Coronavirus bear market of 2020 is now history claimed the reckless bulls. From our view, it's a "dead cat bounce."
Exuberant bulls want you to drink the Cool Aid, because the S&P 500 SPX, -2.04% is now more than 20% higher than its mid-March low.
Stocks are ignoring the severe risks in the global economy and the potential for a second Great Depression.
The stock market is a bubble. And it’s repeating patterns last seen in the lead up to the stock market crash of 1929.
The year is 2020. A novel SARS-like disease has spread out of mainland China to infect over 1.8 million people around the world. The United States is the hardest-hit country with over 500,000 infected citizens — 1,830 of whom have died in the last 24 hours alone.
Experts believe the economy could shrink by a staggering 33.5% in the first quarter as mass lockdowns slow economic activity to a trickle. A collapse in the travel and hospitality sector threatens to create a domino effect of corporate bankruptcies, and unemployment may soon hit 20%.
Meanwhile, the stock market is rising. And if that sounds strange to you, that’s because it is. The stock market now looks identical to the way it looked in the lead up to the great depression. And we may be on the verge of the biggest stock crash the world has ever seen.
The Kindleberger-Minsky Bubble Chart
In 1979, economic historian Charles P. Kindleberger wrote a book titled ” Manias, Panics, and Crashes,” where he outlined the five phases of a financial bubble. Later, Canadian scholar Jean-Paul Rodrigue built on Kindleberger’s findings to develop a more detailed chart of how bubbles tend to unfold. We are currently at the “return to normal” part of this chart. Research Source: Jean-Paul Rodrigue Terrifyingly, Rodrique found that after prices reach their all-time high, they collapse into a “bull trap” before “returning to normal” only to resume an even deeper capitulation.
A quick look at the S&P 500’s 12-month performance shows that this pattern is playing out in the U.S markets.
The U.S. market is currently at the “return-to-normal” stage in the bubble chart.
A broader look at the S&P 500’s, three-year performance shows that this pattern has been going on for longer than many realize with the “first sell-off” occurring in late 2018 and early 2019.
The first “bull trap” occurred in late 2018 and early 2019. |
The bubble seems to have started in 2016 with the election of Donald Trump. But many factors could be at play here, including the Federal Reserve’s historically low-interest rates.
Rates have been held at under 3% for over a decade. And this has allowed companies to use cheap debt to buyback stock. The massive debt loads have also left many companies unprepared for a potential financial catastrophe.
Is This 1929 All Over Again For The Dow?
Today’s chart also shows disturbing similarities with the stock market in 1929, right before the stock market crash that led to the great depression. Then, just like now, stock prices returned to normal for a brief period only to capitulate into one of the worst Dow declines in history.
Stock prices briefly gained-ground only to capitulate into a multi-year long bear market for the Dow. |
The Dow decline lasted for several years after the initial “crash.” Today’s market seems to be repeating this pattern. Image Source: Business Insider
Will America see the widespread poverty and economic devastation that it experienced during the Great Depression? Some economists believe we might already be there — it just hasn’t hit home yet.
According to David Blanchflower, an economics professor at Dartmouth College, unemployment numbers in the United States and Europe suggest the West faces its most significant economic catastrophe since 1929.
Between 1929 and 1933, the U.S unemployment rate rose from 3.2% to 24.9%, with the number of unemployed Americans soaring from 1.6 million to 12.8 million. Now, U.S jobless claims have already exceeded 16 million in just three weeks, and the crisis is just beginning. When it is all said and done, many experts believe the U.S unemployment rate will exceed the 25% record set in the Great Depression.
What Is The Difference Between A Depression And A Recession?
Recessions are periods of economic decline that last or at least two quarters while depressions are economic declines that last for years. With the global economy on lockdown for most of the first quarter, a recession is almost guaranteed. But it will take an unexpected and devastating economic shock to tip the economy into a full-blown depression — a stock market crash may be the trigger.
Following GREENMARK 101, the algothrim suggests that the stock market will hit a new low later this year, lower than where it stood at the March low. While the market’s rally since its March 23 low has been explosive, it’s not unprecedented. Since the Dow Jones Industrial Average DJIA, -2.30% was created in the late 1800s, there have been 38 other occasions where it rallied just as much (or more) in just as short a period — and all of them occurred during the Great Depression. Such ominous parallels are a powerful reminder that the market can explode upward during the context of a devastating long-term decline. Consider the bull- and bear-market calendar maintained by Ned Davis Research. According to it, there were no fewer than six bull markets between the 1929 stock market crash and the end of the 1930s. I doubt an investor interviewed in 1939 about his experience of the Great Depression would have highlighted those bull markets.
Another way of making the same point is to measure the number of days between the end of the bear market’s first leg down and its eventual end. There are 11 bear markets in the Ned Davis calendar in which the Dow fell by more than the 37.1% loss it incurred between its February 2020 high to its March low. On average across those 11, as you can see from the chart below, the final bear market low came 137 days after first registering such a loss. If we add that average to the day of the March low, we come up with a projected low on Aug. 7.
Sentiment also points to a lower low for the U.S. market. That’s because the usual pattern is for the final bear-market bottom to be accompanied by thoroughgoing pessimism and despair. That’s not what we’ve seen over the last couple of weeks. In fact, just the opposite is evident — eagerness to declare that the worst is now behind us.
Another way of putting this: When the bear market does finally hit its low, you are unlikely to even be asking whether the bear has breathed his last. You’re more likely at that point to have given up on equities altogether, throwing in the towel and cautioning anyone who would listen that any rally attempt is nothing but a bear-market trap to lure gullible bulls.
Comparing sentiment during the recent bear market to that of other bear markets of the past 40 years suggests that market timers were more scared at the lows of those prior bear markets than they have been recently. A similar conclusion is reached when we focus on the CBOE’s Volatility Index, or VIX VIX, 5.21% . An analysis of all bear markets since 1990 shows that the VIX almost always hits its high well before the bear market registers its final low. The only two exceptions came after the 9-11 terrorist attacks and at the end of the two-month bear market in 1998 that accompanied the bankruptcy of Long Term Capital Management. In those two cases, the VIX’s high came on the same day as the bear market’s low.
Other than those two exceptions, the average lead time of the VIX’s peak to the bear market low was 90 days. Add that to the day on which the VIX hit its peak (Mar. 16) and you get a projected low on Jun. 14.
One way of summing up these historical precedents: We should expect a retest of the market’s March low. In fact, according to an analysis conducted by Ned Davis Research, 70% of the time over the past century the Dow has broken below the lows hit at the bottom of any waterfall decline.
In truth, there’s no universal definition of a “waterfall decline.” The authors of the Ned Davis study, Ed Clissold, Chief U.S. Strategist, and Thanh Nguyen, Senior Quantitative Analyst, defined it as “persistent selling over multiple weeks, no more than two up days in a row, a surge in volume, and a collapse in investor confidence.” That certainly seems reasonable, and the market’s free-fall from its February high to its March low surely satisfies these criteria. Upon studying past declines that also satisfied these criteria, the analysts wrote: “The temptation [at the end of a waterfall decline] is to breathe a sigh of relief that the waterfall is over and jump back into the market. History suggests that a more likely scenario is a basing and testing period that includes a breaching of the waterfall lows.”
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