just straight down usually. In fact in most past bear markets (outside of the unusual and artificial Covid Crash of March 2020), there are some face-melting rallies that defy all logic and explanation.
I’ve gone over this in the past on the list of the single greatest days in stock market history, the vast majority of those days occurred during massive bear markets like 2008 and the Great Depression.
Bear markets are tricky and dangerous because they’re not straight down. They sell off violently, then they rally hard to the upside, tricking both bulls and bears into thinking the selling is over. Bulls pile back into long positions, and bears close out short positions.
Bear market rallies are the reason so many people lose money during bear markets. It’s precisely becuase bear markets are not straight-down moves that so many market participants lose money and throw their hands up in despair.
Dips are bought, as per usual, but then the subsequent rips are sold off violently, sending stocks to new lows.
I want to look at a few examples in the past where the markets behaved in similar fashion to the way they’re behaving today–which is to say, sharp selloffs followed by parabolic rallies. In virtually every major bear market of the past 100 years, we’ve seen behavior similar to what we’re seeing now.
The chart may not be entirely clear here, but what we can see is that between September 4, 1929 and November 13, 1929, the market fell over 49% with Black Tuesday and the ensuing week being where most of the losses were concentrated.
However, starting on November 13, 1929, the market would then go on to rally furiously over about the next 6 months, gaining nearly 53% in that span. It was up over 37% in the month following November 13, 1929.
But ultimately the market would roll over and resume the selloff around mid-1930, and the bear market didn’t end until July 1932. Really, it was more like March 1933 when the market began going up again.
After beginning a new bull run in March 1933, the market would advance for the better part of the next four years, running up over 285% between March 1, 1933 and March 16, 1937. But then things went south, and the Down dropped about 16% between March 1937 and late June 1937. That was the end of the 1933-1937 bull run, and ultimately from peak to trough, this bear market would see the Dow fall by about 50% between March of ’37 and the bottom point in early April of ’38.
However, in the summer of 1937, the market turned on a dime and rocketed higher, advancing about 16% in about two months, and nearly making a new high. But the rally quickly fell apart, and the real sell-off began. It was basically a straight-down move after this point, as you can see from the chart above.
The market gradually grinded lower starting in January 1973, but starting in late August of that year, it jumped higher, rising about 17% over a two month span, and getting back near all-time highs. But the market couldn’t sustain the rally, it fell to new lows starting in late October ’73, and would drift lower and lower over the ensuing year before finally bottoming out in late 1974, for a total peak-to-trough decline of about 49%.
The bull market peaked in October 2007, and grinded lower for the next 6 months or so for a total loss of about 20% from the peak. But, starting in mid-March 2008, the market went on a bit of a rally, gaining about 14.5% over the next two months. By mid-late May of 2008, the market was only down about 7.5% from its 2007 peak, and there was reason to believe that perhaps a great crisis had been averted.
This rally began right as Bear Stearns was imploding, interestingly enough. People believed that the subprime mortgage crisis was limited only to Bear, and that the damage could be contained, and so the market rallied on those hopes.
However, as we all know, that sentiment couldn’t have been further from the truth, as a massive market implosion was just around the corner. From mid-May 2008 until early-March 2009, the Dow would fall a further 51%, with most of the carnage occurring following the collapse of Lehman Brothers in the Fall of 2008.
And so looking at these examples, we can see that there is a pretty clear trend or pattern that these great bear markets follow: they peak, and then they reverse quite a bit, scaring the shit out of investors.
But then, when markets are down anywhere from 15-20% from highs (notable exception being 1929 when the market was already down around 50%), they start to rally, and it seems like the worst of the crisis is over and that disaster has been averted.
Bulls pile in, bears capitulate, and there’s a general sense that “we’re in the clear” and it’s smooth sailing ahead.
But these hopes are often dashed in short order. Often these early-bear market rallies turn out to be traps, and the worst of the selling is not in the rearview, but just around the corner. Anyone who foolishly believed that the selloff was over and that it was safe to pile back into the market is crushed once the bear market rally ends, as the market almost always heads down to new lows.
This crude illustration I just made is basically how the pattern plays out:
I think there’s a strong probability we’re currently seeing one of these fakeout rallies playing out right now.
Just as a reminder:
- The yield curve is now inverted, which generally always precedes recession
- Oil has spiked, which also generally always precedes recession
- The economy is slowing
- Inflation is scorching hot and the Fed is way behind the curve
- The Fed is hiking into a slowing economy because it is deliberately trying to cause a recession to get inflation under control
- Commodities are skyrocketing due to the war in Ukraine
- The dollar’s status as global reserve currency has never been on shakier ground than it is now, with countries like Russia and China now openly talking about replacing the dollar and ushering in a new world order of multipolarity
- The Fed has ceased QE, and in the past, when it has shut off the money printer, markets tend to go down
- The Fed is going to begin balance sheet reduction, which is yet another headwind for the market
- Mortgage rates are sharply increasing amid the highest housing prices in US history, pointing to a sharp reversal in the housing market
The market has not faced these sort of serious headwinds all together in a very long time–perhaps it never has. It’s like all previous crises in American history rolled into one: the foreign/geopolitical headwinds of the 1930s, the oil/commodities, geopolitical and inflation headwinds of the 1970s, the tech bubble of the early 2000s, and the housing bubble of the late 2000s.
It’s all happening at once.
This market rally we’re seeing right now is more likely than not to be a complete fugazi, and anyone that buys it is probably going to get obliterated.
Now, I could be completely wrong here, and I’m open to that possibility. Maybe global investors are fleeing to the US as a flight to safety amid the uncertainty of Europe and China and emerging markets.
Or maybe it’s just the case that the stock market goes up when a nation experiences rampant inflation–it happened in Venezuela.
But I don’t think this rally is built to last. Given all the headwinds facing this market, I think bulls are poised to get slaughtered in short order here. As we’ve gone over in the charts above, the real selling often takes place after that initial early-bear market fakeout rally.
Which would mean it’s right around the corner for us today.