BEARISH ROTATION (August 16, 2021): The media have featured numerous articles about how there has been a rotation among equity sectors. However, the assumption which underlies almost all of these analyses is that we are in a bull market and that the sequential pattern will lead to continued gains. Few analysts have noticed that the pattern of relative performance between assets in 2021 is most similar to years including 1928-1929, 1972-1973, 1999-2000, and other years which preceded major percentage losses for the U.S. stock market.
Numerous multi-decade extremes support a bearish conclusion for U.S. equities.
2021 has featured an all-time record ratio of the total U.S. dollar amount of selling by top corporate executives relative to their buying. We had more money flowing into U.S. equity funds since November 2020, a period of 9-1/2 months, than during the previous twenty years combined:
Reliable historic valuation measures including Tobin's Q and the Rule of 20 demonstrate that 2021 reached considerably more extreme average U.S. equity valuations than previous historic peak periods going all the way back to the late 1700s:
Throughout 2021 we have had one equity sector after the other beginning a major downtrend in roughly the same sequence as it had done in the early months of previous major percentage declines.
In 2007 small- and mid-cap baskets of U.S. stocks including IWC had topped out on June 1 while QQQ and the Nasdaq reached their highest points on October 31 which was five months later. In 2021 we had IWC and IWM completing their highest intraday levels on March 15 which would suggest that we are right on schedule for the early stages of what could eventually become a full-fledged U.S. equity bear market. The past doesn't exactly repeat itself each time but the parallels are far closer than most investors appreciate until afterward.
Nearly all emerging-market bourses have begun downtrends between several weeks and several months ago. Energy shares and nearly all commodity producers have mostly also been in downtrends for weeks or months, in some cases already suffering notable percentage declines. The trendiest assets including TAN (solar energy) and TSLA mostly completed their highs early in 2021. We are frequently getting more new 52-week lows than 52-week highs for the Nasdaq even though the Nasdaq Composite Index remains very close to its all-time zenith, thus repeating a classic divergence which has marked U.S. equity topping patterns for decades.
In a bear market gold mining shares tend to be among the earliest sectors to complete their bottoming patterns.
Not many investors pay attention to precious metals and their producers, but funds including GDX and GDXJ had completed 7-1/2-year peaks on August 5, 2020 and entered downtrends which persisted for more than one year. During the 2000-2002 bear market gold mining shares (see HUI) were among the earliest assets to complete their lows on November 15-16, 2000, almost two years ahead of the Nasdaq's October 10, 2002 nadir. Gold mining shares (GDX) later completed an important bottom near the opening bell on October 24, 2008 while the S&P 500 didn't complete its final 666.79 low until March 6, 2009. Last year both GDX and GDXJ had bottomed on March 13-16, 2020 while most U.S. equities touched their lowest points on March 23, 2020. It is likely that the corrections for GDX and GDXJ, whether they are complete or not, will be followed over the next several months by key intermediate-term bottoms for nearly all equity sectors.
Bear markets tend to experience about half of their total losses during the first several months.
QQQ plummeted from a dividend-adjusted top of 104.99 on March 10, 2000 to 17.22 on October 10, 2002, a total loss of 83.6%. Very few remember the severity of this pullback which is likely to be repeated within the next few years, and even fewer investors recall that QQQ had lost 40% of its March 10, 2000 valuation by its intraday dividend-adjusted low of 62.95 on May 24, 2000. In similar fashion, the bear market which began from a similar top in 1929 had experienced roughly half of its total losses over a relatively short number of months.
Even investors who recognize stretched overvaluations and recognize the dangerous implications over the next few years are mostly complacent or bullish about the next several months when the downside risk may be especially elevated. Here is a chart of the 2000-2002 plunge for QQQ:
The previous pandemic featured a strong bull market followed by a severe bear market. A repeat is likely.
It is probably relevant that the bear market which began near the end of the previous pandemic on October 31, 1919 (the same calendar date as QQQ's top in 2007), and which continued for a total of 22 months, had completed about half of its total decline within less than four months by February 1920.
The bottom line: we have a sector rotation for U.S. equities which closely resembles the early months of several past severe bear markets. Good bargains will tend to occur earliest for those sectors which tend to bottom first, including gold mining and silver mining shares. Caution is warranted since the initial decline is often roughly half of the total bear-market loss and because U.S. stock-market valuations overall have never been higher. Near all 2021 peaks we have experienced both aggressive insider selling relative to insider buying along with all-time record equity fund net inflows, thereby confirming that the risk of being heavily invested today is highest when it is widely perceived to be lowest.
Disclosure of current holdings:
Here is my asset allocation with average opening prices adjusted for all dividends: 49.5% cash including TIAA Traditional Annuity paying 3% to 5% (only available for legacy retirement accounts) and Discover Bank high-yield savings paying 0.40% (available for all U.S. residents with retirement and ordinary savings accounts); 19.9% short XLK (112.7737); 17.8% long TLT (148.59); 16.8% short QQQ (301.724); 7.2% short TSLA (494.9721); 6.2% long GEO (7.65); 3.1% long GDXJ (43.826); 1.8% short ZM (293.16); 0.9% short AAPL (125.5481); 0.6% short IWF (223.0119); 0.5% short SMH (170.7813); 0.3% long UGP (2.94). It doesn't add up to 100% since short positions require less cash; there is no margin involved.
