Stock Market Drops Confirm End Of Line For Bullishness

Five months of a weakening stock market took bullishness down to dregs. The March-April bull trap was proof of both the bearish trend and the shrunken pool of bullish investors. Now, as the market teeters on its tipping point, those final remnants are giving way to bearishness – and the fear of what comes next.

The next step will be frightening to stock investors

It takes little to push this stock market over the cliff. There are so many stocks down over 20% from their highs. Additionally, many are well below their longer-term 200-day trend lines. Add to that the crushing losses in last year’s fads (meme stocks, biotech IPOs, other IPOs, SPACs and pandemic “winners”) that, until last Friday, still had a small cadre of nervous supporters.

As prices fall, don’t look for fundamental support points. There are an abnormally large number of companies with negative or scanty earnings. Additionally, there are many over-leveraged, weak earners. Dividend yields? They offer scant support when bond yields are rising.

Then there are the excessive speculation strategies that became popular when stocks were rising: margin debt, options, warrants and non-diversified holdings. The recent, sharp drops just hit those holders hard, making wipeout a scary, realistic possibility.

And remember that media reports reflect investor attitudes. The articles over the past few months have generally been explanatory – i.e., why the market did what it did during the previous week, day or hour. Now, with bullishness gone, bearishness will become the main theme. It is the perfect excuse for editors and reporters to focus on the dire facts, distressing data and ominous visions. (Remember that negative articles sell more papers than positive ones.)

A potential S&P 500 firestorm is a real possibility

Morgan Stanley
MS
just described the scenario that many professional investors have long expected: A shift away from investing in an S&P 500 stock index fund. Seems implausible, right? Well, such dramatic changes in highly popular investing strategies always seem so beforehand.

From Fortune.com (April 25): “The S&P 500 will ‘fall sharply’ and join an ongoing bear market, Morgan Stanley warns“

“In a Monday note, the investment bank’s strategists, led by Michael J. Wilson, said that ‘… the S&P 500 appears ready to join the ongoing bear market’ ahead of a stacked week of earnings reports from tech companies like Amazon
AMZN
and Apple
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.

“’In short, the market has been so picked over at this point, it’s not clear where the next rotation lies,’ the analysts wrote. ‘In our experience, when that happens, it usually means the overall index is about to fall sharply, with almost all stocks falling in unison.’

“If the analysts are correct and the S&P 500 does enter bear-market territory, it would mean a 20% drop from the index’s early January record close of 4,793.54. That would take the S&P 500 to 3,837.25, or around 9.5% below its Monday level.”

Think of the situation this way. Trillions are invested in the S&P 500 funds. The good multi-year performance was a real draw. In the past few months, as a multitude of funds started underperforming and appeared riskier, money naturally shifted to old reliable. The same goes for the outflows from now-weakening bond funds.

Perfect! Except, what if the S&P 500 continues to produce negative returns? It’s already down 13%, taking the index back twelve months to April 2021. That is excellent fodder for negative media reports, plus it makes holding cash a viable alternative.

From The Wall Street Journal (April 25): “Wall Street Finds New Value in Cash as Global Fears Weigh on Markets.”

Such a shift out of the S&P 500 is when the downtrend could pick up speed. As money moves out, all 500 stocks are sold, putting downside pressure on their prices – hence, the index, itself. And that is how a popular theme comes undone.

The bottom line: Potential shakeups will be widespread

The financial markets are undergoing historic adjustments that likely will undo the investor thinking that was built atop the Federal Reserve’s long-running 0% yield policy.

It’s not just bonds that are getting hurt. All asset types will undergo reanalysis and fundamental reevaluations. For many organizations, the need to roll over their current, low-cost debt will cause financial stress. Also, market shifts can produce unexpected, widespread effects.