There’s no getting around it now. The widespread serious negatives have reached a critical level. There are no remedies available other than a major reset of investors’ beliefs, logic and expectations.
Importantly, this reset does not belong to the “typical” overly optimistic, fad-driven, financial ease boom. Instead, it is a return to traditional capital market operations that the Fed has distorted since 2008 – 15 years! never Has there been such an extended period and massive anti-capital market measures?
Note: “It was misaligned” is an appropriate description because bond and money markets have now regained their role in setting interest rates. This is an essential step because using market-based, supply-and-demand pricing of capital lies at the heart of strong and successful capitalism.
The Fed’s two main actions were near-zero interest rates, which led to massive inequality, and the creation of trillions of dollars of money that led to high inflation rates – mirroring what all history has shown. Perhaps even worse is the harm done to investors and others by the Fed’s 15 years of inappropriate actions and misleading, even false, explanations.
And now come the new educational courses. It will be painful, and at first it will feel wrong. In fact, the media is already trying to explain away some of the current negatives, and even add a positive spin by assuming that there will be a return to those previous conditions imposed by the Fed. This won’t happen. When trends reverse, they die because successful investing always refocuses from the old, worn-out trend to the new, future-based trend.
Why did there have to be an accident?
The recent sell-off lasting more than two months was insufficient. The extensive list of negatives and strong investor mentality require a powerful revolution to turn things around. This means that a scary landing is needed to produce the desired shock.
As for the current downsides and upsells, I discussed them in these previous articles:
How far can the stock market fall?
There is no way to know now. There are a lot of unknowns about how investors (individuals and institutions) will structure their investment portfolios. We know that options, margin accounts, and other uses of leverage were popular. These investors will feel the pain more than others, because it doesn’t take a 100% price drop to wipe them out.
In addition, there is tremendous investment power in the hedge fund industry. The ability and willingness of these funds to take large positions, both long and short, increases the risks. Remember the old saying: “It is easier to scare an investor than to reassure him.” In other words, the sell-off promoted by short selling can have a significant impact on investors’ willingness to sell and exit.
Add to this the Achilles’ heel of the stock market: the rapid decline in stock prices. Without professionals to help smooth out a stock’s movement, “circuit breakers” (trading pauses) are activated when the price movement reaches a percentage level, down or up. But then trading starts again, so that the same players (long and short) can resume their business. GameStop’s 1-day (January 28, 2021) GME activity (chart below) is an extreme example of a trading pause for circuit breakers.
Bottom line: Investor sentiment is about to take over
When understanding is undermined, reasonable thinking goes out the window, and emotions take over.
Therefore, it is expected that investors (and the media) will soon move into a neutral zone where confusion prevails. Then, as the stock market declines further, we realize – for some reason – that something is wrong and things could get worse. Finally comes failure, when many investors decide to exit, either because they can’t take it anymore or because they anticipate a dire event is at hand – a sharp stock market decline and/or economic depression.
The best way to protect yourself from such mistakes is to have plenty of cash reserves. Not only does this cushion cushion the performance blow, it creates positive buying interest when selling heats up.
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