Is the Market about to Crash?
Market observations by Leon Tuey back in late May of this year.
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Relax...The Bull Market will Continue to Surprise All
For the past several months, pundits have been warning investors of a market correction with many looking for a 5 - 10% correction (they are talking about the S&P and not "the market", of course), scaring the living daylight out of investors. While fully aware of the market's overbought condition and high level of optimism shown by the various sentiment measures, but because of the extremely bullish backdrop, I felt that a meaningful correction was not in the cards. Also, because many of the indices and ETFs have upside targets that have not been met. I concluded that the market will correct, but in a rotational manner, but not of magnitude. That is precisely what is happening.
As most spend their time watching the S&P, they are not aware that since mid-February, the techs have been correcting. Meanwhile, Financial, Industrial, Material issues, and Commodities have been surging to record highs. Short-term, however, these sectors are very stretched and are about to correct. The techs, on the other hand, have been correcting since February and will likely be the first to bottom.
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Inflation
The concern du jour is "inflation" which is rolling off everybody's lips. They point to surging prices, supply bottlenecks, the tight labour market, the sizzling real estate market, etc. While the pundits howl about inflation, Jerome Powell and several other Fed members, however, feel that the current inflation is transitory, but many argued that it is not.
The widespread inflation fear is not surprising as last year, I mentioned that about 12 months after the Fed eases aggressively as they did back in March, 2020, inflation shows up and the market has been telescoping this since last year.
On a short-term basis, I side with the Fed. Inflation is transitory. The broad surge in prices in the first half of this year is not surprising. The curtailment in production caused by the pandemic, the pent-up demand, record savings, and the re-opening of the economies are some reasons for prices to skyrocket. The second half of the year, however, comparison becomes more difficult as in the second half of 2020, the economy was already recovering. Come the first half of 2022, the comparison become even more difficult as the recovery will be normalized; the explosive supply/demand imbalance will stabilize. Inflation, therefore, will moderate. Accordingly, the bull's ascent over the last 12-18 months will not match the spectacular rally of the past eighteen months when the market surged more than 80%. This does not mean that the bull market is over, far from it.
From a secular standpoint, inflation will rise, bit in a modest manner. Demographics, globalization, technology such as AI, robotics, etc., will keep inflation at bay. Also, remember what Jerome Powell said back in the summer of 2018. He said something to the effect that "we would like to smooth out the wild swings of past economic cycles by fine-tuning the monetary policy", the most profound statement that any Fed Chairman ever made. His words were put into action in 2018 and 2019 until the pandemic hit. Rest assured, when the economy is normalized, his new policy will be activated again.
So what, you say?
I've pointed out numerous times that the best environment for equities is in a period of modest growth and stable inflation, the so-called "Goldilocks" economy, not too hot and not too cold which is ensured by Chairman Powell's monetary policy.
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Sentiment
Many have been howling about "Bubble", "Euphoria", and "Speculation". As mentioned, in my wide contacts around the world, however, investors are far from euphoric. Concern is widespread as they are sitting on a mountain of cash and very light on equities (which is backed up by hard data). Also, as can be seen in the following charts, because of the recent market pause, fear is already rising. What these sentiment indicators are telling investors is that the market may correct further, but in a rotational manner, not of magnitude. As the secular trend remains powerfully bullish, emphasis should be on stocks and not watching the S&P.
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More on Sentiment
Most claim the sentiment indicators are contrarian indicators. Not really. As the market retreats, pessimism rises. At the bottom of a correction or a bear market, however, pessimism becomes excessive. Conversely, as the market rises, so is optimism. At the top of a rally or a bull market, excessive optimism is witnessed. Hence, it's at market extremes, the sentiment indicators are most useful. As Warren Buffet advised, "Be fearful when others are greedy and be greedy when others are fearful). Also, Sir John Templeton accurately observed, "Bull markets are born from pessimism, grow on skepticism, mature on optimism, and die on euphoria".
October 10 will mark the thirteenth anniversary of this great bull market. Yet, investors are still wary. Most are grossly under-invested in equities and are sitting on a mountain of cash. As can be seen in the charts below, pessimism is already starting to rise, not because the market crashed, but because it hasn't rallied in recent weeks. Given where these indicators sit, if the market were to drop for one or two weeks, they will give bullish signals. Clearly, despite the widespread concern, risk is limited...
Again, do not be distracted by the headlines and the daily market gyrations, stay invested. Moreover, further weakness should not be feared, but should be viewed as a buying opportunity.
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Leon Tuey, May 24, 2021
Source
https://www.scribd.com/document/509280203/Is-the-Market-About-to-Crash
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