Everyone wants to know what happened this week. Why is the stock market suddenly dropping like a stone? Is it machines selling? Is it traders covering margin calls? Is it short volatility funds going under? Is it higher interest rates? Is it Bitcoin crashing? The answer is yes, all of that.
But most of all, stocks are having their worst week in 9 years, because they have been hyped so irrationally high for so long now. Truly, these markets have not been about investing for at least 5 years.
The same speculative, artificial and illegal interventions that worked to push valuations and risk-taking to the highest levels in history by January 2018, are now turning the other way. It’s called mean reversion. And as we’ve said many times, the aggressive risk-seeking behavior that increasingly drove indiscriminate buyers into dividend paying securities, funds and ETFs the past few years, is also hitting payback once more.
No, over-valued equities are not ‘defensive’, they’re capital destructive, as cyclical price declines routinely take back years worth of income in days and weeks. The chart beside showing the declines in dividend focused sectors and funds over the past week, underlines the point. (See: Boring is no longer beautiful in stocks).
As we wrote in our January 31 client letter before this week’s sell-off, and demonstrated in the chart of the S&P 500 relative strength indicator since 1998 below:
“Indiscriminate buying has infected all sectors. This chart of the broad-based S&P 500 stock index—widely and thoughtlessly benchmarked by funds, pensions and conventional managers—confirms extreme capital risk warnings with a monthly RSI (‘relative strength indicator’ of price and time) today at an unprecedented 93, also far past the manic tops of both 2000 and 2007, when mean reversion next followed.”
We also showed the chart of Canada’s TSX stock index and noted that it would take a decline of just 5% to take Canada’s stock market back to the price level it first reached nearly a decade ago in June 2008. That has now been accomplished in one week.
From here, it will take just a mild bear market decline of 23% to return the Canadian stock market to where it was at the cycle top in September 2000- over 17 years ago. There is every reason to suspect that this will happen, it’s only a question of how quickly.
We say this not because we are clairvoyant; but because markets mean revert. And when they have been mindlessly over-valued and over-bought for so long, equal and opposite in the other direction is due.