Stock Market Selloff Looks Unfinished, And That’s Promising

The stock market’s “Reconstruction Zone” signs went up in November, and now the work is in full force. As is typical, the first step is to tear down the old before constructing the new. This activity was first met with calmness and “buy-on-the-dip” advice. Then, as easy-money fads and favored stocks turned weaker, the advice altered to “think long-term” and “don’t be scared out of your holdings.”

Now come this week’s declines, with the S&P 500 hitting the 10% correction level. The first messaging is that down 10% is a rare event, so the bottom is probably close.

However, that’s not the end of the selloff story, and trouble remains – along with potential opportunities. (See “2022 Stock Market Outlook: 2021 Fads And Fashions Are Forgotten.”)

Why isn’t the market selloff over?

Because emotions are still too bullish and the 2021 bull market fads, while fading, have yet to be cleared away:

• The Reddit-crowd “meme” stocks (See “GameStop And AMC – The Last Meme-Stocks Standing Are Ready For Final Collapse“)
• The high-priced, amazing-growth-story companies with no proven revenues or earnings
• The pie-in-the-sky IPOs (think biotechs), with proceeds needed to replenish depleted operating funds
• The full-color-photo-laden-prospectus IPOs, with proceeds needed to reduce excess leverage (often caused by the private equity owners having borrowed to pay themselves excessive dividends)
• The you-can’t-lose (if you bail out in time) SPACs built to reward insider “sponsors” first and foremost
• Then, there is that magical dream job: Make-a-$million doing leveraged day-trading

Underlying all these fads is the enticing vision of easy money – BIG money. But that’s not new. This driving force cycles in and out of the stock market periodically – and now it is exiting. Some participants will cash out and learn from the experience. Others will overstay and experience the nightmare vision of wipeout or worse.

Once these weak, unsupportable fads are out of the stock market, the next cycle can begin.

Why couldn’t a new, different bull market begin now?

Because those waiting to buy know that this selloff offers a good possibility of going lower – perhaps much lower. Yes, the S&P 500 is down 10+%, but that is not a strong foundation. The still bullish tone in this market means there is plenty of air below the current price level.

There is strong rationale to support further declines. With interest rates rising, valuations are expected to fall. Additionally, the Federal Reserve’s 14-year mantra of lower-rates equal higher-growth makes investors, even Wall Streeters, nervous about what’s coming. Then, there is that nasty troublemaker: Inflation. (See “Here Comes An Inflationary Storm Like None Before.”)

The bottom line: A possible stock market shakeout is worth waiting for

The distress associated with failing easy-money fads, the rising rates specter and the overall growing worries is fuel for another infrequent cycle episode: A stock market shakeout. Just as a fad pushes prices “too high,” a shakeout pushes them “too low.” When the easy money crowd dumps and runs, the smart money crowd jumps in. And that shift sets up the new structure and rationale for both the following rebound and the subsequent bull market rise.

So, when will that be? There are two certain signs of being near to or at the stock market’s bottom:

• First, articles and news reports are filled with negative facts, ominous opinions and dire forecasts
• Second, the thought of buying stocks evokes adverse, frightening emotions (A quote I once read said it well: “You hear the words, ‘stock market,’ and you want to throw up”)

Clearly, even at down 10%, this stock market is nowhere near a shakeout bottom.