The market tanked on black Friday due to the emergence of Omicron variant out of South Africa. The market did a very anemic technical bounce on Monday 11/29/2021. Then out of left field, the Fed Chair Powell spoke about accelerated tapering pace due to the higher than expected inflation.
The market had hoped that the Fed may delay the tapering because of the Omicron variant. Now the Fed spoke loud and clear that tapering (reduced monthly bond purchase) will happen faster than the Street had hoped because inflation is too high. Of course, the market didn’t like it and reacted negatively last week.
Remember the crash of 2020 was stopped by the Fed deploying unprecedented easy money policy. The easy money policy inflated every single asset class. The Fed can’t allow asset inflation keep going into infinity. Therefore the Fed steps in at a very over valued stock market to suck the oxygen out of the stock market. Liquidity to the stock market is like oxygen to people. The new monetary policy will force the stock market to readjust its valuation to reflect the new reality.
Fundamentally, we are very confident that the market has reached its 4-year cycle 1st half cycle top because of this fundamental change in the Fed’s monetary policy.
Technically, the DOW has violated its 200-day moving average. In the prior 4-year cycle (Feb 2016 to Mar 2020), the first time the DOW violated its 200-day moving average was on 10/11/2018. The DOW bottomed on 12/26/2018, that’s 52 trading days from the first 200-day moving average violation.
Today the market is at a similar location as in October 2018, which is the top of its 4-year 1st half cycle top. If history is a guide, we should expect the current market to finally bottom in Q1 2022 with about 20% correction. Because it is very oversold in the short term and due to seasonality, the market might bounce in the finally weeks of December. The selloff will resume again in Jan 2022 to finish the bottoming process. So please be careful. Don’t get sucked into the bear market rally.
In this current 4-year cycle, we have had a phenomenon of momentum outperforming innovation growth stocks due to the outsized influence from ARK Invest. As a matter of fact, ARKK is the momentum index for the entire stock market. ARKK ETF is consisted of many non-profitable companies that are selected by ARK Invest as innovators, which will disrupt our lives in the next 5-10 years significantly. Those companies could be future Apple, Amazon, etc.. Due to the extreme easy monetary and fiscal polices, the retail investors speculated and have hopped on the same innovative train with ARK Invest. ARKK had an outsized performance of 384% out of the pandemic low at 33 in March 2020 to the momentum peak in Feb 2021 at 159.70. 2021 has proven to be a bad year for ARK Invest and the cycle had turned on ARKK 9 months earlier than the general stock market. So far ARKK has corrected 43% off its high at 159.70. It wouldn’t surprise us to see ARKK correct more than 50% when this correction is finally over.
There are many people compared ARKK to the DOTCOM bubble due to the very high valuation of the ARKK type of stocks. They believe the ARK Invest chief Cathie Wood is leading the retail investors into a bubble territory. We see merits in this argument, but we also realize the differences between ARKK and DOTCOM bubble. Many of the ARKK type of stocks are making money today, they have the ability to make money. Back in the DOTCOM days, many of the bubble stock companies didn’t produce any revenue. All they had were some business plans plus a DOTCOM name.
So we do believe that ARKK will come back, but it’s going to take some time. Below is the prior and current 4-year cycle analysis which should give us some guidance.
From the above table, you can see that:
- Momentum stocks are the best in the 1st half of the 4-year cycle because the momentum stocks have been severely oversold before the 4-year cycle bottomed
- Momentum trades don’t last long as people rotate out of them as soon as the sizable profits are made. It takes a lot to keep the momentum going. The typical momentum stocks are story stocks anyway; they require constant news to pop it up.
- The 2nd half of the 4-year cycle has less percentage gain because the operating environment namely the monetary policies are tougher in the 2nd half of the 4-year cycle
- Momentum trades are hard to come by in the 2nd half of the 4-year cycle because the prior momentum winners in the 1st half cycle have been destroyed. It takes 24-36 months for them to repair the damaged momentum. Some of them will never come back to their former glory.
- The 2nd half of the 4-year cycle doesn’t last as long as the 1st half. Again, this is because the operating environment is more challenging in the 2nd half of the 4-year cycle
ARKK will not bottom until the general market bottoms in Q1 2022. ARKK will rise out of the current 4-year 1st half cycle bottom along with the general market, but we will not see its former high until the next 4-year cycle. In other words, ARKK will under perform the market for the remainder of the current 4-year cycle.
The Chinese stock market also topped in Feb 2021 along with ARKK type of momentum stocks. The Chinese stock market will not see its Feb 2021 high until the next 4-year cycle. The Chinese stock market will under perform the US stock market from this point on. The crackdown on tech, real estate bubble bust and the political tension between the US and Chinese governments will weigh on everything in China.
