The U.S.
markets went down less than 10% in October, and it felt like the world
collapsed. Practically every metric went from overbought to oversold in a
matter of days. I have compiled lots of interesting charts, scary statistics
and worrisome predictions to give you an unbiased view of what happened to the
market last month, how it compares to past corrections, and what we can expect
for the future.
First of
all this was a global sell-off, with global stocks losing nearly 8 Trillion
Dollar in the past month, which is the most in one month since 2008. In this
chapter you will see lots of referrals to 2008, which could indicate that the
worst is not yet behind us.
As usual, the “smart money”
was the first to be out of the market, and it was mainly the retail investors
who got hit the hardest. Since the market decline in January, the smart money
flow has crashed to levels last seen in 1995!
Looking at
the 70 largest countries in the world, almost 80% of their markets have now
witnessed a “death cross”; this is triggered when the 50 day moving average crosses
below the 200 day moving average, which indicates that sentiment is eroding and
investors become wary.
In the U.S., nearly half of the stocks are now
down more than 20% from their 52-week highs, which, in most cases, is also
their all-time high.
A few
companies in the S&P 500 are already down more than 50%! As a contrarian,
this is of course a very
interesting long-term entry point.
In China
the damage is even worse, where not only single companies are down massively,
but entire sectors are now down by more than 40%!
Unfortunately,
history shows that even if stocks are down by 50% or 60%, the damage can become
even larger. The following newspaper snapshot shows the damage done to tech
companies after the dot-com bubble burst. In the case of Amazon, would you have
had the guts to ride out its 98.7% decline to 5.51 Dollars, only to have it
grow to 2000 Dollars 16 years later?
How often
do these big declines take place in the market? Since World War 2, 56 pullbacks have taken place (a decline of
5% to 9.9%), 22 corrections (which is
considered as a decline between 10% to 19.9%) and 12 bear markets (more than 20% decline).
On average, a pullback takes place
once a year, a correction every 2.8
years, and a bear market almost every
5 years.
The good news? Stocks recovered all their losses within 2 months of a pullback, and within 4 months of a correction.
"The
four most dangerous words in investing are:
'this time it's different.’”
- Sir John Templeton -
When people
are shocked about how fast these moves in the stock markets take place, you
should show them the following table. It shows that basically all the “fun”
takes place on only 20 days a year. Missing out on the 10 best days of the year
gives you an average negative return of -9.1%, while missing the 10 worst days
of the year gives you an average stellar return of 35.8%.
These
statistics are great, but it`s of course impossible to use in your normal
trading or investing activities. The reality is that you get shaken around
throughout the year, whether you`re a bull or a bear. Fact is that this shaking
is more volatile during bear markets or corrections than at any other time in
the market. The following table shows the largest daily changes that have taken
place over the past 70 years, and you can see that both the largest increases,
as well as the largest decreases, have mostly taken place when the market was
below its 200-day moving average. Volatility is the name of the game during a
correction, and trading on this can be much more rewarding than having a static
bullish or bearish position.
What will
the future bring? Looking at the below chart, you can see every drop larger
than 10% within 30 days from a multi-year high. Unfortunately for many of us,
such a drop has taken place at large inflection points in the past, notably
2008 and 2000.
Another
worrisome development is the fact that the “last hour compounded return” has
crashed since July. Institutional traders and hedge funds normally don`t make
large trading decisions until the final hour of the trading day. The first hour
of the trading day is considered by many to be the “amateur hour”, where retail
money comes pouring in. Who would you rather follow?
I`ve shown
you plenty of reasons why the market is due for at least a correction, but most
likely a full-fledged bear market, and I wanted to give you one more clear
example of the massive exuberance taking place in the S&P 500. It`s the
Median Price to Sales Ratio. This ratio is an indicator of the value placed on
each Dollar of a company`s revenue. Currently the ratio sits at an all-time
high of 2.63 “Index Dollars” for every “Revenue Dollar”. It is one thing to put
a multiple on a company`s profits, but to put a multiple on a company`s revenue
is a whole different ballgame. Until 1995 this level has always been at or
below a 1:1 ratio, which in my opinion can be considered healthy. However,
after 1995 the ratio has skyrocketed, only dipping back to 1:1 for a short
while during the financial crisis. Is a multiple higher than 1:1 the new
normal, or will we revert to the mean?
As i`ve
stated multiple times in the past months, reversion to the mean is a very
strong and inevitable movement. Overshooting the mean takes place just as much
as undershooting, and the larger the overshot, the larger the undershot will
be. These overshoots can be measured in standard deviations; how much does the
current level deviate from the average level, considering a normal price distribution?
The next chart shows the standard deviations from the average level for
consumer confidence, inverted unemployment levels, and equity market
valuations. Currently that deviation lies at a lofty 1.3 from the mean, above
the levels in the 60`s, and nearly reaching the levels from the late 90`s.
Sit tight
the next 1.5 years, because it promises to be highly volatile, with extremely
high chances of U.S. markets ending up in bear market territory, clearing all
the exuberance that has been created not only in the past 10 years, but since
we abolished the gold standard in 1971. There will be a washout unlike anything
we have probably ever seen, which will set the stage for the young millennials
and generation Z to fully benefit from a new rise, with new rules, new
standards, and new players at the top of the largest corporations and the
biggest government institutions.
“Hard times create strong men. Strong men create
good times.
Good times create weak men. And, weak men create hard times.”
- G. Michael Hopf -
The information contained in this publication is not intended to constitute individual investment advice and is not designed to meet your personal financial situation. The opinions expressed in this publication is that of the publisher and is subject to change without notice. The information in this publication may become outdated and there is no obligation to update any such information.
