While a stock market mania is in progress, virtually anything is possible. Previous manias and bubbles have shown quite convincingly that anyone may enjoy great success, since it takes no particular skill at all to buy stocks, asserts Alan Newman, market strategist and editor of CrossCurrents.
All it takes is money to ride the rising tide. It’s all about demand. Success leads to additional demand and an increased exposure to risk, and eventually an overwhelming demand when leverage is utilized for maximum exposure. However, risk is double edged.
The ease of wealth gains in a mania is always countervailed when participants ultimately realize that keeping wealth gains is a different story entirely. Stock bubbles take valuation and sentiment measures to ludicrous extremes. We’ve examined this at length many times before. Suffice it to say the damage done after bubbles burst is substantial.
The average bear market is both deeper and longer than our experience to date. This most recent mania ended as 2021 ended, with the SPX at 4,796 and the Dow Industrials at 36,799. At the mid-October bottom, the S&P 500 were down 27.5% and the Dow had lost 21%. Isn’t that enough damage to end the bear market?
Sorry, but in this case, it’s not even close. Just using the historical averages, we should expect “long drops,” so there is likely more to come in both time and price. The historical average of 38% and 318 days would take the Dow Industrials to 22,741 and the S&P 500 to 2,988, another 25% down from today, sometime in early March of 2023.
Long drops, indeed. However, that is just an average. Stock bubbles typically result in substantially more damage. Far longer drops in both price and time. The four previous bubbles, topping in 1929, 1973, 2000 and 2007, were followed by bear markets that endured an average of 527 days and a 60% decline in price.
This coincides exactly with our much repeated forecast of an eventual bear market target low of Dow 14,719, a forecast we came up with at least two years ago. Time wise, a duration of 527 days would take us out to late January 2024 before the ultimate bottom.
Okay, but what about the massive rally since the October 13th bottom? Couldn’t this be the beginning of a new bull market? That would be an impossible call, given still stretched valuations. With the latest rally, the S&P 500 P/E is now a lofty 20 against a historical median of 14.91 and a mean of 15.98. Incredibly, by this measure, the index is still 25% to 34% overvalued.
Meanwhile, the decline from last year’s highs was quite tame by historic standards. The last session that qualified as capitulation (up volume vs. down volume of 1:9+) occurred on March 12, 2020. Given our data history, the normal expectation would be 24 sessions of capitulation in the 19 months since. We’ve had none!
As well, our technical charts show nothing like the kind of action that typically ends bear markets. There was no panic anywhere along the ride down nor was the ride down marked more than occasionally with truly rotten days, down 3% or more. By historical standards, volatility has been ridiculously tame.
Simply put, stocks are grossly oversold and sentiment measures indicate weeks of consolidation or even a rally phase to test a best case of major resistance at Dow 34,281. Seasonality is turning somewhat favorable now, but we expect it to all fall apart again by February 2023 with a lot more downside in store next year.
