What to Do When the Market Doesn’t Make Any Sense

The market bubble is finally unwinding – but based on the bizarre nature of recent events, we’re still far from safe ground. Today we investigate what smart people do when the world around them seems out of touch with reality…

From Peter Reagan at Birch Gold Group

Last August, when the Fed appeared to have blinders on and were only “monitoring” inflation, we could already tell the wheels were coming off the wagon.

Today it looks as though financial markets could be detached from reality itself, with some pundits claiming “recession next year,” despite the fact a recession already appears to be underway right now.

A very popular portfolio allocation strategy (called the “60/40”) is performing historically badly right now.

Mortgage rates are soaring to levels not seen since 2001 (7.71%), and all the market indices have essentially been crashing since January of this year. On top of that, inflation is still running red-hot, and has been since June 2021.

For Americans scraping to save for retirement or retirees on a fixed income, reciting all this bad news probably feels like beating a dead horse.

Which brings us to the situation today, where the markets seem detached from reality itself.

The stock implosion of 2022

WolfStreet recently put some elbow grease into building a list of all 6,281 U.S. listed stocks, and their performance since January of 2020.

The findings are quite disturbing to say the least.

About one out of every six stocks on the list (1,001) have imploded, down 80%+ of since reaching their peak price from the beginning of the analysis period. And this number doesn’t even count companies that were delisted during this time.

Five of the more notable examples are below:

  • Redfin shed 96% of its peak value.
  • Bed Bath & Beyond lost 91% from its peak.
  • saw 81% of its value disappear.
  • Roku watched helplessly as 90% of its market cap evaporated.
  • Even Red Robin Gourmet Burgers, an “essential business” during COVID panic, still walked away with 82% of its stock value gone.

WolfStreet actually maintains a list of imploded stocks, with new members added with alarming frequency. Each one of the 1,001 companies that lost more than 80% of their value during the “Everything Bust” is likely in a state of panic:

For these companies “caught offside” by the Everything Bust, many workers and investors – and their families – must be deeply anxious about the falling share prices. These companies’ vendors may be worrying about getting paid, and their customers may be worrying about weak links in their supply chains. Foolish bubble-blowing bankers bear a heavy burden of responsibility for making so many people so worried. May justice be done. But I expect there’s more pain ahead first.

Since 16% of all common U.S. stocks have essentially tanked according to this analysis, it sure seems like any pundit claiming “recession next year” is way off base.

Another way financial markets appear to have become detached from reality is the manic behavior of “meme investors.”

“Random silly enthusiasm from retail investors”

Nobel Prize-winning economist Eugene Fama is considered the father of the “efficient market hypothesis” (EMH). Here’s a brief summary:

…asset prices reflect all available information. A direct implication is that it is impossible to “beat the market” consistently on a risk-adjusted basis since market prices should only react to new information.

In other words, in a free market where all participants have access to the same information (and know what it means), asset prices are accurate. Prices reflect all known information.

In other words, based on this theory, it’s impossible to beat the market without non-public information. (I’ve sometimes paraphrased EMH as, “The market is smarter than you are.”)

The primary issue with EMH is that it’s almost certainly wrong. How can you explain the success of investors like Warren Buffet, Sir John Templeton, George Soros or Benjamin Graham? As you’d expect, this hypothesis has been challenged by many experts. I don’t want to write an entire on the subject, though, so let’s summarize the counterpoints:

Behavioral economists attribute the imperfections in financial markets to a combination of cognitive biases such as overconfidence, overreaction, representative bias, information bias, and various other predictable human errors in reasoning and information processing.

In other words, EMH might not be correct because human beings are involved. Irrational, sentiment-driven humans are behind an awful lot of trading.

And we’ve seen this quite recently. Bloomberg’s Matt Levine recently discussed the “Wall-Street Bets”-style meme traders. Their manic market behavior sure looks like it counteracts the efficient market hypothesis:

random silly enthusiasm from retail investors on social media can save a big company from bankruptcy. You have a somewhat nostalgic consumer-oriented company, it falls on hard times, it has too much debt, things look grim, short sellers are circling, and then some people on Reddit are like “hey let’s have some fun and stick it to the short sellers,” it becomes a meme, the stock rallies, the company raises money at the new high stock price, it pays off its debts, it expands into non-fungible tokens, the retail investors save the day.”

Levine wrapped up with one consequence of this irrational investing behavior that resulted from the meme traders’ “overconfidence, overreaction” and other human behaviors described by the behavioral experts above:

Amateur traders who gather on social media can’t trade sophisticated products like credit-default swaps – products that protect against companies’ reneging on their debts. But their speculation drove the price of these swaps past levels reached during the 2008 financial crisis.

In other words, all it takes to recreate the 2008 financial crisis (for one company at least) is a rumor on Reddit and a flash mob of random amateur investors having fun with financial markets.

Let’s say you’ve managed to avoid those 1-in-6 imploded stocks, and you’re not a day-trading meme stock investor. Why should you care about these stories?

Because these two very different stories have one important element in common.

Right now, financial markets are insane.

Fully one in six publicly listed stocks have vaporized 80%+ of investor funds?

The “random silly enthusiasm” of online hobby traders can send a company’s risk profile back to 2008 levels?

I’m going to propose an amendment to the efficient market hypothesis: asset prices reflect all available information especially when it’s wrong. “Information” in this context can be a respected analyst’s recommendation, or a boiler-room pump-and-dump scam or a day-trading fad.

In my revision of EMH, “information” is not reality. “Information” might be sentiment (hope), it might be enthusiasm, or it might be an outright lie.

Honestly, does this seem like a market firmly grounded in reality to you?

Staying sane in a crazy market

Probably the biggest oversight of EMH is it gives human beings too much credit.

Boom and bust cycles are a recurring feature of markets. Yet the same people get lured in off the sidelines, over and over – as if they’ve forgotten the dot-com crash, or the Great Financial Crisis, or Black Monday. They lose heavily and sell at the bottom and swear off stocks forever, but forever only lasts until the next bubble forms and mania sets in…

Like Wolf wrote about a recent IPO:

Wait a minute… Why would anyone buy the shares at any price given that, after 23 years, Mobileye still loses a ton of money?

Clearly, people aren’t buying shares based on reality.

A market that’s simply ignoring fundamentals can seem like a party that never ends. But all parties end.

If you recognize the problem, the logical question is: “How do I protect my savings?”

Right now is a good time to make sure your financial plans are grounded in reality. Examine your retirement plan (especially where you’re exposed to risk), diversify as you see fit, and consider making changes if you don’t like what you see.

Are all your savings only “on paper”? Like thousands of other concerned Americans, you may decide you’d feel a whole lot safer knowing that a portion of your savings are diversified with physical gold and silver. There’s a reason both of these precious metals have been in high demand lately. For thousands of years, we’ve looked to gold and silver to preserve (and even grow) our savings during times of economic turmoil and crisis.

I think the financial markets are completely out of touch with reality.

As an antidote, what’s more real and tangible than physical gold and silver?

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