Dog Vomit, Downside, and a Stock Market Rally

'And... it's gone'... FAANGs are round tripping, too... The 'flag stock' of the bubble... The 'Gods of the Market' are humbled... Growth is dead. Value is back... The croissant doth provide... Dog vomit, downside, and a stock market rally...

Let the epic dead-cat bounce commence...

The stock market sell-off that pushed the S&P 500 Index to a new 2022 low on Thursday seems due for a breather... a massive dead-cat bounce.

As I referenced in last week's Digest...

The phrase "dead-cat bounces" refers to an old Wall Street adage about rallies during bear markets... Even a dead cat bounces when you throw it down the stairs.

One reason for a dead-cat bounce is that investor sentiment is getting washed out...

I (Dan Ferris) have stopped paying attention to most sentiment indicators because they vacillate between extremes, even during bull markets... But our friend Jason Goepfert at SentimenTrader.com has two very good ones. He calls them Dumb Money Confidence and Smart Money Confidence.

They've both hit extremes, suggesting there's a rally around here somewhere. Jason says...

The Dumb Money is panicking while the Smart Money is buying.

It's not surprising, given how far and fast the big stock indexes have fallen...

As of Monday's close, the S&P 500 Index was down nearly 17% from its January 3 peak, which is a little more than four months ago. The Nasdaq Composite Index closed roughly 28% below its November 19 close, which is a little less than six months ago.

Jason watches other indicators, too... One of them is the 90% Downside Day indicator, made famous by an award-winning 2002 paper. It says that when 90% of trading volume is in falling stocks on at least two days (and they don't have to be consecutive days), a bottom is likely near.

On Monday, as markets hit new lows for the year, Jason posted on Twitter...

Over the past 60 years, there have been 12 times (besides today) when 2 out of 3 sessions saw 93% or more of volume focused on falling stocks. 11 of them witnessed a rebound.

And on Tuesday, when veteran trader Helene Meisler posted on Twitter, I remembered how white hot a bear market rally can be...

[I] am reminded of something my mentor Justin Mamis always said: Memorex doubled 4 times on its way from 300 to zero

Stock markets on the whole don't go to zero, but the point is clear. Whether we're in a bona fide bear market is up for debate... But it feels like a bear market, and it also feels like we're due for a rally.

Just look at the damage Goepfert's Dumb Money crowd has already endured. By now, most not-so-experienced investors must have a funny but painful phrase echoing in their minds...

'And... it's gone'...

That's a line from the animated comedy TV series South Park... It's used for a meme on social media that represents the brutal, totally unexpected losses experienced by naïve investors.

In the original scene, a young, inexperienced investor gives money to a financial adviser who is seated in front of a computer. The money hits the account, the adviser types a few keystrokes, and a second later says, "And... it's gone."

The meme might have been trotted out earlier this week, but I haven't seen it yet. Why earlier this week? Well, as Bloomberg reported on Sunday...

[A]mateur investors who jumped in when the lockdown began have now given back all of their once-prodigious gains, according to an estimate by Morgan Stanley. The calculation is based on trades placed by new entrants since the start of 2020 and uses exchange and public price-feed data to tally overall profits and losses.

The small, know-nothing retail investors who started day trading with their government stimulus checks while they were locked at home during the pandemic have lost all the money they made...

It was by no means an instant loss... but those of us who've seen this happen many times over the last few decades know that a novice investor's first big losses hit his psyche as suddenly and unexpectedly as in that South Park scene... even though it might take four to six months for them to stop denying they've lost it.

We reported a similar analysis for the ARK Innovation Fund (ARKK) in our January 14 Digest... Then, portfolio manager Simon Lack of SL Advisors estimated that the average $1 invested in ARKK was underwater... And it has only gotten worse.

And yes, this seems very familiar because I've mentioned this more than once. I'm repeating it on purpose to remind you of how all the stupidest money comes in at the top and how it takes longer than anybody ever expects to completely wash out the sentiment.

Also unsettling for ARKK holders... it's no longer outperforming the S&P 500 since inception...

The meme-stock crowd is in the same boat as the ARKK crowd...

And the boat is not exactly Noah's Ark!

A basket of 37 meme stocks tracked by Bloomberg has hit a new all-time low, slightly lower than before the meme-stock phenomenon spread rapidly on Reddit and other social media... sending the likes of GameStop (GME), AMC Entertainment (AMC), and others up thousands of percentage points in days.

And investors who thought they were playing it safe by buying FAANG stocks have done only a little better... If you've been holding Meta Platforms (FB), Amazon (AMZN), Apple (AAPL), Netflix (NFLX), Microsoft (MSFT), and Alphabet (GOOGL) since February 19, 2020 ‒ the market's pre-COVID-19 peak ‒ you're at minus 2% on Amazon, minus 56% on Netflix, minus 12% on Facebook... and about 14% overall.

The whole group looks like it's headed down the same path that all the garbage stocks have already followed...

Though all this damage suggests there's a ripping bear market rally in our near future, that doesn't mean the bubble has burst and the big indexes are done falling...

The bubble won't be gone until the last shoe drops...

The last shoe is electric-vehicle maker Tesla (TSLA).

Hear me out...

Tesla is trading 37% off its all-time high of $1,229.91... which was just 15 days before the Nasdaq peaked on November 19. But a 37% drawdown is barely a blip for a stock that rose 35-fold (3,500%) in two and a half years... from June 3, 2019 through its November 4, 2021 peak.

There's much more downside ahead for Tesla. And the bear market we are likely in right now will not be over until Tesla crashes... I say this partially for an anecdotal reason.

Every great bull mania has a "flag stock" – one stock that sums it up and represents its excesses. It puts a name and an ethos on the moment and encompasses the most important hopes and fears of the day...

The flag stock of the 1920s boom was Radio Corporation of America, which you and I know today as RCA... Radio was a new technology back then, analogous to the Internet in the late 1990s or the blockchain of today.

RCA share-price data isn't readily available, but you can look online and find any number of charts. They all tell the same story... huge multibagger gains that were all lost in an epic round trip, just like what is happening to ARKK and the meme stocks right now.

Cisco Systems (CSCO) was the flag stock of the dot-com boom. At its March 2000 peak, it was valued at $555 billion, then the largest market cap in the world, because it was selling "Internet plumbing"... switches and routers. Now 22 years later, Cisco – a profitable company then and now – has yet to eclipse its March 2000 high.

A Tesla round trip would take its share price back to around $88 ‒ where it was at the beginning of 2020. That'd be similar to the performances of RCA, ARKK, and the meme stocks... That means Tesla has nearly 90% downside potential from today's share price of about $750.

For now, the company is still well-ensconced in bubble territory. Tesla is still valued at more than the next 10 biggest car companies combined!

Here's another reason there's more downside in the overall market...

Besides the fact that its flag stock is still trading at a bubbly valuation, this other reason is simple. You remember those folks who lost all their pandemic stock market profits?

Well, I don't think they're done betting yet. They'll come back to the table one more time, for sad reasons that I've found a fun way to explain...

Check out this excerpt from Rudyard Kipling's classic poem, "The Gods of the Copybook Headings." The "Gods" in the title uphold simple, timeless wisdom. The Gods of the Market represent the perennial folly of unrealistic expectations. It goes like this...

Then the Gods of the Market tumbled, and their smooth-tongued wizards withdrew,

And the hearts of the meanest were humbled and began to believe it was true

That All is not Gold that Glitters, and Two and Two make Four –

And the Gods of the Copybook Headings limped up to explain it once more.

As it will be in the future, it was at the birth of Man –

There are only four things certain since Social Progress began.

That the Dog returns to his Vomit and the Sow returns to her Mire,

And the burnt Fool's bandaged finger goes wabbling back to the Fire;

The Gods of the Copybook Headings will always return to reassert their timeless wisdom, trumping the Gods of the Market.

Market dynamics and timeless wisdom are not mutually exclusive... but wisdom encourages prudent behavior, and markets can encourage foolish behavior – which they have been doing of late.

As the stock market stands right now, the Gods of the Market have tumbled... and unfortunately, all too many of the poor dogs who've round tripped in meme stocks and other garbage will return to their vomit...

It's a nasty phrase but contains some truth. Folks who lose a lot of money seem too eager to try to win it back the same way they lost it, not learning the lesson of how unskilled they are at that particular endeavor.

And remember, Morgan Stanley (MS) said they gave back all their gains, not that they lost all their money... They won't be done until they're wiped out.

I said something similar last week, minus the dog vomit, pig mire, and burnt fingers...

Like my bearishness of the last two years, I'll likely repeat this frequently, since our flawed human nature loves to forget it.

If the Gods of the Copybook Headings were asset managers, they would be value investors. And they are reasserting their wisdom once again, just as the poem suggests...

And their wisdom says that value and valuation are beginning to mean something again...

Investors have sold growth stocks, says Bloomberg's John Authers, because they were too expensive. I'm not sure I agree, and Authers acknowledges what I've said many times... that valuation is a lousy timing tool.

He likens the current market downturn to the end of the dot-com boom, when he says investors sold for the same reason... drastic overvaluation.

Bad timing tool or not, he has a decent point. The dot-com peak and the recent peak are the two most expensive moments in U.S. stock market history... So the idea makes sense. Though it's a lousy timing tool in the short term, long-term valuation is like the force of gravity...

Eventually, lofty valuations will fall back to Earth...

If Authers is right that too-high valuations are driving the downturn in stock prices, the market as a whole could have quite a bit more downside, if history is any guide... and it's pretty much our only guide.

The S&P 500's cyclically adjusted price-to-earnings ratio ("CAPE") has fallen since the index peaked in January but is still trading above the 1929 peak, one of the ratio's three highest levels since the 1870s...

I've written many times, in my Extreme Value newsletter and elsewhere, of the attractiveness of value stocks compared with growth stocks... Value stocks are the cheapest ones in the market by the basic metrics like price to earnings and price to book value. Growth stocks are those with the fastest-growing sales and earnings... if they have earnings at all.

Both the Russell 3000 Growth Index and the Russell 3000 Value Index are down since growth stocks peaked on November 19. But their performances have diverged widely.

The value index is down 8% since the peak, while the growth index has lost 27% of its value... A 19-percentage-point outperformance is nothing to sneeze at. It says, "Growth is dead. Value is back."

If history is any guide, value stocks will outperform for at least another few years, if not for longer... And yes, just as the big stock indexes will rebound at some point, so too will value stocks correct, along with the commodity trades that have worked so well since last year.

But these value and commodity cycles tend to be five to 10 years long, so maybe the easy money has already been made, but the big money still lies ahead.

Sometimes when markets are volatile, it's wise to step back, take a breath, and get a little perspective... It has been a brutal few months, so let's step way back. When you do that, you will see that...

We all live in a giant pastry...

NASA scientists now believe we live in a croissant-shaped bubble in space. They call it the heliosphere and say it extends roughly twice as far from our sun as Pluto does.

The idea is part of a model of the universe developed by 40 scientists. NASA just gave nine research centers across the U.S. a five-year grant totaling $12 million to study the croissant.

I realize it sounds amusing, but it's potentially very serious business... We apparently owe our lives to the croissant. Scientists say that the croissant-shaped bubble we live in "casts a magnetic force field around all the planets, deflecting charged particles that would otherwise get into the solar system... and destroy our DNA."

So instead of saying, "Thank God above" to express gratitude, maybe we should say, "Thank the flaky, buttery goodness above."

As for me, these days, I thank the flaky, buttery goodness above that I got so bearish and counseled holding plenty of cash, gold, and silver... And I hope you followed that advice.

And if you didn't follow it, it's not too late to do so. Like the Gods of the Copybook Headings say... the croissant doth provide.

Miss the Madness With These Eight Stocks

"The action we've seen over the past few months reminds me of the Great Recession," says Matt McCall in the most recent episode of his video podcast Making Money With Matt McCall. "So I want to share the story of how I got through that tumultuous time – and many others over my 20-year-plus career – and came out on the other side."

It's worth tuning in to hear about Matt's story, as it shows the value of taking advantage of down times in the market.

Click here to watch this video right now. For more free video content, subscribe to our Stansberry Research YouTube channel... and don't forget to follow us on Facebook, Instagram, LinkedIn, and Twitter.

New 52-week highs (as of 5/12/22): None.

In today's mailbag, more feedback on railroads... plus thoughts on yesterday's Digest, which talked about state governments contributing to inflation and an opportunity in I-bonds – a nearly risk-free investment paying more than a 9% yield... Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com.

"You misspelled the title of this story [Wednesday's Digest]... It should read "Shame-ish" Inflation Story. Railroad owners need to be called out for their shameful refusal to do their jobs." – Paid-up subscriber Steven O.

"Maybe instead of using the term inflation, of which the Feds and media have people thinking 'a little is a good thing,' use the term devaluation which is the byproduct of government's creating money they don't have out of thin air without corresponding economic growth. We could wake some folks up." – Paid-up subscriber John M.

Corey McLaughlin comment: I think we might start doing this... If everyone used the word "devaluation" instead of "inflation," it sure changes the narrative out there today... and makes a pretty good point, too.

"Interesting article about the I-bonds. Since you are limited to $10,000 a year, but $5,000 more if with a tax return, a suggestion would be in December make an extra tax payment of $5,000 ‒ or whatever is needed ‒ so you have that refund coming." – Paid-up subscriber Dwayne O.

McLaughlin comment: Here I must point out that we're not tax planners, but this sounds like a decent idea. One other relevant point I didn't mention yesterday... The annual limit of buying $10,000 in I-bonds per year applies to businesses, corporations, and trusts, too, just like individuals. So, if you have one of those, you could buy more than $10,000 via a Treasury account linked to those entities, in addition to an I-bond for yourself.

Good investing,

Dan Ferris
Eagle Point, Oregon
May 13, 2022