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Anything can happen between the time I write this column and its publication. From the moment my fingers press the keyboard (December 7, 2021), the major US averages increase. But is the rebound legitimate?

The good news about the timeliness of this column is that it is a question that can apply to today, the 7th, and any bounces that may arise in the next month or so.

But before I try to answer that question, today’s column was brought to you by the Federal Reserve’s Semi-Annual Financial Stability Report. According to the report, US households have a growing appetite for the risk of participating in the stock market. The report, which contains very late data, cites that household stock ownership is cyclical. “Over the past three decades, a survey-based measure of the share of households that would be willing to take financial risks peaked in 2001, bottomed in 2009, and then rebounded significantly. In 2019, according to the most recent survey, it was once again approaching its 2001 peak. “

In 2001, the shareholding was high. The stock market roared for years as the tech bubble swelled… then the stock market collapsed.

In 2009, the shareholding was low. The stock market was devastated after the financial crisis… then the stock market roared.

In 2019, shareholding was high. I had called for a stock market crash caused by the recession; COVID-19 happened before my hypothesis had a chance to prove itself.

Somewhere between 2019 and today, shareholding plummeted as investors pulled out of markets during the COVID crash.

In 2021, shareholding is back in fashion. Margin debt is higher today than it was before the pandemic, according to Yardeni Research, Inc.

Margin debt is debt incurred by a brokerage client by trading on margin – the investor borrows to buy stocks. When the price of the stock with margin falls, the stock is “called”. If you’re called on margin, you need to find the money to cover it or sell stocks to raise money. If you’re paying interest on the money used to buy stocks, you probably don’t have a lot of money in reserve. Well guess what? Margin calls usually trigger sales, which lowers prices and leads to more sales. A market correction in a heavily leveraged market can feed on itself. In this context, we must ask ourselves if the rebound is legitimate?

On the one hand, I remember the description of the stock market by then Federal Reserve Chairman Alan Greenspan in 1996. He said that the stock market exhibited “irrational exuberance.” Despite what some would call overly bullish stock prices, the markets had a good 1997. And a good 1998. And a good 1999.

When things are good, I remember that they can stay good. To some, this may seem obvious. However, it seems that there is often no wisdom in crowds, as the Fed’s financial stability report pointed out. Not everyone can be as astute an investor as famous golfer Al Czervik, who boldly said, “Oh, everyone’s buying? So sell, sell, sell!

Rodney Dangerfield as Al Czervik in the 1980s movie “Caddyshack”. Image: Warner Home Video

Al advised to sell on July 25, 1980, as if predicting the coming recession. Al was a few months ahead, but the sell would have avoided about a 25% drop from the top to the bottom of the S&P 500, as it came out when everyone was buying and optimism was high.

But, I guess even Al would have been wrong if he had sold stocks in 1996, at what had seemed like the height of investor exuberance – at least for Dr. Greenspan. However, it turned out that 1996 was the start of a huge productivity revolution, ushered in by the widespread use of the World Wide Web.

Investors today want to suggest that blockchain technology is the new World Wide Web, which should justify ever higher market valuations. Of course, the blockchain has potential uses, such as processing payments, identifying NFTs (non-fungible tokens), and archiving records. However, I would say that the benefits of blockchain don’t compare to what the web has provided us: email, video conferencing, SaaS (software as a service) and, well, answering almost every question (except for the meaning of life) at your fingertips.

In other words, as bullish as the investment world is today, I don’t see how major US stock averages can continue to deliver 20% year-over-year returns. Something must give way. Valuations are high. Earnings growth is faltering. Equities are threatened by the prospect of rising interest rates. This doesn’t mean stocks are dead, but it does indicate a moderation in US stock returns in 2022, with more frequent pullbacks.

We are entering 2022 with fairly solid foundations. The third quarter 2021 earnings season is almost over, with more than 95% of S&P 500 companies reporting. Year-over-year third quarter profit growth stands at just over 40%, thanks to revenue growth of nearly 15%. This compares to year-on-year profit and revenue growth of 108% and 22%, respectively, in the second quarter of 2021. The big takeaway for the third quarter of 2021 has been holding overall corporate margins. despite mounting cost pressures in the form of accelerating higher wages, higher shipping costs and high commodity prices. The net profit margin for the third quarter of 2021 was 12.8%, compared to 12.7% in the second quarter of 2021 and 10.4% year-on-year.

The resilient margin performance of the S&P 500 companies reinforces the fact that companies are learning to deal with supply chain issues, as well as labor and material shortages. So, yeah, I’m not ready to call stocks death just yet. But I wouldn’t be surprised if the recent 5% drop in the stock market doubled or tripled before stock prices rebound.

It is difficult – if not impossible – to assess the extent and timing of these things. I’m trying to focus my attention on whether these things can happen quickly and bounce back or if they can go on for a long time at a rate that we can avoid. These fragmentation are generally associated with economic recessions. And I think you can call it recessions, as long as you don’t get carried away by the prevailing good news and ignore the creeping negative signs.

It’s clear to me that US economic growth is going to slow, but that doesn’t mean recession – just potential equity issues. (The stock market cares less about level and more about direction, including second derivative metrics.)

It’s no different than what’s happening with the stock market right now. I see a moderation – perhaps a disruption – in stock prices, but not a crash. After a correction of around 5% in the S&P 500, the stock market was oversold in the short term. A rally can resolve the carnage that occurs beneath the surface with a slight recoil. Yeah, I said it. The level of the stock market looks okay, but there are some scary things happening that you wouldn’t see without a serious inspection. If the stock market’s internals improve with a rally, maybe we’ll postpone that 10-15% pullback at some other time. But I bet the stock market has hit half of something bigger.

The percentage of companies listed on the NYSE trading below 10% of their 52-week high fell to 26.34% on December 1, 2021, its lowest level since November 2, 2020. Excluding corrections and reversals bear markets, such readings are very rare. They are exceptionally rare so near a high market. As of December 1, 2021, the percentage of these companies reaching new 52-week lows was 9.83%. In the previous two years, higher readings can only be found during the 2020 Covid crash. The relatively small pullback in the S&P 500 stock market is misleading investors. It’s a warning sign.

In the aftermath of Thanksgiving on November 26, 2021, the stock market behaved like a real turkey and bounced. The trading day was recorded as a 90 percent down day (90 percent of all points and volume of companies traded on the NYSE were down). Ideally, the market would have rebounded the next day with an Up Day at 90 percent, signaling that stock prices had fallen low enough that an intense sell-off was replaced by enthusiastic buying.

There is still a chance for that, but the further we move away from the 90% Down Day date, the less likely it is that a buying rush will occur. The threat is that a 90% Down Day without 90% Up Day tracking (or two consecutive 80% Up Days) requires lower prices to spark that enthusiastic buy. Without this follow-up request, it would not be unusual to expect one or more days of an additional 90% decline over the next thirty trading days (or mid-January). The stock market may want to adjust to concerns of moderate growth and rising interest rates over the next month.

I’m not too worried about it. If you have a bunch of cash, you might consider using a 10-15% correction as an opportunity to invest in US stocks. When others sell, buy – at least if there is no recession on the horizon; I don’t believe there is. 2022 may not be as good for the market as it has been the past two years, but given persistent inflation and a near zero percent rate of return on your bank account, cash are not an attractive long-term asset class.

Allen Harris is the owner of Berkshire Money Management in Dalton, Mass., managing investments of over $ 500 million. Unless specifically identified as original research or data collection, some or all of the data cited is attributable to third party sources. Unless otherwise indicated, all references to specific securities or investments are for illustration purposes only. The clients of the Advisor may or may not hold the securities that are the subject of their portfolios. The Advisor makes no representation that any of the securities mentioned have been or will be profitable. Full disclosures. Direct requests: aharris@berkshiremm.com.

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