Next stock market drop could unleash waterfall of selling
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Compared to their 2021 highs, stocks are a terrific bargain. The problem is they have already been a bargain at higher prices before. Only now, those highs are in the clouds – a dimming memory. What’s real is the classic, real downtrend that shows every sign of becoming worse.
Coming is the final death of 2021 bullish-speculation, now barely maintained by hope and temporary price pops. This is the environment when speculators drain their savings, over-leverage with margin debt and shift to options.
A good picture of the dire situation facing these investors is the chart of GameStop and AMC – the notable examples of the 2021 speculation fervor. Each has been bouncing off traditional price barriers: GameStop at $100 and AMC at $15. It’s okay to buy on such a drop the first time, hoping for a rebound, and perhaps the second time, hoping for a “double bottom” launch. However, when the stocks drop back for a third time, watch out. It’s a sign that underlying selling is at work, meaning a crash through the barrier is imminent.
GameStop (right scale) and AMC (left scale) daily graph
John Tobey (StockCharts.com)
But the stock market is already down so far…
Yes, but conditions warrant the drop. First the initial blowoff of speculation. Then, the deteriorating fundamental picture. Yet to come is the specter of recession – a natural conclusion, given the dramatic, negative fundamental changes we’re seeing and we know are coming.
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Also, keep this in mind:
The 1971-72 “nifty-fifty” growth bull market became very popular, with growth stocks reaching extreme valuation measures by the end
The 1973-74 bear market included the OPEC-caused energy crisis, rising inflation, and other fundamental problems (e.g., the Vietnam War). It first wiped out the extreme valuations, then took to heart the negative fundaments, and finally plummeted as fears of recession turned to depression. By the end of the 7-quarter fall, the market had fallen almost 50%
In other words, the S&P 500’s being down about 13% in “correction territory” does not mean the downtrend is stretched. In fact, the reversal days of big, widespread jumps (like Wednesday, March 9) quickly give way to more declines, showing bullishness is still at work in the face of underlying selling.
The bottom line: Don’t view 2022’s stock market decline as an opportunity – yet
There are problems afoot, 2021 bullishness is still not dead, valuations are still high, forward-looking earnings estimates have not reflected the latest negative fundamentals (plus, analysts are still in a bull market frame of mind, with this being a temporary setback).
Cash reserves “low” returns are looking mighty nice these days. Plus, they keep emotions in check and provide resources for future opportunities.
Holding cash reserves keeps emotions calm
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