Times like these, eh? We’re all living through them, but they’re hard to talk about in a meaningful way.
It’s easy to use reductive sayings. Anyone commenting on the markets tends to fall back on these pithy aphorisms even though they don’t actually offer much guidance.
“Buy the dip” some say. “Blood in the streets” certainly applies too.
Sometimes they’re a bit more subjective. It’s common to hear that bear markets don’t end until there is “capitulation.” On the surface, this doesn’t mean much.
That’s one to dive into, though — one that we may be able to anchor in reality, at least to some extent.
It’s one of the few stock market sayings that implies some kind of fluctuation… a final act that heralds a change in momentum.
But what does that really look like? Here’s a partial answer.
There are two aspects of capitalism with a stock market-based system that people don’t really talk about.
First off, destruction of capital is important. Risk and reward are inherently linked — or at least they should be.
For markets to work, people need to be able to move in and out and take losses with the expectation that a new, worthier investment will pay off later.
That brings up the second aspect. Capitalism and market economies are a way to fiddle with time. Quite literally, this is monetary time travel.
In this sense, money invested today is a way to move wealth from the past to a time in the future. If you bought Tesla, Amazon, or whatever else is way up over the last decade, you traded money for equity with the expectation to trade equity for money later.
This gets a bit more obvious when it comes to housing loans or bonds. Borrowing is a way to bet that, after interest, what you cannot truly afford is better to own now than waiting to buy it in the future.
When we’re in a broad bear market, which we most certainly are today, the tolerance for how far into the past or future people are willing to assume they’ll get a certain return collapses. Investors abandon past preconceptions and accept the price they can get today for speculative investments they assumed would pay off over a far longer time frame.
This is the true nature of capitulation that people are talking about when they discuss the end of a bear market. It is when speculation, risk and reward, tolerance to wait and see how things pan out, and so on and so forth collapse as far as they will go.
In the stock market, we track that with share prices, price versus earnings — both projected and trailing year over year — book value, etc. Capitulation is a holistic concept in this sense. It’s not something you can call ahead of time.
Clarity is only possible looking back. But we can get a sense of it looking forward too.
We talked about this when I wrote about how inflation peaks signal a period of outsized gains.
There are other signs of building capitulation and what the markets will look like afterward.
According to Bank of America data, U.S. investor cash holdings are up 6.1% and have risen to their highest levels since 2001 based on a survey of 288 investment professionals who oversee a total of $833 billion for pension plans, insurance companies, asset managers, and hedge funds.
Retail investors — meaning you, me, and everyone else who doesn’t work with a 10-figure account on behalf of an investment firm — pulled a net $87 million out of equities last week versus a one-year average of a $3.3 billion inflow, according to JPMorgan.
Stocks, bonds, cryptos, and anything else you can name are all suffering. Money is flowing out, and a majority of people in the market are willing to sell at a loss rather than bet on a gain down the road.
Does it signal a bottom? Hardly. Does it mean that something else won’t come along that pushes the floor lower? Certainly not.
But this is how a bear market resolves. There is a lot of money on the sidelines waiting to flood back into the stock market.
A lot of it is waiting for a clear signal… a confirmation that it is over… a rise in index values and stock prices that will be missed if investors wait too long.
We’ll keep watching for the true signals of a bottom and letting you know about investments that are worth making now before money floods in and the big gains quickly come and go. Stay tuned.
