My first video edition of Market Minute was just over a month ago – and I warned that we were getting back into a reversion-to-the-mean market.
That was good timing, because today, I want to explain why you need to be wary of this recent rally… it’s a classic example of how a momentum market traps unsuspecting investors.
In fact, I recently gave an interview about that right here. So be sure to check that out after you watch today’s video edition.
And if you prefer, you can scroll down to read the transcript.
Transcript
Hey folks, welcome back to another video version of Market Minute. I’m Jeff Clark, and I have a handful of things to say today. You know, the first time we got together here in a video version was maybe about a month ago, it was towards the end of July.
And at the time I talked about how I thought the market was transitioning from a very strong momentum-based market into more of a natural ebb-and-flow, kind of a reversion-to-the-mean type of the market.
And that was pretty good timing, because right after we posted that video, the stock market went into a bit of a correction.
We had a pretty good sell off, and the momentum names – the stocks that had gone up the most – were the ones who got hit the hardest. And the stocks that had not really participated in the rally actually sort of caught a bid.
So we had a really good taste of what it’s like to see a reversion to the mean. And if you followed me on Twitter or I guess it’s called X these days, my log in there is @JeffClarkTrader. I had posted a handful of potential reversion-to-the-mean trade ideas, and it was really interesting because for a couple of weeks, they worked out pretty decently.
The Correction
Most of the stocks that I listed as potential buys were doing okay. And most of the stocks that I listed as potential sells were going in that direction as well.
Now, however, after the market had this little correction, everybody freaked out, the VIX got to 65 and all of that. We’ve had this remarkable bounce back, a very strong momentum-based bounce back.
And now a lot of folks are thinking we’re back in the momentum game.
We’re not. I’m just going to put that out there right now.
This is how a transition from a momentum market to a reversion-to-the-mean market happens to work.
And if you go back and you look at other examples of very strong momentum-based markets, shifting gears, you can see back in 2000, during the dot-com craze, you can see it in late 2007, 2010, 2011, in that timeframe, and most recently back at the end of 2021, we had very strong momentum-based markets start to rollover and transition into a reversion-to-the-mean.
A Classic Example…
And they all seem to unfold in the same manner.
The very first correction off the top tends to freak everybody out. People get nervous, they sell things, the VIX explodes higher, and then following that we get this remarkable move back up again.
And that move back up tends to get all the folks who just sold – they just got emotional and sold everything they had – they scramble back in, and they chase stocks higher again.
And then they swear – and this is what happens, is the market teaches them that stocks only go up. So they run back in and they swear “the next time the market falls, I’m not sellingin fact, I’m going to buy more.”
And that’s how a momentum market traps you.
And what happens is over the course of several more months, they keep trying to buy, as stocks are selling off and they buy, and they buy, and they buy, thinking that things are going to go back up just like they did on that first correction. And then they wind up suffering as a result.
The Poster Child of 2024
And to give you an example, rather than going back to looking at the markets years and years and years ago, the multiple examples that I talked about, let’s look at what I’ll call the poster child of momentum trading for 2024.
So this is Super Micro Computer (SMCI) and you can see at the very start of 2024, we started this this dramatic, huge rally, all momentum-based. It was just basically straight up.
It was just higher high, after higher high, after higher high. And you can see right about the middle of February, we hit this peak at about $1,000 a share.
So the stock went from roughly $300 to about $1,000 a share in about five weeks. And again, the folks chasing momentum were just back pounding the table on this and rushing and buying.
And then you got a rather sharp correction down to point one here on the chart. That’s down to $750. That’s a 25% correction. That’s pretty significant.
And I mean it looks very small on the chart. But that’s a significant move knocking 25% off the top. And while that was happening folks were freaking out a little bit.
Folks who had bought in were getting the heck out because they didn’t want to suffer a loss as it drew down.
And then over the course of the next several weeks, you can see how SMCI rallied all the way back up to a new high, hit $1,200 a share. And what this serves to do is people chase it back in.
So everybody who sold out here at point one is now rushing to buy back in at point two, and they’re cussing and they’re saying to themselves, “I’m never going to sell this stock again. I was bluffed out of a position I hate that. So the next time the stock market falls, I’m going to hold it. In fact, I’m going to buy even more.”
And so what happened here as after we finished the top here at point two, we corrected again, pretty significant correction. Another 300 points or so down to point three.
And all the momentum folks who freaked out on that first correction didn’t freak out this time. They held on. And in fact, at point three they decided, hey, it’s time to buy even more. So they loaded up the boat a little bit more. You get this little bit of a bounce, and then you sell off again down to point four.
Once again, momentum folks remembering what happened after that first correction and then another rally to new highs. They figured “I’m not going to sell it. Stocks only go up. We’re going to buy some more.”
So they bought more at point four. And then you go through a period of choppy consolidation. And you can see what happens here, point five as we started off in August and now we’re at point six.
Momentum Markets Trap You
And what has happened is everybody who chased this everybody in the momentum game to chase this all the way up earlier in the year, got bluffed out, chased it back in and has bought more, and more, and more, on each decline is now just basically in a world of pain.
This is what makes a momentum market difficult, because it traps you.
It traps folks who play that particular type of game into thinking that stocks only go up,
Folks, stocks don’t only go up. That’s the situation that we’re dealing with right now. And so when I look at the stock market, I look at the behavior over the past several weeks, that decline in early August, folks, that was the shot across the bow.
That was the warning shot that says, hey, this momentum market is transitioning. And so I think we have to keep that in the top of our mind. Even though stocks have come back, we’ve rallied right on back and everything looks wonderful again, I’m telling you, there’s a problem with the market and I’m bearish on stocks.
I think the next several months and the next year or so are going to be very, very difficult.
Reversion-to-the-Mean Is the Way to Go
It doesn’t mean the stocks have to collapse from here, but I think folks chasing momentum are going to have a world of hurt. I think folks that are trading a reversion-to-the-mean strategy are going to do quite well.
And I say that with a little bit of history behind me, because I know we did really well in 2001, 2002.
We did really well in 2008. We did really well in 2011. We did really well in 2022 and 2023. And so I expect we’ll do really, really well when this momentum market shifts into a reversion-to-the-mean market again.
Now you should have there a link to a recent interview that I did.
And I talk about a reversion-to-the-mean strategy. I talk about the things that I expect are going to happen over the next several months, maybe the next year-and-a-half or so in the stock market and different ways to trade that.
So if you want to learn a little bit more, you can click on that link, and you’re not going to find this interview in very many places.
My publisher is not really promoting her all that much, for reasons that I’ll talk about in another video, perhaps later this week, perhaps tomorrow, maybe it’ll take me a couple extra days to get that out there. But it’s a valuable interview.
I think you can get a lot out of it. So, like I said, I think we’re still in a transition, I think it’s smart for investors to stay cautious here, even though the markets are making new all-time highs.
I think you still ought to be defensive and you ought to be looking for a way to take advantage of a reversion-to-the-mean strategy.
So we’ll leave it at that and we’ll check back in, in the next Market Minute and we’ll talk soon.
Take care,
Jeff Clark
Editor, Market Minute