What a Long Strange Trip It's Been
Markets have had quite a run since their sizeable COVID bear market correction of March 2020. Investor joy should be high given the 90%+ sixteen month S&P 500 run(1) through June 2021, a period that included the largest 50 day market rally in history and one of the largest one-year rallies in history(3). No corrections in that period, so smooth sailing for much of those sixteen months. Speculation (and risk) reached frenzied levels earlier this year as meme stock and cryptocurrency trading dominated the investment universe. This is something one seldom sees in the beginning stages of a bull market, so our perspective is that we are migrating through the latter stages of this bull market cycle. As we've noted, the elevated valuations/euphoric phase can continue for quite some time as stocks trade at what we perceive as expensive levels.
Last year, with the economy shut down, there were significantly fewer cars on the road. The National Highway Transportation Safety Administration announced in June this year that there were 13% fewer cars on the road in 2020, but traffic deaths spiked to the highest level since 2008: 38,680 killed. Doesn't make sense - how can this be, fewer cars and yet more accidents? According to the agency, drivers felt safer with fewer cars on the road but became significantly more reckless in 2020, resulting in this tragic spike.
The same feeling of confidence and safety occurs in market cycles after long upward moving slopes and significant gains. This tailwind causes investors to engage in behavior indicative of their confidence...for example, borrowing to buy securities...
Margin Debt: Borrowing to buy stocks (margin debt) is a risky proposition and these debt levels have continued to rise to all-time highs. As of May 2021, margin debt levels hit $862 billion.(Source: FINRA) Again, this sort of phenomenon does not occur with the accompanying despair of bear market bottoms. Borrowing is just another sign of the euphoric phase of the market cycle.
However, No Need to Panic, Corrections are Normal
Given our short memories (the fact that we forget how market declines feel in real time and haven't experienced any in sixteen months), investors will not get an indefinite free lunch. Corrections (10% or more declines) are coming at some point and this should be construed as normal - they happen, on average, once or twice a year. Market declines are especially damaging to investment borrowers (margin debt) since borrowing exaggerates market movements. The rush to sell by these borrowers will be a movie theater exit metaphor.
However, it's time to mentally prepare for corrections now - an educated investor is less likely to assume Armageddon when they naturally occur.