Worrisome Week Starting?

We haven't focused only on markets for a while. Today let's do just that.

What triggered this? Basically, it's worrisome signs that things could unravel soon - and we don't know the depth or breadth of that unraveling. By unravel, we mean that stock prices could plummet and scare a lot of folks. Then again, the "little guys" who've swarmed the market since around November of last year may get excited and think it's bargain time. If they do, the plummet may be temporary. If they don't, the "Melt Down" may be upon us - leading to an authentic bear market.

What of the worrisome signs? There are many, but here are two standouts:

The Buffet Indicator: It's determined by dividing total stock market value by GDP. It's never been higher. And in the past, when it gets to extremes, it's been an indicator of stock market correction - or worse.

Then there's the Case Shiller Stock Market Index. It's around 38. The last four times it held over 30, the stock market got into serious trouble.

Both of these can be seen as shining a light on a Blow-Off Top. That's when prices of any item shoot up in a short period of time. You can illustrate these on a chart. When you do, you see prices rise straight up in what's called a "parabolic" move. Short-term parabolic moves for an individual item typically result in quick price correction. If you own the item, your response may range from annoyance to panic, depending on what you paid for the item, and when you paid it. If you think the item's healthy, you may just find it annoying. If you just invested at the top of the parabolic move, you may panic and sell.

The former reaction typically characterizes a longer-term investor who's done some homework and is convinced the item has long-term merit. The latter reaction comes from those who did no homework, but had their mojo revved up by the quickly rising prices. They may have missed the run-up and watched as others accrued gains. So they dive in when the price peaks. Of course, if they listen to financial media, or read most of the nonsense out there, they've likely been told things can only get better. So they jump in at exactly the wrong time and have no idea why the item's collapsing. Panic.

When an index goes parabolic, it's a lot harder to just hold on. Check a chart of the NASDAQ in 1999-2000 and you see a good example. Or maybe oil 2007-2008. At the peak, investors who hadn't benefited from the previous rise piled in. They couldn't stand missing out on the party. But when they get there, everyone who'd been having a good time is either gone or exiting as they enter. The thing is, only so many folks can exit at once. And if you're just getting in, you'll miss whatever window of opportunity to leave might exist. So you're stuck. When you try to leave, the price is plummeting and you can't get out at anything close to what you paid, or any fairly reasonable price.

This cycle has repeated many times. For the Dow only, there have been 19 parabolic moves, i.e., Blow-Off Tops, since 1928, according to a research piece we just studied. Even if you can spot the run-up, it's really hard to know when it's going to reverse. You can, of course, just get out; but you may face an incredibly long stretch of time when prices continue up beyond anything you might have imagined. And that can hurt.

But when we started we referenced this week. We're not saying for sure that we know that a reversal is coming in stock prices this week. But something is happening that may impact prices: the jury decision in the Derek Chauvin case. That's the cop that had his foot in George Floyd's neck. He's been on trial for weeks. And with closing arguments just finishing up, the case goes to the jury. 

What happens if they find this guy innocent?

You must have some suspicion that trouble would ensue. And your suspicion would be justified. If that trouble reaches a certain level, it could rattle markets. Then again, maybe it won't. But really bad civil unrest doesn't yield a positive outlook for our economy, never mind our society - again, depending on the degree of the unrest. 

So keep your eyes open. And if you're overexposed to the stock market, give that some thought too. We'll be doing just that.