Don't Ignore the 'Warning Shot' That Mr. Market Just Fired

What the heck happened?... Don't ignore the 'warning shot' that Mr. Market just fired... Only the third time in history... A horse of a different color... Boom or bust?... Prepare your portfolio now...

It was the question of the night...

A family member was over at our house last night, eating our snacks, and said the words that we sometimes hear from him: "Hey, since you're a finance guy..."

I (Corey McLaughlin) didn't know exactly what he was about to say, but I had a good idea it was about what happened in the markets yesterday...

"I was down a lot of money, like a lot of money, this morning," he said while nibbling on some Goldfish. "Then, by the end of the day, I was up."

"It was crazy," I said.

"What the heck happened?"

It was a good question.

Yesterday was 'not normal'...

We covered the nuts and bolts in yesterday's Digest, but after publishing last night, I thought more about the essence of the craziness that had just taken place...

As I answered my family member, this kind of hit me...

As I wrote yesterday, it appears that a lot of selling by "retail investors"... meaning do-it-yourselfers... in the first hour of Monday's trading started a quick tumble that put the tech-heavy Nasdaq Composite Index and benchmark S&P 500 Index down 4%...

I told him what we've been saying here... that a lot of people with money in the markets are getting concerned about what the Federal Reserve is going to do next with interest rates and other monetary policies to try to stem inflation.

In any case, things looked really bad for the markets yesterday morning as many key trend indicators were broken... meaning the bottom might be falling out.

But by the afternoon, professional investors – hedge-fund traders, money managers, and the like – had stepped in and were buying enough shares of different stocks to stage a stunning one-day reversal in the indexes and many sectors.

The S&P 500 and Nasdaq each finished the day positive, up 0.28% and 0.63%, respectively, from down more than 4% hours earlier...

It was a truly wild performance worthy of questioning...

As I was busy rewriting parts of yesterday's Digest to reflect the big swing, I felt like this had to be one of the crazier days the U.S. stock market had ever seen... As I'll explain today, turns out this is true – and it was maybe crazier than you might think.

At the same time, I thought, if you simply looked at the closing numbers of the major indexes yesterday... up a tiny, tiny bit... you probably would think nothing significant happened in the markets at all... And I don't want the significance of what actually did happen yesterday to be overlooked...

Because, upon further review, we either just received a "bear market warning"... if not for the immediate future, then for the not-so-distant one... or this sell-off could also end up being part of a short-term bottom that sets up bigger gains ahead.

We're not going to tell what is going to happen next because we can't know for sure.

But at the very least, single-day swings like the markets had yesterday are so rare that they alone are reason to pause and take a close look at your portfolio... and make sure it's prepared for anything that might come...

Said another way, don't ignore the "warning shot" that Mr. Market just fired...

Monday's big intraday swing has only happened two other times in market history...

Our Stansberry NewsWire editor C. Scott Garliss shared the numbers with us today...

Yesterday, the S&P 500 recovered from an intraday loss of more than 3.98% and finished the day positive. This was only the third time it ever happened...

You're probably not going to like seeing when the other two occurred (both in October 2008 at the runup to the worst of the financial crisis)... And that this suggests more losses could happen over the next several months.

But you also might be encouraged by the one-year recovery after these two market days...

Today, the S&P 500 continued this small-sample-size trend, slipping 1.12%...

The history with the Nasdaq is similar.

As our Empire Financial Research founder Whitney Tilson shared in his free daily newsletter today...

One of my colleagues sent me this bit of trivia, showing exactly how crazy yesterday was: it was just the sixth time since 1988 (when open/high/low/close data began) that the Nasdaq erased an intraday decline of more than 4% to close higher on the day:

In the previous five cases, covering four time periods (two were only a month apart in late 2008), the market was down one month and three months later in every case except one, but was higher in all but one case a year later. Interesting...

Today, the Nasdaq lost 2.28%.

Longtime readers know that many of our editors hate to say 'this time is different'...

I certainly am not about to argue with them... It's wise to just look at what's in front of you.

But I also find it kind of hard right now to say what the "this time" is that we should even be talking about...

The best bet might be to start with October 2008... the only other time the Nasdaq and S&P 500 both behaved like they did yesterday.

October 2008, of course, was a month of Wall Street and financial panic that movies have been written about...

Back then, stocks were already down about 30% from their 2007 highs by that November, but remember, the S&P 500 fell another 25% from there... and the stock market did not hit bottom until five months later, in March 2009.

This is all to say that the little amount of precedent we have for a historically volatile day like yesterday suggests more losses are to come, broadly speaking, for stocks over the next six months... and that a bottom to this sell-off hasn't arrived yet...

At the same time, today stocks have been overdue for a "garden variety" 10%-ish correction too. These happen about every year on average. The issue of course is it's impossible tell right now if this sell-off is one of those... or if a bigger one is still to come.

As Scott wrote in a private note today...

The signs say the recent sell-off isn't over. Based on past precedent, there's more pain to come before a rebound. But over the next 12 months, we should see solid returns.

It's natural something like this is happening, especially when we're experiencing such a large rotation out of growth and into value.

Scott also wrote yesterday to keep watching how stocks perform in the last few hours of each trading day over the next week or so... From his two decades of experience on Wall Street, he senses that algorithmic (computer) trading is behind the late-day moves...

Then again...

At the very least, the fact that retail selling during Monday's open has been cited as the primary reason for yesterday's sharp sell-off shows you how much "fear" is in the market today.

It's natural for people to be afraid of what they don't know. And never in history have we seen the amount of stimulus we've seen over the last two years...

The Federal Reserve is carrying a $9-trillion balance sheet. The U.S. government has sent thousands of dollars directly to every American recently.

Inflation is surging at record levels... And now, the Fed is about to make announcements about taking stimulus out of the economy. Nobody has seen how this ends up before.

Yet, as we've written before and as Dr. Steve Sjuggerud shared in a recent issue of his True Wealth Systems newsletter, returns for stocks have been pretty good while rates are rising – because that signals a belief in a strong economy ahead – but stocks tend to crash once rate hikes stop.

As Steve wrote in our January 22 Masters Series...

The start of previous rate-hike frenzies led to gains in the S&P 500... not crashes...

The Fed hiked rates 17 times from June 2004 to mid-2006. Yet the S&P 500 soared over that period... rallying 46% before its peak in 2007.

Stocks climbed even more from 2016 to 2020. The Fed hiked rates for years... But the S&P 500 still rallied nearly 80%.

But if economic growth slows while the Fed is hiking rates (not to mention if inflation persists because of the pandemic), that is a horse of a different color.

At the same time, careful readers also know that our Ten Stock Trader editor Greg Diamond has been tracking an "analog" between today's market and that of the dot-com bubble and the 2000 stock market top in the Nasdaq.

As Greg wrote in our January 8 Masters Series...

All is not well under the hood of the stock market.

If this analog continues, I'm expecting this bull market to end by February or March 2022.

Yup – that's a bold prediction, I know. But let me explain further...

This analog has been on point for more than a year now, so there's no reason for me to doubt it. I say it often to my Ten Stock Trader subscribers – be unbiased and let the price action guide you.

And check out the chart above that we shared from Whitney that shows what happened to the Nasdaq in 2000 and 2001... one month, three months, and one year after a day like yesterday. It was down 12%, 13%, and almost 50%, respectively.

Remember, the Nasdaq outperformed the overall market all the way up from the March 2020 bottom as cash was thrown into the system and interest rates were near zero.

It "makes sense" that higher-growth names would sell off first on the way down as the Fed makes dollars a bit stronger... But, as we know, Mr. Market also often doesn't make sense.

In the end today, we're not going to make any declarations about what's going to happen next...

Wiser men than me, like our Dan Ferris and David "Doc" Eifrig, have written lately to say why it's not very useful to try to predict things... one way or another... In fact, Doc will be sharing his thoughts on this topic in tomorrow's Digest.

I think you can pick up on why from the conflicting evidence and uncertainties we feel today.

I will also say that anyone can find a historical nugget about the markets that might not end up meaning much in a day or week from now...

Financial analysts share them all the time on Twitter and elsewhere... It's wise to be skeptical.

But, if you take nothing else away from today, take this...

When we see instances that have happened "only two other times" in history – and both times were in the depths of a financial crisis and stocks sold off another 25% from there – it tells us it's time to pay attention...

Said another way, what happened yesterday might be a final warning that you want to ready your portfolio for the "unexpected"... In the meantime, don't try to predict what the unexpected will look like or when it will happen.

Just prepare. Manage your risk. Heed your stop losses. Own a diversified portfolio featuring high-quality stocks of capital-efficient companies... and don't get "out over your skis" in any one sector or position. As we've been saying, this is going to be a volatile year...

Along those lines, you're going to want to hear this...

Three of our top editors are sitting down together for an all-new presentation at 8 p.m. Eastern time this Thursday, January 27, to talk about how to prepare your portfolio in 2022...

Steve, Doc, and Director of Research Matt Weinschenk will talk about how you can design your portfolio to protect and grow your wealth no matter what happens in the markets next...

This is the most important investment recommendation you will see from Stansberry Research all year.

They'll share their thoughts on what they're expecting in the year ahead and the powerful tool they recommend individual investors use to build a truly "all weather" portfolio that will perform well in any market environment.

You don't want to miss it.

If you're worried about what's going on in stocks today or found anything we wrote today of interest, I urge you to listen in to Steve, Doc, and Matt on Thursday. The event is totally free. We just ask that you sign up in advance here.

New 52-week highs (as of 1/24/22): Travelers (TRV).

In today's mailbag, a question about portfolio management... Do you have a comment, praise, or rage? As always, e-mail us at feedback@stansberryresearch.com.

"Good morning, I am going to take your suggestion and rebalance my portfolio!!! I'm a little confused though. Reading the January 4th article by Corey McLaughlin and scrolling down to where Porter wrote...

If a stock has a beta that's less than 1, then increase your position size until multiplying its beta by that factor will equal 1. And do the inverse for stocks with betas that are greater than 1.

"Multiply what factor? Excuse my ignorance but I don't understand this. I understand beta, just not how to do this. If you could explain it, or at least post an example, I would greatly appreciate it." – Paid-up subscriber Clint G.

Corey McLaughlin comment: Good question, Clint.

I'll answer your question and then offer up another relevant option for everyone as well...

The "factor" Porter was referring to is the number you'd need to multiply by to make a particular stock's "beta" equal to one.

Probably the easiest way to figure out this factor is to divide the stock's beta into or by one, depending on if the beta's higher or lower than one to begin with.

Let's use chocolate-maker Hershey (HSY) as an example... Longtime readers know this is an old, reliable favorite of our founder Porter Stansberry.

Hershey's five-year "beta" – which you can find on our Stansberry Investor site – is 0.4. So since it is below 1, you'd divide 1 by 0.4, and get 2.5.

If someone currently has $1,000 worth of shares of Hershey, which is trading for about $200 as I write, that's five shares...

If they wanted to make that position have a beta of 1, they would then multiply the current position size by the "factor" of 2.5, meaning increase it to $2,500, or roughly 12.5 shares.

If the stock's beta is greater than one, you'd do the inverse, as Porter said, and divide its beta by 1 to get the "factor," which will end up trimming the position size.

Remember though, like Porter wrote, the thing you want to think about first before doing any math is what risk tolerance you are comfortable with – and your goals.

A beta of 1 means the stock, or your portfolio, moves equally with the S&P 500.

A beta of 2 means the stock moves twice as much, both up and down, meaning potential for bigger gains but also greater losses.

A beta of -1 means the stock moves precisely opposite to the S&P 500.

You can adjust your factors accordingly to have the beta equal 1, 2, or whatever number you want.

Let me also say, you can do all this yourself... or you can let our editors do it for you.

In particular, our Portfolio Solutions products – which feature the best picks from all of our research made into fully allocated portfolios – are designed to save you a lot of this trouble of doing it on your own... and go even deeper than just thinking about "beta."

We offer different model allocations for different goals, like income generation or capital protection...

Not only that, our team has created "position size calculators" for each type of portfolio... These tell subscribers how many shares of each company they should buy and the maximum percentage of the portfolio that is at risk with any of the positions.

If you want to learn more about this, be sure to tune in to our upcoming event at 8 p.m. Eastern time on Thursday.

As we said at the end of today's essay, Steve, Doc, and our Director of Research, Matt Weinschenk, are sitting down to talk about how to prepare your portfolio for 2022... and we expect these types of ideas to be part of the discussion as well.

You can sign up for free right here.

All the best,

Corey McLaughlin
Baltimore, Maryland
January 25, 2022