By John Persinos
The writer Gore Vidal once referred to our country as The United States of Amnesia, because the public's collective memory tends to be short. This principle especially applies to Wall Street right now, which seems to have forgotten how bear markets historically play out.
The stock market has rallied through April and into June, recovering much of the losses incurred in the early weeks of the coronavirus pandemic. The bulls are back in charge. However, considering the severe weakness of the fundamentals, this bullishness isn't warranted. I'll explain why and also steer you toward a proven way to make money with reduced risk.
Stocks zoomed higher Wednesday, in the wake of encouraging jobs data. Automatic Data Processing reported yesterday that private-sector employment lost a total of 2.76 million jobs in May, below the consensus forecast of 8.66 million. In April, the private sector lost 19.56 million jobs.
Global stocks also rallied Wednesday, as China's services sector showed surprising signs of strength. The Caixin/Markit services purchasing managers' index, which focuses on smaller, private firms, jumped to 55.0 in May from 44.4 in April. A reading above 50 indicates growth, while a reading below 50 indicates contraction. The latest reading was the highest since October 2010 and represented the first growth since the beginning of the coronavirus outbreak in early 2020.
Is the bear sleeping...or lurking?
So we're out of the woods, right? Not yet. Bear markets tend to unfold in distinct phases. There's the initial plunge, such as we witnessed from February to March when stocks racked up the fastest bear market in history.
Then there's a strong rally, as we're in now, born of "relief" at positive news. And then there's a prolonged, demoralizing decline that lasts for 12 months or more and drags the market well below the lows of the original plunge.
It's an inauspicious sign that the current rally lacks breadth and is being driven by a handful of mega-cap stocks. This rally is vulnerable and could evaporate at any whiff of bad news, such as a spike in COVID-19 cases.
Read This Story: Making Sense of a Rally That Doesn't Make Any Sense
Since the crash of 1929, which helped start the Great Depression, the S&P 500 and its predecessor index have undergone 14 separate bear market rallies. The stock market during the 1930s witnessed several powerful rallies; they all fizzled.
Let's look at more recent history. Below is a chart of the bear markets of 2007-2009 and 2000-2002:
Large-cap tech stocks have been partying in recent weeks like its 1999, so the 2000-2002 time frame is particularly relevant and makes for a compelling case study.
By September 2000, the tech-heavy NASDAQ composite had regained most of the dizzying losses it suffered in the spring of that year. Wall Street's optimists assumed that the NASDAQ had turned the corner and investors jumped back into the market with relish. But then stocks nosedived again and embarked on a long, soul-crushing decline. Two years later in 2002 the NASDAQ finally bottomed out, down more than 80% from its peak.
I strongly suspect we're currently in the midst of a "bear market trap," when stocks that have been plunging appear to be reversing their fall, but in actual fact are only pausing before they resume their downward trajectory. Bear market traps happen when excessively optimistic investors misinterpret or ignore bearish signs.
Bearish signs abound. According to the research firm FactSet, analysts predict a year-over-year decline in earnings in the second quarter (-43.1%), third quarter (-24.9%), and fourth quarter (-12.5%) of 2020. The consensus of economists currently foresees a 40% decline in U.S. gross domestic product in Q2.
In pre-market futures trading Thursday, the three main U.S. stock benchmarks were poised to open lower on lingering fears of social unrest. You need to brace yourself for future sell-offs. Stay invested but take defensive measures. Partially pocket your gains to elevate cash levels, so you'll be ready when bargains emerge. But don't chase the rally.
If you're looking for ways to make money right now, but with greatly reduced risk, follow the advice of my colleague, Amber Hestla.
Amber Hestla is the chief investment strategist of our premium trading service, Profit Amplifier. Amber has devised an innovative and powerful tactic that turns tiny price moves into massive gains.
Amber's trades work in bull or bear markets. Want to start making profitable trades, with the confidence that you're not taking undue chances? Click here for details.
John Persinos is the editorial director of Investing Daily. You can reach him at: mailbag@investingdaily.com
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