What Could Investors Expect If Stocks Peaked Today?
Weekly Notes With Tiho — Issue 6
Location: Bangkok, Thailand
I’m not calling the final top in this bull market.
Even if does top here, there is no way anyone in our industry has the ability and the foresight to correctly and consistently predict calls like that.
You could speculate on it, though.
Put your money where your mouth is, as they say.
I’ve done that plenty of times. I’ve had some wins and I’ve had some losses.
And there is plenty of reasons a speculative bet like that just might turn out to be a winner.
Just make sure your risk management is in order — but that's a topic for another day.
This week I am writing to you from the beautiful Thailand. I'm visiting islands of Phuket and Phi Phi, as I look for some real estate opportunities.
Everything here is perfectly calm, similar to the lack of volatility in the stock market right now.
However, Savvy and wise investors do understand that periods of low volatility are often followed by periods of high volatility, and visa versa.
References Made To 1929, 1987 & 1999
In the previous post entitled Looking For Stock Market Opportunities Around The World, I discussed various valuation metrics which all confirm that US equities are expensive.
I actually even said bloody expensive, just to correctly quote myself.
There are bearish gurus, experts, famous fund managers and analysts out there — all of whom believe we are in a similar period to 1929, 1987 or 1999.
They might be right… eventually.
However, for the sake of this article let us assume they are right as of Monday morning.
Let's assume US equities have peaked and are now about to correct.
After all, at the beginning of this month (When Does Good News Become Bad News?) I did entertain the idea that if global equities were bottoming between late 2015 and early 2016 on bad news — they ought to peak and correct on good news.
Is The Correction Around The Corner?
So what could be the damage to the US equity market and what would it look like?
Earlier this week, I asked myself that same question.
Terminology is always a bit of an issue in our industry. But generally speaking, most investors view:
- -5% or more as a pullback;
- -10% or more as a correction;
- -20% or more as a bear market;
- -30% or more as a serious crash; and
- -50% or more as the end of the world.
A standard -5% move on the downside would get to us towards a flat year to date performance.
United States total return index would lose just about all the gains for the year, as it mean-reverts back towards its 52-week moving average.
A corrective sell-off would be -10% or more. That would pull the index back all the way to the August 2016 peak.
Just before the final innings of the US election race and the surprise Trump victory.
Ok, so you might be looking at the chart and thinking: “Well, not too bad. Good opportunity to buy.”
What If The Super Bears Are Right?
What about a more meaningful sell-off?
If we assume the top is in, a standard bear market -20% sell-off (or more) would push the S&P 500 towards September 2015 levels.
Perhaps the most interesting point here is the price level would still be above January 2016 lows.
There are so many perma-bears on Twitter, who have been forecasting a bear market since 2015.
And funnily enough, even with a -20% fall, the index would still be at the point of profitability for those who bought stocks two years ago.
Another observation to take into consideration is the time it takes to reach such a sell-off.
Would the index crash there in a hurry?
Or would it take its time to reach the -20% drawdown?
If the latter, we also have to take into consideration the dividends being paid out to buy & hold passive investors — which would cushion the fall by around 2% annually (at the current payout).
Moving along, let us observe the last chart.
We are looking at something serious here, such as a recession or even a major (global) crisis.
A serious bear market of -30% or more would take US stocks back towards July 2013 levels.
This would be quite a catastrophe for those buying today.
It would also be disappointing for those who bought August 2015 and January 2016 lows. If you were a regular reader of The Short Side of Long blog, you would recall I made that purchase.
And finally, what about the “end of the world” scenario, where US equities correct by -50% or more?
The index would find itself trading at levels last seen in mid-2007 and mid-2011 when adjusted for dividends. The whole breakout from the secular bear market range (2000-2012) would be reversed.
For the super bulls, which are convinced we have started another secular bull market run (similarities to 1949-1966 and 1982-2000), it truly would be the end of the world.
Where Would The Money Flow?
I have stated in the previous articles that, at current valuations, US equities will probably not produce the desired result of 8 to 9 percentage that so many institutional and retail investors are after.
Will stocks continue to rise, but at a much slower pace, consolidating along the way?
Maybe stocks will have a big-bang blow off top, as many bulls expect?
After being up 9 years in the row (including 2017), maybe a meaningful correction is overdue? And if so, what will the correction look like?
These are the questions none of us have correct answers too. There are just risks and probabilities.
However, US equities are not the only game in town. There are lower-risk assets with better opportunities to be found elsewhere.
Some of these other global markets offer far better future expected returns.
Furthermore, one could also make the case that in a recessionary environment, a significant stock market correction could prop up Treasury bonds and Gold.
Both of these assets are in a serious historical drawdown.
The chart above clearly shows that the long end of the curve offers some value. For the long duration total return index to make new record highs, investors could net a 25% gain from these levels.
But all of these case scenarios are hypothetical and speculating on them has profound consequences.
If you would like to know how I am tilting clients portfolios, which asset classes I am buying and where I see opportunities — let us make arrangements for an investment consultation.
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