Stocks have enjoyed a strong boost in recent weeks. The mentality of perceiving every setback as a buying opportunity continues to shape investors’ thinking. However, inflation has fundamentally changed today’s market environment. The habit of «buying the dip» can therefore be fatal.
At the end of last December, I said in a column that the Black Swan heralding a bear market had taken off. And I recommended buying put options on Tesla and Bitcoin.
Translated into English: The bull market in financial assets that began in 2009 has ended. Why? Global central banks have stopped printing money. The US Federal Reserve began flooding the financial markets with newly printed money starting in 2009. By 2012, the European Central Bank followed suit as did the Bank of Japan and the Bank of England.
Logic says that when the pace of money printing is greater than financial asset growth, the price of the financial assets has to go up. More money chasing relatively fewer assets has to equal higher asset prices.
That means that profits, dividends, interest rates have hardly anything to do with the overall value – price - of financial assets.
On the other hand, while virtually all central banks have stopped printing new money so far this year; and the amount of available financial assets have surged (for example cryptocurrency) at some point the overall price of financial assets has to go down.
In a July 11 column, I reiterated that the Black Swan is still flying and recommended to ignore bear market rallies. As I write this about a month later, the bear market rally continues and many stocks have bounced back retracing a good portion of their losses from the start of the year.
Why? Investors believe that market declines - dips - are to be bought. After all, most investors believe that if money tightening does crash the markets and even the economy, the central banks will come running to the aid of investors once again and begin flooding the markets with newly printed money.
Stock price growth has far outpaced US economic growth. In the United States, GDP has averaged hardly 2% growth since 2010 while stock prices have averaged over a 12% gain.
Investors just can’t seem to believe that stock market gains are not the most important metric facing governments. Believe it or not, today inflation is more important to governments than the stock market. Lower stock prices hurt many. Lower take home pay due to rising inflation hurts many more voters everywhere.
Therefore, logic tells me that government leaders care more for their jobs than for investors. As a result, they will not pivot back to money printing to protect stock prices.
All long-term bull runs end when the basic underpinning changes. In the 1920s, 10% margin drove prices higher. Today, moving to money shrinking from money printing has altered the basic fundamental of this market.
Long bull market runs train investors to stay the course and buy the dips. We have had a six-bagger bull market since the Fed started printing money in 2009, with the S&P 500 up over 12% annually. Yes, the smart thing to do was to buy whenever the market declined. Many investors have become very rich by buying each and every dip since 2009.
This is why bear market rallies are killers. Investors have been trained to buy the dip, and therefore they need to buy now. Since June, we have seen a big surge of new investor money going back into the market and even buying cryptos.
But here’s the ultimate truth about markets and the economy: Financial asset prices cannot keep growing five to six times faster than the underlying economy. Specifically, when money printing - the real reason stock prices have surged — has stopped.
Put differently: Slow 2% to 3% economic growth cannot forever support such a rapid gain in stock prices without money printing. At some point stock prices have to collapse.
So, when will investors stop buying the dip? When they have no more sideline cash to invest. When that happens, look out below. Far below.