November 2018 - Bubbles and Bottoms for Stock Markets -

The good news? November was less wild than October. The bad news? December started the rollercoaster all over again!

The usual suspects, FAANG, were leading the pack once again, showing declines larger than 20% from their all-time high.
The scary thing is that this might just be the beginning. Comparing the market capitalization of the FAANG stocks to the market capitalization of the tech stocks during the dot com era as a percentage of the total US stock market, you see that FAANG is off their highs, but if they would follow the same path as tech stocks during the dot com bubble, we have a lot more pain ahead.

Looking at the number of occurrences when the Dow Jones index had an intra-month decline of more than 8%, and a closing of the month that was at least 4% lower than the month before, it finds itself in bad company. It took place twice this year and before that, *drum rolls* in 2008 and 2000. This pattern basically takes place every time a market peak is set, and I fear that this time it`s not different.

Whichever way you look at it, things are overvalued and highly irrational. The following chart gives a different perspective, this time in the form of the number of occurrences when the Dow Jones closed at a 52-week high, while less than 50% of the stocks are above their 200-day average. This means that only a select group of companies carry the stock markets to new all-time highs. For a solid stock market to take place, we normally see a broad participation, where the “high tide lifts all boats”. At this stage of the cycle, that`s definitely not the case.

Below is an interesting table about the duration of all drops of 10% or more, from an all-time high. You can see that it can take a while for a bear market to happen, although it definitely happens at a faster pace than bull markets. To go from -10% to -20% can take up to 1.5 years, or 18 months. If you`re a bear, that`s only about a 7% yearly return.
My suggestion is to not fall in love with your position, but instead to “whack a mole”; keep a “fixed” number of shorts on the index. Use a flexible number of shorts to enter the market for a short period of time after a heavy “short squeeze” and exit after a 3-4% profit. This way your “fixed shorts” will benefit from the long-term decline, while the “flexible shorts” will benefit from the highly volatile environment.

Of course, that`s easier said than done and with short squeezes being as large as a 10% increase in a day, not many traders will be able to survive it.
So how bad are the markets right now? Is there any way to earn money anymore, in any type of asset class? The simple answer is no. The number of asset classes that show increases of more than 5% per year, is zero this year. The median asset returns are now -1.69% for the year, with the maximum being a meagre 2.43%.

Looking more closely at stock market returns, you would probably be shocked to find out that total returns of the S&P 500 between 2-9% are actually quite rare, and 60% of the time you will find that 10%+ returns are the norm. When you see this chart, you might have the wrong impression that positive returns happen way more often than negative returns. Do keep in mind though, that it only takes one 50% decline, to erase 200% of profits…

Here are two charts that make you think, “hey, why don`t I just go long pre-market and after hours, in January, March, April, July, October, November and December?” And honestly, I wouldn`t blame you. It seems like going long pre-market/after hours and avoiding the slowest months of the year has been a winning combination for decades, and doesn`t look like it`s going to change anytime soon. (Not taking any broker fees into consideration).
The first chart makes me wonder; is this the best visualization of the “capital flight to the East” that we`ve seen over the past decades, where Asia is getting richer (those markets are open during pre-market/after hours) while the US is gradually losing its power?

I`ll finish this chapter with a funny visualization of what it takes to be a good trader/investor. It`s all about the poker face. Don`t celebrate when you`re up, don`t stress when you`re down. Just stay humble and take the market day by day.

One of the funny things about the stock market is that every time one person buys, another sells, and both think they are astute.

- William Feather -

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.