Is this a classic 'bear-market trap'... or a new bull market?
A version of this post first appeared in "Insider Today," a daily email written by Henry Blodget and David Plotz. To receive it in your inbox, please sign up here.
Many observers have been mystified by the stock market's behavior since mid-March. Despite a crippling blow to the economy, 40 million unemployment claims, the near shutdown of major industries, increasing civil unrest, and threats of military force against US citizens, stocks have recovered almost all their losses.
The bulls believe the market is just looking forward from the current carnage to the recovery, which they believe will be stronger than many people think. They point to the massive emergency measures that the Federal Reserve and Congress have thrown at the crisis, which have helped cushion the blow and reduce the worst-case scenario risks. And they believe that, although things are terrible now, the news will get better from here.
One of Wall Street's top strategists, however, thinks this optimism is just delusion. David Rosenberg, of Rosenberg Research, says investors are falling into a "classic bear market trap."
Most bear markets, Rosenberg observes, go through distinct phases. There's the sharp, initial plunge, which scares the bejeezus out of everyone and triggers panic selling. Then there's a strong recovery in the face of this fear, which deludes people into thinking the worst is over and a new bull market has begun. Then there's a long, brutal decline that lasts for a year or more and takes the market far below the depths of the initial plunge.
Rosenberg believes we're in the second phase — a "bear-market rally" that is calming fears and deluding people into thinking that the storm is over before resuming a more painful decline.
Having worked as a professional analyst and journalist during two of the bear markets Rosenberg describes (2000 to 2002 and 2008 to 2009) — and having studied the "Great Crash of 1929" — I can confirm that these patterns are real.
By September 2000, for example, in the early months of the "dot-com bust," the Nasdaq had recovered most of the gut-wrenching losses it suffered that spring, and most of the "smart money" (including, unfortunately, me) believed that the worst was over. But then stocks rolled over again and began a more sustained, devastating, and demoralizing decline. Two years later, the Nasdaq finally bottomed down more than 80% from its peak.
The same thing happened in 1929. By the spring of 1930, the market had recovered much of the ground it had lost on "Black Monday" and other dark days the prior fall, and some investors thought stocks were off to the races again. Then the crash resumed, and the economy headed into the Great Depression. Two years later, in 1932, the major index closed down more than 80% from the top.
As David Rosenberg says—and as the chart below from the Conference Board shows—we saw a similar pattern in 2008. And we could certainly see a similar pattern here. The blue line is 1928-1932. The gold line is 2007-2011. The black line shows the current market through May 29th.
I will also note, however, that moments of greatest fear and skepticism are often the best buying opportunities. Back in mid-March, for example, the market was plummeting hundreds of points a day, and it seemed like the world was ending. Since then, though, the economy and pandemic, despite being horrific, have not suffered the worst-case scenarios that some investors envisioned, and investors who bought in March have been rewarded.
If the economy continues to recover, and we have some medical breakthroughs or good luck and do not experience a major "second wave" of the pandemic, the market could well climb the "wall of worry" back to new highs.
So, in other words, as always with the stock market, there are smart investors and persuasive logic on both sides.
How should a normal person invest in the face of this uncertainty?
The answer is different for each of us and depends on our individual risk tolerance and time horizon. No one knows the future, so we should build our portfolio so that we will be and feel OK no matter what happens.
For most of us — including me — that means diversification. Enough "safe" investments (cash) that if stocks drop 50% to 80% over the next 18 months, I won't panic at the loss of my retirement and sell. Enough "growth" investments (stocks) that if the market continues to rise, I'll offset the inexorable bleed of inflation and earn an acceptable rate of return.
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