The stock market has been unstoppable since its March free fall. The Dow Jones Industrial Average and the S&P 500 are now trading around 15% lower than where they were in February.
The collective sigh of relief among traders has been nearly audible over the past few weeks as the rally continued despite worsening economic data and a historic plunge in oil prices. Many called a bottom and jumped back in. But looking at the data from further out shows valuations are unreasonable.
The bulls naively cheering the rally are in good company—stock market crashes in the past have been fueled by similarly optimistic traders. They believed the first dip was merely a correction. But this legless rally is just another red flag pointing to a stock market bubble that’s mid-burst.
Past stock market bubbles have one thing in common: Shape. That’s because, more than anything else, equities are driven by sentiment. Whatever investors are feeling is played out on the trading floor.
Right now, they’re feeling optimistic; they believe valuations are fair. But that’s going to come to an end as the stock market bubble of 2020 reaches its final phase: Captiualtion.
The three most notorious bubbles over the past few decades all follow the same pattern.
First, there’s the stock market crash of 1929 that led to the Great Depression.
Next up is the dot-com bust of the year 2000.
Finally, there’s the bitcoin bubble that burst back in 2018.
All three follow a distinctly similar pattern that has come to be known by many names but essentially describes the anatomy of a market bubble.
So far, the current market is tracking this pattern almost exactly.
And if that is indeed the path the stock market is on, we have yet to face the stages of “Fear,” “Capitulation,” and “Despair” that mark the end of this tumultuous cycle.
You might be looking at these graphs thinking, “we’ve already seen fear and despair, what about the huge drop we saw in March?’
Indeed we did see a massive drop in March as coronavirus spooked the market. But fear doesn’t exactly describe the way investors felt as sharemarkets tumbled. The Fed’s consumer sentiment guide shows that investors were getting more bullish as the economy shut down and the stock market fell.
Now, investors are trying to convince each other that we’re over the ‘correction’ that happened in March—“onwards and upwards” is their chant. Retail investors are snapping up stocks. “Buy the dip!” is their battle cry.
Meanwhile, the smart money—the big money—is taking profits.
Bank of America’s Fund Manager Survey shows that cash positions among fund managers have risen to 5.9%— their highest in nearly a decade.
Warren Buffett, a man known for his willingness to buy when the market is down, has been holding tight to his cash pile despite resounding calls that the bottom has passed.
There are other echos of past stock market bubbles that investors are ignoring, too—like the fact that the market is being driven by a handful of tech-heavy hitters.
As coronavirus panic set in, investors flocked to the big-name tech firms perceived as safe—Apple (NASDAQ:AAPL), Amazon (NASDAQ:AMZN), Alphabet (NASDAQ:GOOGL), Facebook (NASDAQ:FB), and Microsoft (NASDAQ:MSFT).
Those five companies now represent nearly half of the market’s overall value. If one, or worse all, of the stocks, make a wrong move it’s game over for the market.
Not everyone sees the stock market taking a nosedive. In fact, many are calling for a quick recovery. But you can add that to the growing stack of evidence pointing to a meltdown—it’s not until the majority of commentary is pointing to further losses that you’ll know it’s safe to start retaking positions.
Disclaimer: The opinions expressed in this article should not be considered investment advice from CCN.com. As of this writing, Laura Hoy did not hold a position in any of the aforementioned securities.
Last modified: April 30, 2020 6:00 PM UTC