When’s The Big Selloff?

If you think calling the top is hard, try calling the bottom.

“I’ve had people reach out to me about, is this the bottom and are we actually now in a position to buy the dip?”, one CIO told Bloomberg, for a cautious-sounding article penned 13 years on from the 2009 lows. His answer to such inquires: “It doesn’t seem like this is the time just yet.”

It never does. Identifying a market nadir is difficult for the same reason it’s mostly impossible to pinpoint peak euphoria: Human emotions are in play. Today’s pessimism can easily become tomorrow’s abject despair, just like today’s euphoria can morph into tomorrow’s mania. Markets always overshoot.

Sizable drawdowns are typically accompanied by decidedly unfortunate events, which almost always seem existential in the moment. Today it’s the conflict in Ukraine. In 2020 it was a global plague. In 2011 it was the dissolution of the eurozone. In 2008 it was the collapse of the US financial system. And on and on. Bubbles, on the other hand, are by definition characterized by heady, sometimes exponential gains, and it always seems like everyone’s getting rich but you.

In either case, we tend to mistake irrationality for prudence. If a crisis really is existential, you buy bunker supplies not equities — “obviously.” If everybody who spends $50,000 on a Bored Ape Yacht Club jpeg can sell it next month for $250,000, you buy jpegs not puts — “obviously.”

In the moment, even the most judicious among us usually find it impossible to stay levelheaded. Indeed, during manias, seasoned investors have a tendency to buy into bubbles on the excuse they’re not being irrational, but rather betting on the irrationality of others. That’s a (very) thin line.

What to make of the current conjuncture, then? Plainly, nuclear war is bearish, but it’s not possible to hedge that risk. If you ask Morgan Stanley’s Mike Wilson, multiple contraction could undershoot in the near- to medium-term and investors should consider selling into relief rallies, like the squeeze seen last Wednesday.

“The risk to growth should now take center stage for how long this bear market lasts and how deep it goes, with falling dividend futures and payout ratios supporting [the] over-earning thesis,” Morgan said, in a summary of recent client notes. The downside risk for stocks is “most acute” over the next six to eight weeks, a period when headwinds to growth will continue to mount, the bank warned, citing geopolitics, demand payback, the waning fiscal impulse in the US and the impact of inflation on consumption and margins.

Note that some indicators are approaching contrarian “buy” territory. For example, BofA’s Bull & Bear Indicator now registers just 2.9 (figure below).

The bank’s Michael Hartnett cited outflows from stocks and bonds, deteriorating market breadth and “bad” technicals in emerging market and European credit.

Meanwhile, Goldman noted that ex-US, equity valuations have now plunged into just the 20th percentile (figure on the left, below).

“At the same time, the escalation of events in Russia/Ukraine has triggered a sharp decline in risk appetite,” the bank’s Peter Oppenheimer remarked, noting that Goldman’s RAI “was already negative YTD, but saw another large decline this week.” As the figure on the right (below) shows, the headline gauge now sits at -1.6.

Goldman’s RAI has “seldom stayed near or below -2 for very long as markets tend to overshoot on the downside,” Oppenheimer went on to say, adding that “eventually, such sharp declines in the RAI should present opportunities to add risk.”

That assessment came with a tautological caveat: In order to take a constructive view, you’d need to be reasonably sure the US isn’t headed for recession and that equities aren’t poised for a “deep bear market.”

Ultimately (and anecdotally), quite a few market participants seem to share my take. On Friday, in “Frenetic,” I wrote that,

I’ve waited for weeks on something that looks like a capitulatory purge, only to be disappointed, although I’m not sure that’s the right word. The point is just that as bad as 2022 has most assuredly been, there hasn’t yet been a day when it felt like US shares truly gave up the ghost.

Commenting for the Bloomberg piece linked here at the outset, a JPMorgan veteran named Anastasia suggested she’s looking for the same kind of fatalistic despondency I’ve been unable to spot at the index level in the US.

“History tells us that the more capitulation we see, the greater the potential for market upside in the following months,” she mused.

That sounds straightforward enough. The problem, though, is that capitalizing on such opportunities means not succumbing to abject despair yourself.

Everyone swears they’re capable of demonstrating fortitude. But when push comes to shove, you invariably discover that almost nobody is “greedy” when there’s “blood in the streets,” to mix market maxims.