Two Potential Roadmaps for 2022 and Beyond
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Does it look familiar to you?
If you answered “yes,” you’re probably not alone.
As you can see in the chart below, it looks a lot like the price action of the SPX since early 2020.
However, it’s actually a chart of the SPX during the early to mid-1960s.
Now I’ll ask you if the following chart of the tech-heavy Nasdaq 100 Index (NDX) looks familiar.
Again, you’d be forgiven if you said “yes.”
This chart also shares some similarities with the price action of the NDX since the beginning of 2020.
But this chart isn’t from the 1960s, like the first one I shared. (The NDX didn’t even begin trading until the 1980s.)
Rather, this one is from the late 1990s dot-com boom.
Why do I mention this?
Well, as you might’ve guessed, I believe these two periods could offer clues to the market’s performance in the year (or years) ahead.
Let me explain…
We’ll begin with the 1960s.
I suspect few TradeSmith Daily readers were actively investing at that time. However, that period had a couple of striking similarities to today’s market environment that extended beyond the price action of the major indexes.
The first was inflation.
At that time, inflation started to rise sharply higher for the first time in the post-World War II era.
Today, inflation is once again surging higher for the first time in decades.
The second is the rise of “one-decision” stocks — stocks that you can buy and never have to worry about selling.
Back then, the investing public was in love with the “Nifty Fifty.” As the name implies, this was a group of roughly 50 blue-chip growth stocks.
They were generally high-quality businesses. In fact, many of these companies — like American Express, Coca-Cola, and Disney — are still doing well today.
However, their popularity at the time pushed many of their valuations to absurd extremes. Price to earnings (P/E) ratios of 50 or higher were common.
Today, we’re seeing a similar phenomenon in an even smaller group of high-growth, blue-chip stocks known by names like “FANG,” “FANGMAN,” or “FANG+.”
It includes stocks like Meta (FB), Apple (AAPL), Amazon (AMZN), Alphabet (GOOG), Netflix (NFLX), Nvidia (NVDA), Microsoft (MSFT), and Tesla (TSLA), among others. And many of them are currently just as expensive — or even more so — than the Nifty Fifty were at that time.
As you can see in the updated chart below, this combination of rising inflation and extreme valuations led to a major sideways bear market where many stocks ultimately went nowhere for years.
In fact, after accounting for inflation, most investors averaged negative returns for more than a decade.
While I certainly hope I’m wrong, I believe we could be approaching a similar period today.
However, as I alluded to earlier, the late 1990s had some interesting parallels to today’s market environment as well.
First, speculation was running rampant in the markets.
Back then, folks were quitting their jobs to trade anything related to the up-and-coming internet, or “World Wide Web.”
Investors tossed traditional valuation metrics out the window as they embraced the “new economy.” Many tech companies with no profits — and sometimes no sales — soared hundreds and even thousands of percent.
Today, it’s arguably even worse, as investors will seemingly trade almost anything.
“Meme stocks” with failing businesses? Sure, why not?
SPACs (special purpose acquisition companies) with no real business to speak of? You bet.
Humorous cryptocurrencies or digital pictures of rocks and apes with no actual use or value? Sounds great!
The late ’90s were also a time of relatively easy money.
Now, it’s true that interest rates were significantly higher than they are today.
However, the Federal Reserve had slashed rates from nearly 10% to below 4% in response to the recession of the early ’90s. And it kept them relatively low throughout the decade even as clear signs of a bubble emerged.
Today, rates remain at historic lows, as they have for most of the last decade. More importantly, the Fed has unleashed a virtual tsunami of stimulus over the previous two years in response to the COVID-19 pandemic.
And again, like then, it has maintained these policies even as markets have detached from reality.
While the central bank is now promising to begin withdrawing this stimulus, it has not yet started to do so. And it may already be a case of “too little, too late” if it does.
If the markets follow this path, we could see a huge blow-off top where the investing public goes all-in on stocks, followed by a violent reversal as the speculative bubble unwinds.
Now, let me be clear.
I’m not predicting that the market will follow either of these paths exactly.
However, as the popular adage goes, “history doesn’t repeat, but it often rhymes.” And I think these two eras may be useful roadmaps for investors in 2022 and beyond.
So which path am I favoring?
Well, given the massive amount of stimulus we’ve seen in recent years — and the fact that we’ve yet to see extreme signs of investor euphoria rivaling the dot-com peak — I believe the latter scenario is more likely.
But as a TradeSmith subscriber, there’s no need for us to guess. We can simply stick to our plan and let our powerful tools and indicators keep us on the right side of the market.