The Market About to Crash by More Than 20%
Why the Stock Market's Best Days Are Over
I firmly believe that a contrarian attitude combined with a long-term perspective yields beneficial results in life. If you follow the crowd, don't expect outcomes different from the crowd. If everyone studies a degree, works 12-hour days, buys a luxury car, and takes 3-week vacations in the Caribbean, don't expect to achieve different results by doing the same.
What happens to all these people? They have to work until almost 70 (in the best-case scenario).
This newsletter focuses on investment, which is precisely what I want to talk about today. I believe the markets are nearing a significant recession or at least a drop of more than 20%.
This may surprise many given the strong performance of the global stock market this year, but I have many reasons to support this claim.
Firstly, the volatility index is at its lowest in many years. This indicates that the market does not expect short-term movements. Historically, periods of very low volatility have always been followed by corrections, bringing the market down several percentage points from its peaks.
Another alarming fact, if not the most concerning, is that market breadth is at its lowest in over 50 years. WE HAVEN'T SEEN SUCH LOW BREADTH SINCE 1955. For those unfamiliar with the term, breadth measures whether index results are driven by the majority of stocks or just a few. High breadth indicates healthy growth as all stocks report solid numbers. Conversely, low breadth means the index's return depends on just a few stocks.
Currently, the latter is the case, with results depending on a few stocks (NVIDIA, Apple, Microsoft, etc.). Generally, this indicates a return to the mean.
For instance, the capitalization-weighted Nasdaq has outperformed the equal-weighted Nasdaq in 9 of the last 10 days.
Referring back to the previous breadth data, we haven't seen less than 20% of the S&P 500 index components outperforming the index itself in a month since 1955.
Essentially, all this suggests there is a massive bubble in the markets, and this bubble is in its final stage.
Additionally, some might argue these are isolated data points. However, if we look at the 3-month correlation between the S&P 500 index and its equal-weighted version, where all stocks contribute equally, it is the weakest since 2000, the peak of that era's bubble. This is another way to observe breadth, showing that the majority of stocks are not performing the same as a few large stocks that have significant quantitative influence on the well-known general index.
This is one reason why I like being a long-term contrarian. For several months, we have been buying very out-of-the-money (OTM) options to benefit from a potential downturn. We remain exposed to the index, obtaining extremely good returns while much of the portfolio is tied to low-risk assets with attractive yields.
When can we say it's the end?
Obviously, I don't know. I can only intuit, and when the data confirms it, I will share it with you. Based on the leading ISM data, it should be around the end of this year and the beginning of next year.
On the other hand, consulting our favorite indicator, we see the following: