The Bull Market That Investors Do Not Want

A passerby helps a woman from San Jose, Calif., mount a statue of a bull at the foot of Broadway in the financial district in New York. (Kathy Willens/AP Photo)

Commentary

In years past, when a Fed chairman stepped up to the mic to announce some policy decision, the markets always took note. Oftentimes it might have reacted in knee jerk fashion, but calmer trade usually returned pretty quickly.

Not any more.

The fast-moving action of this week is going to be more par for the course because the Fed has basically sparked a booming new bull market—not in stock prices, but in volatility.

Their coming rate hikes are lining up with two other factors that promise to create a perfect storm.

If you like excitement, 2022 is going to be the year for you!

2022 the Year of Wild Volatility

Here’s what will bring the thunder:

First, it’s a midterm election year.

This year the midterms are getting a little more coverage than usual. Off-year elections usually only attract those heavily invested in politics. And most investors don’t usually equate midterm elections with market volatility. But there is a correlation.

During every midterm election year since 1950, stocks have experienced significant intra-year dips. The average downside move over those years was 17.1 percent—very near bear market territory. But some bigger bear slides have happened too. In 2002 the market sank 33.8 percent and in 1974 it tumbled 37.6 percent.

So midterms matter. Then you have to factor in the bots.

It’s been estimated that 80 percent of the volume on the New York Stock Exchange is now computer driven. Depending where you look, you may find some different number, but the actual number doesn’t matter. The bottom line is real, live people making trading decisions and executing in the market are a minority today.

When the very first computers started sending orders to the stock market in 1998, execution time took a few seconds. By 2010 those transactions were measured in milliseconds. Computers are fast—and they don’t stop to think about the market. If the criteria they are programmed with are met, they’re firing orders. And this has accelerated every aspect of the market.

This is what a typical market cycle looks like:

Stock Market Cycle. (Bob Byrne)

Years ago, this cycle could take years to play out. Take the Tech Wreck of 2000 for example. The chart below pretty much contains the entire cycle laid out above.

NASDAQ Composite Detailing the "Tech Wreck of 2000." (Barchart.com)

It took two and a half years for the market to go from “enthusiasm” at the 2000 high to “discouragement” at the 2002 low. Then five years to climb the “wall of worry” and another five years to get through the “aversion” and “denial” phase. That’s 12 years all together.

Today, driven by computers armed with insanely complex algorithms, that same cycle can play out in weeks or months.

Now throw in the Fed.

Because of all the factors we’ve talked about in the past, the economy is facing the highest inflation it’s seen in 40 years. (Since before computerized trading!) And it’s fallen to the Fed to do its job and do something about it.

Their problem is, recent prices in the stock market have been largely fueled by their zero interest rate policy. Cheap money needs something to buy. But now that they’ve threatened to take away the punch bowl to deal with inflation, they’ve basically flipped the switch on a bull market in volatility.

So What Does This Mean to You?

If you like rollercoasters, buckle up. If you don’t, you may want to get off the ride.

It’s not simply the threat of higher interest rates that is going to drive all the volatility this year. Markets can deal with interest rate increases.

Between 1983 and 2015 the S&P 500 was back in positive territory three months after a rate hike 50 percent of the time. Within six months, the market was up 75 percent and by a year later the market had recovered 100 percent of the time.

What they can’t deal with is not knowing for how long, or by how much, the tightening will occur. And that’s roughly where we are.

The Fed will come out and make all kinds of statements designed to keep the market calm—I wouldn’t bet the house on anything they have to say.

The coming higher rates are going to hit the big tech growth stocks specifically. What you should know is that some shares have been getting hit harder than others and may be getting closer to the “discouragement” point in the market cycle.

Take Cathie Wood’s ARK Invest funds. Her ARKK innovation fund is probably the best proxy for big, innovative growth stocks. They’ve been getting slammed, while other tech stocks like Microsoft have held up pretty well because institutions have clung to it.

Given the high-flying nature of Wood’s ARKK stocks, I’d say a bounce off the panic low could rally 40 to 80 percent.

So if you’re interested in playing growth stocks during 2022, ARKK would be a good place to look. On the other hand, it is a bigger risk to jump on growth stocks during particularly volatile times.

This may be the time to add some value stocks to your portfolio instead. And where value goes, you can’t go wrong with Warren Buffett (Berkshire-B).