The Bear Market Reality of 2023

This 'perfect' indicator points to big upside in stocks... It's all so easy, isn't it?... We can't forget about the greatest financial mega-bubble in all recorded history... Mega-bubble prices, mega-bubble results... The bear market reality of 2023...

A 'perfect' bullish indicator just triggered for only the 18th time since World War II...

According to data from Carson Investment Research, stocks were higher six months later in every other case. And stocks were higher a year later in the first 16 instances, as well.

It gets even more exciting for investors...

This bullish indicator has now occurred twice this year.

That's right...

On March 31, this signal triggered for the first time in 2023. And even after the market's recent correction, the S&P 500 Index gained more than 4% over the ensuing six months.

This signal has only happened twice within 12 months two other times – 1962 and 1974 to 1975. In those cases, the S&P 500 surged more than 20% over the next year.

This rare signal is called the Zweig Breadth Thrust ('ZBT')...

Longtime investment analyst Marty Zweig developed the ZBT several decades ago.

Zweig, who died in 2013, was perhaps most well known for warning Wall Street Week viewers that he didn't like what he saw in the market just before "Black Monday" in 1987. He also wrote the 1986 book, Winning on Wall Street, about his investment strategies.

The ZBT is a 10-day moving average of the percentage of rising stocks on the New York Stock Exchange. A move from 40% to 60% in 10 days or fewer triggers the "buy" signal.

In fact, this time, it apparently happened in just five days.

So maybe, unlike most of the past two years, most stocks are now (finally) rising. And perhaps a perfect historical record means they'll keep rising for six to 12 months (or more).

I (Dan Ferris) guess everything is just fine now. Everybody knows inflation is falling. And everybody now knows the stock market will go up for at least the next six to 12 months.

It's all so easy, isn't it?

Except, well...

What about that whole 'past performance is not indicative of future results' thing?

Doesn't that also apply here? Can we really say that these 18 data points over nearly eight decades indicate a higher probability that stocks will rise over the next six to 12 months?

That's a tiny body of statistical evidence. So perhaps some chance exists that it's entirely meaningless.

Is it more plausible to you that the ZBT is a flawless indicator? Or is it more plausible that anybody who takes it too seriously could easily wind up being fooled by randomness?

A random data set can easily contain a streak of 18 points that conform to each other in some way. So I don't think it's anywhere near a slam dunk that we're all about to get rich.

It's never that easy and obvious.

And ZBT or not, I find it hard to get too bullish during the greatest financial mega-bubble in all recorded history...

That won't surprise regular Digest readers, of course.

I'm a bottom-up, fundamentals-based investor. I want to invest in stocks for the long term.

And when you're focused on compounding your money in great businesses over the long term like I am, you don't view indicators like ZBT as the force of gravity. Rather, it's more like an interesting historical anomaly that may or may not work again.

Just because something worked 17 times doesn't mean it needs to work the 18th time.

To a long-term, bottom-up, fundamentals-based investor like me, valuation is the force of gravity. Returns will suffer if you pay too much. And you'll lose money if you pay mega-bubble valuations – even if you buy a great, cash-gushing business that keeps growing.

Anybody who bought Cisco Systems (CSCO) in March 2000 knows what I mean...

Back then, the company's annual revenue was less than $19 billion and its market cap was more than $550 billion. Today, Cisco's annual sales are about $57 billion and its market cap is roughly $195 billion.

After 23 years, the stock has yet to make a new all-time high.

If you don't pay bubble prices, stocks of great businesses are great investments...

That's because they can reinvest their earnings at high rates of return. And for investors like us, that leads to high rates of compounding your wealth over the long term.

Generating returns is a cumulative process that takes many years.

And of course, the best stocks are the ones you can hang onto indefinitely. They remain great businesses. And they keep gushing cash and reinvesting it at high rates of return.

Anybody who bought Amazon (AMZN) for less than (a split-adjusted) $1 per share a couple decades ago and is still holding at $144 per share today knows what I'm talking about.

In the short term, the market can send stocks in all kinds of unpredictable directions. But over the long term, the market always rewards consistent winners with a higher share price.

It's hard to remember that core investing idea when stocks soar and fall and soar again – like they've done over the past few years.

It's also hard to refrain from putting money into the same great businesses that treated you so well in the past. But right now, that's exactly what you have to do – or you'll wind up like the poor folks who bought Cisco 23 years ago.

Stocks are still at mega-bubble valuations, as measured by important metrics like the cyclically adjusted price-to-earnings ("CAPE") ratio...

The CAPE ratio for the S&P 500 is above 30 today. That's higher than the 1929 peak (which was just shy of 30). And it's not that far away from the late-2021 peak of 37.

This ratio was above 30 from August 2020 to May 2022. The market kept soaring until the final five months of that period. So this ratio is clearly not a timing indicator like ZBT.

But it is an indicator of how unattractively priced the market is for long-term investors...

The weird thing about this year isn't that stocks are still expensive or that they went up.

Rather, it's that the bear market has kept raging this year – and nobody has noticed...

Nobody has realized that because the S&P 500 is up nearly 18% and the Nasdaq Composite Index is up about 35% in 2023. They're both admittedly blistering performances by historical standards.

Even I wrongly said on a recent episode of the Stansberry Investor Hour podcast that 2023 has been rough on market bears. That's only true if you've bet against the two big indexes.

If you've bet against everything, well that's a horse of a different color...

This next part might surprise you. But if you would've "shorted" an identical dollar amount of every stock in the market starting on January 1, you would've made money so far this year – despite the two big indexes' 2023 performances and the recent rally.

In fact, through the recent bottom on October 27, the average stock in the small-cap-focused Russell 2000 Index was down nearly 19% so far this year. And the average S&P 500 stock was down more than 7% over that span.

And the numbers get even worse over the longer term...

The Russell 2000 peaked in November 2021. Despite the recent rally, the average stock in the index – which covers roughly two-thirds of the entire stock market – has fallen 32% since then. And the S&P 500 is down 6% from its January 2022 peak. But the average S&P 500 stock is down 11%.

Notice the use of the word "despite" twice in the past four paragraphs...

I was reminded today of an excerpt from my December 2020 Stansberry Investor Hour interview with Market Wizards author Jack Schwager. During our chat, Schwager said...

I interviewed Jason Shapiro, who is a real contrarian trader. And he said that his favorite word is "despite." He says that if you ever see, "the market went up today 'despite' certain news," that's a really bullish signal. When they can't even explain why the market went up despite opposite news, that itself is telling. It's a related point and one worth knowing.

My point is that despite the big indexes' 2023 performances, a double ZBT signal, and whatever else you've got...

We're still in a bear market.

Now, I get that almost everybody thinks it's a new bull market...

A major reason for that is how the big market indexes are calculated.

The biggest stocks in the market have the biggest effects on the biggest index's returns. And you've probably heard many times by now that the S&P 500 and the Nasdaq Composite have soared this year mostly due to the strength of the so-called "Magnificent Seven" stocks...

Apple (AAPL), Microsoft (MSFT), Alphabet (GOOGL), Amazon, Nvidia (NVDA), Meta Platforms (META), and Tesla (TSLA) are seven of the eight biggest stocks in the S&P 500. And they're the biggest seven stocks in the Nasdaq Composite.

If you're curious, Berkshire Hathaway (BRK-B) is slightly bigger than Tesla today. But I guess the folks who use the catchy nicknames don't think it would be as magnificent if they swapped in the 93-year-old Warren Buffett's company for the allure of electric cars.

The Magnificent Seven stocks have all gained at least 45% this year. Nvidia is up more than 235%. Meta Platforms has soared more than 175%. And Tesla has surged nearly 100%.

And yes, they're some of the greatest cash-gushing businesses in history. They also have great brands and good balance sheets.

I'm not saying they aren't – or that they don't. What I'm saying is that no matter how great they are, they're expensive as heck. That makes them all lousy investments right now.

Look at their price-to-earnings (P/E) ratios...

An average of 53 times earnings is expensive. That's especially true given that Apple's revenue has shrunk over the past four quarters and the revenue growth of five of the other six Magnificent Seven stocks has declined over that period. (Nvidia is the exception.)

I probably wouldn't pay 53 times earnings for any business. I'm not saying I'd be 100% right. But at that valuation, the odds are against me compounding money at a high rate of return for the long term.

Also, a high earnings multiple is supposed to indicate a fast-growing company. It doesn't mean, "Hey, it's shrinking, but it's still Apple and it doesn't matter how expensive it is."

That's like saying a rock is so big that it has overcome the force of gravity.

It makes no sense. It's the sort of thing people say when they're walking into a market buzzsaw – not when they're making prudent capital-allocation decisions.

The whole proposition is a nonstarter for anyone focused on how much he should pay for a great business. They're all somewhere between fully valued and way too expensive.

They're not bargains. They're not attractive.

As long-term-focused as I am, I'm also only human. And I've studied bear markets perhaps a little too much in my 26 years in this business. So forgive me for pointing out that...

The Magnificent Seven's blistering 2023 performance just feels like an extended bear market rally...

Yes, I realize that the ZBT hasn't happened during bear markets. It's solely a bull market indicator.

That doesn't matter.

If I had to guess – and it's only a guess – why anybody thinks a new bull market started in October 2022 or that 2023 has been a good year for stocks, I'd say it's simple...

They're disoriented by the greatest financial mega-bubble in all recorded history.

Bubbles rise and fall over time. And if you don't understand that you're living through the greatest financial mega-bubble in all recorded history, maybe you won't expect it to resolve itself more painfully and over a longer period than any previous mega-bubble.

If I'm right about all that, the stock market might not make another new all-time high for 20 years or more. It took 25 years after the 1929 peak and 15 years after the dot-com peak in 2000. It has been 34 years and counting for Japan after the mega-bubble peak in 1989.

I've heard it suggested that we live in an age when everything happens faster. This line of thinking refers to the innovations and rises in our standard of living from better technology. And maybe that faster upward lift in the human condition will keep equity markets buoyed.

But to me, that sounds a lot like "this time is different." And "this time" is never different.

Bubbles always burst. And the bursting is always ugly. This time hasn't been different since at least 1637 – when the Dutch tulipomania bubble imploded.

Even if we're in a period when innovation and a soaring human condition keep bidding up stocks, it won't lead us all to a pot of gold on the other side of a magical rainbow.

Maybe we'll only get a sideways market that ratchets up and down for five or 10 years instead of 20 or more. But extreme overvaluation and extreme amounts of misallocated capital during the greatest financial mega-bubble in all recorded history will still end badly.

Of course, you won't catch me trying to predict the future...

That's not my thing. Rather, I'm in the business of preparing for a wide range of outcomes.

And the data suggests that I should absolutely prepare for stock prices to fall from their current heights. While doing that, I should also spend a lot of time and effort telling my Extreme Value and The Ferris Report subscribers exactly how to do the same.

The bottom line is simple...

Market bulls will tell you that the ZBT says most stocks are rising right now. And this indicator has pointed to higher prices for stocks over the next year in every instance since President Harry Truman accepted Japan's surrender in September 1945.

But it's still impossible for any fundamental-based equity investor to get too excited today.

It's not just the Magnificent Seven, either. Almost all high-quality stocks are expensive...

The iShares MSCI USA Quality Factor Fund (QUAL) is full of cash-gushing, capital-efficient businesses with great balance sheets. It's just like the businesses in the Magnificent Seven.

QUAL trades at 21 times earnings today. That's less than 53 times – but it's still high. I'd be a lot more interested in buying shares if it was down around 15 times earnings.

So as wonderfully perfect as the double ZBT signal seems, it doesn't change anything for me. It doesn't make an overvalued stock market any more attractive than it was before.

And we're still waiting for the greatest financial mega-bubble in all recorded history to burst.

New 52-week highs (as of 11/16/23): Cintas (CTAS), CyberArk Software (CYBR), ICON (ICLR), Intel (INTC), Ingersoll Rand (IR), Linde (LIN), Microsoft (MSFT), Motorola Solutions (MSI), Roper Technologies (ROP), VanEck Semiconductor Fund (SMH), Sprott Physical Uranium Trust (U-U.TO), and Visa (V).

In today's mailbag, subscribers share their feedback on the inflation numbers reported by the U.S. government earlier this week... and thoughts on yesterday's Digest about how to properly value a business. Do you have a comment or question? As always, you can e-mail us at feedback@stansberryresearch.com.

"Every past [Consumer Price Index] number has been adjusted after the numbers have been 'crunched.' It gets zero press because it's old news and nothing can be done about it anyway. I'm beginning to understand that we aren't in anything close to a free republic. The U.S. is an empire and it's been a good run. All empires end and I'm thinking we are in the tail end of ours here too.

"BRICS is a pretty big example that the rest of the world is done with us too... Our government is NEVER going to stop spending. I'd say it's time to party like it's 1999 because I doubt 2099 will have a U.S. in it. Definitely not one that we've enjoyed for 249 years." – Subscriber James S.

"What a great Digest yesterday. Thank you for this very useful information." – Subscriber Dan K.

Good investing,

Dan Ferris
Eagle Point, Oregon
November 17, 2023