Quantitative Easing

Pain Purifies: Markets at the Point of No Return

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What happened?

The three main indices were taken from the stake on Thursday.

thursday performance

Thursday indices performance (Finviz)

Friday was more of the same.

friday performance

Friday index performance (Finviz)

Stocks and bonds are sold indiscriminately. This is a full-fledged liquidation. Only the energy sector saw green on Friday.

heat map

Market Heatmap (Finviz)

The pain purifies

There are times to make money in the markets and times not to lose money. We are now in a time where we are not losing money. A time to focus on preserving capital and preventing your nest egg from being decimated. The market sell-off was a complete sell-off. Even so, I’m not sure the pain has passed. It reminded me of a lesson I learned during my “Winter Warrior” mountain infantry training at Ft. Drum, New York as part of the famous US Army’s 10and Mountain Department.

army training

Winter Warrior Training Ft. Tambour, NY (Staff)

The mantra “pain purifies” was instilled in us at that time. The instructors explained that the extreme conditions and intense training were painful, but would toughen us up and prepare us for what real combat might be like. Many soldiers did not survive for one reason or another. For some it was a physical problem. For others, it was a mental dilemma not being able to cope with the freezing cold.

This is similar to what happens to market participants during times of high market stress. Some participants have used leverage and are quickly wiped out by margin calls as their positions are forcibly liquidated, the physical. While others bend under pressure and sell low, unable to bear the pain any longer, the mind. All of this leads to massive sales like the one that is happening right now. Why is all this happening? I postulate that the main reason is that the Fed flips the script. Let me explain.

Don’t fight the Fed, or Brad Pitt for that matter

If you’ve been around for a decade, you’ve obviously heard the phrase, “Don’t fight the Fed.” Well, market participants need to realize that the “Don’t fight the Fed” mantra works both ways.

When the Fed supports markets with zero interest rate policy and endless liquidity via quantitative easing, high-growth speculative stocks soar to sky-high valuations.

Yet when the Fed shifts gears and begins to hike rates, many seem to want to take a stand and fight the Fed. They explain that “this time it’s different” and that the dizzying valuations are justified. Listen, when you hear that the Fed is going to start raising rates and eliminating liquidity using quantitative tightening effectively shrinking the balance sheet, it’s time to act before it starts.

As a seasoned veteran who successfully invested and preserved my capital through the bubbles of 2000 and 2008 and the crashes that followed, I can tell you never to fight the Fed no matter what. The Fed telegraphed what it was going to do well before raising interest rates by 50 basis points on Wednesday.

Ultimately, when you hear the Fed start talking about raising rates and unwinding the balance sheet, it’s time to lighten the high speculative stocks multiple. Take those profits and save most of them as a dry powder to redeploy once the coast clears if you’re younger and still building your nest egg. If you are already retired or about to retire, keep some cash and use some of those funds to increase your positions in income-producing securities. That’s what I did.

You will hear some say, well you lose 7% staying in cash because of inflation. The part they miss is staying away in cash and redeploying once the sale is over. You will invent this and reinvent them more often than not when stocks rebound. The seeds of the coming boom are being sewn during the current crisis. Another issue that I think market participants could continue selling is the fact that the Fed has lost all credibility.

The Fed has lost all credibility

First, the Fed was telling us that inflation was only transitory. Fed Chairman Powell was adamant about this fact. Inflation was only going to be temporary due to the economy reopening faster than supply chains could get back up and running. Powell was wrong and now the Fed is way behind the curve in the fight against inflation. Additionally, Powell essentially took a 75 basis point rate hike off the table on Wednesday. This was first seen by market participants as good news that pushed the market higher on Wednesday. Nonetheless, euphoria turned to despair as investors feared the Fed was not doing enough to stamp out inflation. This would lead to a hard landing and a recession in the coming months. Nevertheless, a lot of damage was caused. Now let’s take a look at the current state of affairs and see what positives we can muster.

Current state of play

Here are the positives.

Great damage already done

Much damage has already been done. We spent quite a bit of time on the low end.

spy performance

Spy performance (Looking for Alpha)

Additionally, valuations of major large cap stocks such as Microsoft (MSFT), Apple (AAPL), Google (GOOG) (GOOGL), Netflix (NFLX) and Meta (FB) have been significantly reduced. A saying we had in the army was that the battle isn’t over until all the generals are shot. Well, it seems most generals of the stock market have already faced the firing squad, so to speak. The next bright spot is that we had a day of surrender.

Major redness has occurred

Even though we’ve been in a steady downward spiral lately, we didn’t have a 90% drop from the lead before Thursday’s selloff. This is called a “surrender” day. It’s the day the margins are called and the weak hands throw in the towel. Moreover, the market is currently extremely oversold and should definitely rebound. Nevertheless, I would sell the tear if it happened. I don’t feel like the sale is made. Let me explain.

Market at the point of no return

I have the impression that we are currently at the point of no return for the markets. It’s a pun. I’m basically saying that I don’t expect earnings growth to continue, which will cause market multiples to contract further, creating an environment with little to no chance of positive returns. I sense a recession is in the cards. Here’s why.

Hard landing in the cards

The Fed is so offside and behind the curve that I see the chances of a soft landing as virtually nil. Think of it as a fighter jet trying to land on an aircraft carrier in bad weather.

This implies a hard landing which will undoubtedly lead to a recession. These are my thoughts on the current state of affairs. Now, let’s sum it up.

The conclusion

Let me start by saying that no one can predict the future. The best we can do is assess the current state of affairs and use our experience and intuition to make the best decision for ourselves. The market is at a point where it could still be just the end of an “ordinary” 20% correction, or the start of a major bear market.

Even so, there is plenty of dry tinder at this point and the market could rebound next week. The key factor I see in determining whether or not we rebound from here is whether the indicators reflect that inflation has peaked. Next week’s CPI number will be crucial. I feel for those who are fully invested whose portfolios have suffered significant losses. If you decide to buy the dip, here are some protocols I employ, especially in volatile times like this, to reduce risk.

Always have an exit strategy in place

When it comes to investing in speculative or “non-income” stocks such as high-growth tech players, I always have exit strategies in place when initiating a position. I set a trailing stop sell order to execute automatically. Conversely, I set limit buy orders at lower prices on my income position at points where new stocks will increase my return by reducing my basis. AT&T (NYSE:T) is my biggest holding, and I’ve actually added twice in the past few days.

Finally, always layer new positions over time to reduce risk. Remember, it took two years for the Nasdaq to fall 90% after the initial dot-com bubble burst in 2000. There are two components to bear markets, distance and time. The market may fall 20% in the short term, but it may linger or fall further and take years to recover.

Your entry is required!

The true value of my articles is provided by the prescient remarks of Seeking Alpha members in the comments section below. Do you think the sale is over or we have more downsides in the cards? Why or why not? Thank you in advance for your participation.