The Learning Will Be Painful

Dip buying is dead... ARKK's painful journey... Getting a glimpse of reality... The learning will be painful... Epic dead-cat bounces... A bear market hurts so good... 'Wear comfortable clothing'... Greg Diamond is crushing it...

Get ready for a bumpy ride...

It's looking more and more as if we've entered a bona fide bear market.

That might shock my regular readers... I (Dan Ferris) have consistently said you won't know you're in one until long after it's begun. And I can't call this a bear market yet, as much as I might want to.

We're only six months into the Nasdaq Composite Index's decline and four months into the S&P 500 Index's drop... It could be a full year – November for Nasdaq and January for S&P 500 – before we're able to say that the big indexes are definitely in bear mode.

But for today's Digest, let's assume this is a genuine, dyed-in-the-wool bear market that will eventually take the major stock indexes down more than 50%... My guess would be around 65%.

What's more important this week is this message... From personal experience of trading through two of the worst bear markets in history (the dot-com bust and the financial crisis), I can say unequivocally that this is what a bear market feels like.

Nobody is having much fun being long stocks these days, with the Nasdaq 21% off its November 2021 peak and the S&P 500 12% off its January peak.

With few exceptions, stocks just went up and investors learned that it was easy to make money by buying every dip in the market... "Buy the dip!" they cried on social media.

That worked right up until late last year, but it doesn't work anymore...

Buying the dip is dead...

Bloomberg recently reported that buying market dips has been more painful in 2022 than any time since 1974... and that the average return after buying a dip so far this year has been -0.2%, also the worst since the 1970s.

The S&P 500 made 17 year-to-date ("YTD") lows in the first four months of the year, more than any comparable period since 1977. Barron's says it has been the worst start of any year since 1939.

The lessons will not be unlearned easily...

Some investors still want to buy the mother of all dips in one of the rankest speculative vehicles in all recorded history... ARK Invest's flagship ARK Innovation Fund (ARKK).

On Tuesday, ARKK saw investor inflows of $366.7 million, its biggest in a year. Through yesterday, the fund saw a total weekly inflow of $447.4 million.

ARKK is trading roughly 70% below its February 2021 peak. Bloomberg analyst Athanasios Psarofagis said... "It definitely feels like a buy the dip."

The problem here is that ARKK still holds a lot of hyped-up tech garbage, at least some of which probably won't exist in another year or two... Twenty-five of ARKK's 34 equity holdings reported negative net income for the last four quarters.

The other nine are not what you would call "consistently profitable." Not a single one has reported five consecutive years of profits.

Buying dips in ARKK is like buying dips in flash-in-the-pan dot-com stocks in late 2001... most of which earned no profits... and some of which earned no revenue... and many of which ceased to exist shortly thereafter.

The ARKK portfolio is concentrated... Its top 10 holdings account for roughly 58% of its $12 billion in assets.

The best-performing top 10 ARKK holding of 2022 is also its largest... Tesla (TSLA), only down 17% since January 1. Six of the 10 are down 57% or more in that period. Six of 10 are down 60% or more since the Nasdaq – ARKK's closest benchmark – peaked on November 19, 2021.

The ARKK faithful who ponied up nearly $500 million to buy it this week might be taking cues from their fearless leader, ARK founder and CEO Cathie Wood.

Two weeks ago, Wood bought the dips in pandemic winners ‒ now post-pandemic losers ‒ Roku (ROKU), Roblox (RBLX), and Zoom Video Communications (ZM). All three stocks fell even more after Netflix (NFLX) reported the loss of 200,000 subscribers.

Wood postures as a bull on disruptive innovation...

But in reality, she just bought every tech fad of the last decade.

It's all here... electric vehicles, autonomous driving, cloud computing, video streaming, telehealth, e-commerce payments, crypto, mail-in cancer screening, 3D printing, gaming, online education, genomic testing...

It's a scattershot approach, which I doubt will yield much other than losses. As we reported in our January 14 Digest, the average dollar invested in ARKK is underwater.

Watching naïve investors march single file behind the No. 1 financial Pied Piper of our time is cringe-inducing... though not as brutal. It calls to mind the 50-year-old man who recently succumbed to burns he received when he sat in front of the Supreme Court building in Washington, D.C. and lit himself on fire to protest climate change.

ARKK investors metaphorically did the same thing by pouring money into the fund this week. Wood doused herself a couple weeks ago when she said...

A year ago, we thought our portfolio would deliver a 15% compound annual rate of return, now we think 50%.

Even if Wood's ridiculous projection came true, it would be small consolation to all those underwater ARKK holders... With the fund down 70% since its February 2021 peak – when most of the money came in – it'll take nearly three years at 50% per year for ARKK to break even.

The sort of folks who buy ARKK won't wait three weeks, let alone three years. The Nasdaq took 13 years to eclipse its March 2000 peak.

Given the hopeless money-losing garbage it holds, you should not expect ARKK to ever see its 2021 peak again, if it even still exists in 13 years.

I'm just saying self-immolation is a bad way to protest the weather... and doubling down on the miserable bet that's already burned your money up once is a bad way to rebuild your capital.

ARKK dip buyers have some painful unlearning ahead of them...

They've learned to believe that it's perfectly reasonable for a business that's losing money every quarter to trade at 50 times revenues.

According to Bloomberg, there are still 576 companies with market caps above $500 million that are valued in the U.S. stock market at more than 10 times sales ‒ what I call the "what were you thinking?" threshold...

I'll explain.

In a March 31, 2002 interview in Businessweek, then Sun Microsystems CEO Scott McNealy criticized investors who bought his company's stock at the height of the dot-com bubble...

[T]wo years ago we were selling at 10 times revenues when we were at $64. At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10 years, I can maintain the current revenue run rate. Now, having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those basic assumptions are? You don't need any transparency. You don't need any footnotes. What were you thinking?

The S&P 500 has yet to crack the down-20% threshold generally agreed upon to represent bear-market territory. The Nasdaq has barely done so.

It's not yet time for a tech company CEO to ask, "what were you thinking?" in public... but I've been asking it in one way or another for a few years. Better two years too early than two minutes too late.

Investors won't unlearn that stocks aren't worth stratospheric valuations until the market beats it out of them... Given how poorly they've learned in the past and how insane valuations currently are, that'll need to be financially beaten nearly to death.

They'll have to learn to forget all the money they "made"... They'll have to forget overly inflated multiples of sales... They'll have to learn the difference between a steady, profitable business and a wildly speculative endeavor whose odds of success are poor.

Most won't really learn at all... They'll just sell out in total despair somewhere near the bottom of a brutal bear market. And if the bear plays out proportionally to the bull, it'll be the single most brutal bear market in history.

So, don't buy the dip in ARKK or any other egregiously overvalued speculative garbage. If you think a stock is cheap right now simply because it's down 70%, you need to adjust your mode of thinking to believe it can easily fall another 70%.

The degree to which people think that's a provocative statement is the degree to which they don't understand how brainwashed market participants get by bubbly valuations.

Like I said, I've traded through this twice before. I promise you… this is what it feels like, and what I'm describing is how people get it wrong and get wiped out.

It's like they've been looking at the world in a funhouse mirror all their lives...

Now, they're just getting their first glimpse of reality, but they still believe the funhouse mirror is reality and the regular one is a distortion...

Folks have no idea how bad it can get because they have no idea how horribly overdone it all got... and mostly still is, despite the declines already seen.

Take an easy example... GameStop (GME), the brick-and-mortar video-game store where you can buy, sell, and trade games and equipment.

It's a dying business. It has lost $491 million over the last two years. It has generated zero net cash flow since about mid-2018. The pandemic killed it, and it is not coming back... It's that simple.

The stock soared to $347 during the height of the 2021 meme-stock frenzy as retail investors short squeezed big hedge funds. The retail crowd strongly believes it can do so again, despite the stock falling 66% from its all-time high. Today, it's around $115 per share.

The business isn't worth more than about $2 to $3 per share... if that. But who but me and a few curmudgeons believe a stock that's fallen roughly 66% from its peak has another 98% downside? Hardly anybody.

Changing "hardly anybody" to "almost everybody" will require serious, serious pain... GME holders are driving straight at a brick wall with their eyes glued to the rearview mirror.

Bull markets make legions of fools look like geniuses...

Bear markets can make even experienced investors look like idiots... The bear following the biggest bull in history is bound to catch even the savviest, most experienced investors off guard.

Unlike bull markets, bear markets are not a smooth, one-way ride...

Though dip buying is dead, you should still expect 'the most epic' bounces...

As hedge-fund manager Michael Burry recently tweeted...

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.

It's an awkward expression because cats aren't made of rubber and I doubt a dead one bounces much, if at all, no matter where you throw it... A ball bouncing down a staircase is a better image of the classic price action of a bear market: lower lows, lower highs, and a sharp bounce after every drop.

Point is... whether they last one day or six months, bear-market rallies can do some real damage if you're short going into them.

Burry simply ups the ante, correctly pointing out that stock prices see many of their best single-day performances during bear markets. As John Mellencamp might say about a bear market... it hurts so good.

Burry's stats portend plenty of days like Wednesday, when the S&P 500 and Nasdaq indexes both rose more than 3%... presumably because the Federal Reserve announced it'll now target a benchmark federal-funds interest rate 0.5 percentage points higher instead of 0.75 percentage points higher.

The sharp bullish reaction felt like the market heard only what it wanted to hear... I distinctly heard Fed Chair Jerome Powell say he'd rather see the benchmark federal-funds rate around 2.4% sooner rather than later.

Powell considers 2.4% a neutral interest rate for reasons I suspect only he and his 400-strong army of PhD economists know.

Given the market's plunge yesterday and today, "sooner rather than later" quickly became the signal, and "not 0.75 percentage points" became the noise.

The market's sharp rise on Wednesday reminded me of the late, great mathematician Benoit Mandelbrot, who once wrote that in financial markets... "Large [price] changes tend to be followed by large changes ‒ of either sign ‒ and small changes tend to be followed by small changes."

In short, volatility tends to cluster... Volatility in equity markets tends to rise as prices fall. So you should probably expect more of the same.

This downtrend isn't over yet and might not be for a year or more. The longer it goes on, the longer it's likely to go on.

Most folks probably still assume that the longer it goes on, the more likely it is to end. That's true eventually, but I don't think we're there yet...

The ARKK inflows suggest the buy-the-dip reflex is still too well-ingrained. When they're finally broken of that habit, perhaps in the next six to 12 months, that's when you can start getting bullish again...

If stock prices continue falling...

What should you do about it?

On the less serious side, former hedge-fund manager and The Acid Capitalist podcast host Hugh Hendry told me on this week's Stansberry Investor Hour (SIH) episode that he sees more downside ahead and quipped... "Wear comfortable clothing."

It's also not too late to adopt my mantra... "Prepare, don't predict." If you've already done so, you're holding plenty of cash, gold and silver, and maybe some bitcoin… and of course, you've sold all the speculative garbage out of your portfolio.

Cash, gold, and silver are all outperforming stocks. Though the Consumer Price Index says inflation is 8.5%, the dollar has risen a little more than 7% against a basket of currencies... So, despite inflation, holding cash can give you peace of mind during the short term when stock prices fall.

Gold is up nearly 3% YTD, and silver is down 3.5%. Silver is more volatile than gold. I called it "the meme stock of metals" when I discussed it with APMEX's Patrick Yip in a recent SIH podcast interview...

It's worth holding, though, as Patrick pointed out that silver tends to move more than gold, after gold makes its move... silver should soon move higher.

You may also wish to adopt a bearish stance and look for good short-selling opportunities... That's my least favorite option for the vast majority of investors. Trading in bear markets will prove impossibly difficult for most folks.

They'll get whipsawed out of both long and short positions with losses. But yes, it can definitely be done and there's one guy I know who is absolutely crushing it right now...

My Stansberry Research colleague Greg Diamond...

Greg is an experienced master trader – and has bucked the trend. Having predicted the current downtrend, Greg's success rate so far this year is running around 80%.

Greg predicted the current downturn on Episode 240 of the SIH podcast... which aired on January 6. He won't tell me the details of his trading because they're reserved for his Ten Stock Trader subscribers.

What he will say is that his technical analysis and research have led him to maintain his bearish posture. He expects stock prices to fall for the remainder of the year.

And he's willing to tell you why and what you can do about it...

All you have to do is subscribe to his Ten Stock Trader. And given that he's crushing it like nobody else, you will be even more interested to learn about this special offer to Ten Stock Trader. Click here to learn all the details right now.

New 52-week highs (as of 5/5/22): Zanite Acquisition (ZNTE).

Our inbox is filled with your feedback on yesterday's Digest and thoughts about why the Federal Reserve didn't act sooner to help fight inflation... We'll start by sharing some notes today and continue next week... In the meantime, keep your comments and questions coming to feedback@stansberryresearch.com.

"Congratulations, Corey, as you have outdone yourself with today's column putting together the theater of Powell with the realities of the economy and adding in the discordant projections of the future... always remembering, 'hope is not a plan.'

"And you discussed the past leading to these tough times (and more to come) via highlighting the juxtaposition of the Fed decisions using all its models and high-paid economists versus the data on the ground available for such an erudite group to see, even as they rejected the data and tried to jawbone results while they let the problems continue to build.

"Thus, we go forward Fed-watching but holding them in much less regard than they believe they should receive. Thanks again!" – Paid-up subscriber John M.

Corey McLaughlin comment: Thank you, John. Glad you appreciated the essay and picked up the points I was hoping to get across...

When I began writing about the Fed once upon a time, I started with an open mind, but they've closed it over time with the kind of decisions you mention.

"Why did the Fed not act earlier? I suggest that it's in large part because most high-level, decision-making politicians and bureaucrats have little understanding of real-world, on-the-ground practical economics. It's difficult to see ground-level economics distinctly from the ivory towers or window-shaded boardrooms." – Paid-up subscriber K.S.

"My personal opinion is they have been politicized and possibly not astute enough to recognize the result of pumping huge amounts of money into the economy." – Paid-up subscriber Rodney N.

"Many may see this as simplistic:

"1 – The Fed is reactive, not proactive.

"2 – The economy, like a supertanker, does not react to small movements of the rudder such as 0.25 % every two months. A 1.0 % increase back in March might have some effect by June or August, for which the Fed should wait and see. They can always cut it back if necessary.

"A good part of inflation is when demand outruns supply. Really, if a consumer's credit card carries $10,000, how much will a $25 interest increase impact the supply of goods?" – Paid-up subscriber Dan B.

"Hi Corey. It seems to me, all things considered, that this inflation and the slow reaction to it by the Fed was all by design and has been going as planned. I expect it to continue if the rate hikes still only keep the interest rates at only a fraction of the inflation rate.

"Another sign that the inflation was intended is how much Fed money is being used by BlackRock to drive up the housing prices, that you mentioned, to the levels they currently are. Therefore, I am long on commodities." – Paid-up subscriber Martin P.

"Because the Fed is acting in concert with the great global reset. Everything that is happening in this country and planet wide is coordinated and synchronized for a New World Order.

"The Fed is not working for the benefit of all concerned but instead is helping to engineer a situation where the majority of people gladly accept a government-controlled digital currency, presented on the basis that this is the solution to inflation and supply-chain issues, etc." – Paid-up subscriber Wayne F.

"The Fed didn't remove economic stimulus because they are dimwits. Sorry to be blunt but that is the fact of it. A group of academics with no real-world experience, attempting to manipulate the economic decisions of hundreds of millions of people, is a ludicrous ideology that causes nothing but distortions and disasters.

"This process should be a decentralized function of a free and open market. So as Ron Paul keeps pounding the table about... we need to end the Fed, stop allowing them to create distortions and chaos, and return economic sanity to this country." – Stansberry Alliance member David R.

Good investing,

Dan Ferris
Eagle Point, Oregon
May 6, 2022