Was That The Shakeout That Launches The 2022 Bull Market?

Wouldn’t that be nice? A day and a half stock market leap that ends the downtrend. That would mean investor thinking has changed…

Inflation? It’s lost its punch. Fed raising rates? Whatever – At least they’re attacking inflation. Covid-19 pandemic? Seems an annual, flu-like shot is the answer. World War III? It’s resembling a Russian annexation that was fodder for worldwide political posturing. Right?

It’s amazing what a galloping stock market can do to investor attitudes. Even the bond market has backed away from its “higher” yields. Take that, consumer sentiment survey.

Since Wall Street bases stock prices on forecasts, clearly good times are coming. Right?

If only…

While these times are different from the past (they always are), there is a major missing piece in this happy picture. “Shakeout” means more than a sharp down followed by a quick up. It’s a shaking of the stock market tree to chase off “weak” and short-term investors.

A shakeout’s cause isn’t a mathematical market decline. Instead, it is investors’ state of mind. It’s the point where an investor, having overreached for easy money, becomes discouraged. The overreach can be caused by leverage, a risky strategy, or simply overoptimism (expecting too much). When the negative emotions become too much to bear (think despair or fear or even guilt), they easily override rationale thought, thereby provoking a strong desire to dump and run.

Thus, the shakeout of such investors is based not on the stock market crossing a 10% correction line, but on their feelings about what’s happening to them. In other words, human nature produces a shakeout – and human nature does not change with the times.

So, what’s next?

Well, perhaps we won’t have a shakeout. However, that would mean 2022’s new rise will be atop 2021’s previously popular reasoning, strategies and fads as they fade, fade away. There’s no way around it: That vision is weird.

Last year’s stock market fads have all fallen, but they still have many followers. Moreover, the many uncertainties and concerns behind the 2022 downtrend still weigh on forecasts. Those conditions are delaying new investment strategies and products (no, selling bonds and buying stocks is not a new strategy). Therefore, a real shakeout would wipe the slate and make investors interested in something new and more appropriate for what’s coming.

When Wall Street moves to something new, it spends little (AKA, “no”) time consoling investors or supporting past fads that are now lost causes. The most reaching out they do is to encourage shifting to that something new.

The bottom line – Shakeout’s pal, bull trap, may be here

It’s good to remember that Mr. Market can act like a conniving huckster – enticing investors to buy or scaring them into selling at exactly the wrong time.

One effective strategy is the “bull trap.” It’s a temporary upside reversal in a downtrend – particularly a fast, dramatic, exciting rise like last week.

Once launched, investors will determine the climb’s height and length. It really depends on the depth of bullishness that still exists even in the downtrend. Then, just when the bulls start counting on their future gains, the market turns down. That turnabout doesn’t spur selling immediately. Instead, it’s a jagged walk down the path of “buy on the dip,” “stick to your guns,” “don’t be frightened out,” “it’s just a correction,” until, finally, “sell.”

Of course, that means those bullish investors are riding the downtrend twice, setting them up for an eventual, “I’m out of here!”

If that’s the kind of shakeout we’re headed for, prices will be much lower, offering an excellent opportunity to “buy low.” (If not, there will be plenty of opportunities to buy back in as conditions warrant.)

One last thought: Buying when others are bailing is not taking advantage. It’s the stock market, and those wishing to sell will do so at whatever the existing price is. Buyers fulfill that desire by supporting the market price.