CAPITAL IDEAS: The market will likely rise in the second half of 2021 - theberkshireedge.com

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Good news, everyone! The stock market will probably rise in the second half of 2021.

Over the last 125 years, if the Dow Jones Industrial Average (DJIA) rose in the first half of the year, it was up 72.4% of the time in the second half. That’s more than the 66.9% of the time it’s usually up in the second half. The Dow is up 64.5% of the time in the second half of a President’s first year in office.

If you can’t pick it up in my writing, there’s some sarcasm in my jubilation. But, yeah, I guess it’s not bad news, so maybe that makes it good news. My point isn’t that the historical trends are favorable, but that they aren’t headwinds.

I’m always looking for a reason to bail on my stock positions. I don’t want to lose my money. However, because the stock market has gone up so much year-to-date isn’t enough of a reason for me to employ the adage, “what goes up, must come down.” History marks us as relatively safe. Not everything else does, but history does.

What doesn’t mark us safe? Well, I am concerned that economic growth will hit its peak in the next month or two. I’m not expecting anything negative, but I’d argue that the stock market has priced in a lot of the good news. Since mid-April, the market has been mostly going sideways; I am not picking up anything the market hasn’t already considered. What happens now that the stock market has consolidated? I stay invested. There is a chance of an upside resolution. And I believe the risk is limited to a single-digit correction in the second half of the year. I suspect that a correction would be reversed by year-end, making it a year-end like many others.

Although the risk is relatively limited, I’m not expecting much gain from the market for the next 6-12 months. It’s overvalued. Of course, it was also overvalued in 1996 when then-Federal Reserve Chairman Alan Greenspan declared the stock market was experiencing “irrational exuberance.” He was right on the sentiment, but that didn’t stop the stock market from advancing wildly for the next few years.

Fundamentally, it’s irrational of me to expect much more gain from the stock market. But it’s also not prudent to fight an accommodative Fed or the massive amount of fiscal stimulus that remains in the economy. And it may not be the wisest plan to fight the exuberant investors throwing money into a market hot for Meme stocks and cryptocurrency.

So, I’ll stay invested, but I’ll keep looking for reasons to get out of Dodge. Or Doge, as the case may be.

For some perspective, my expectation of a single-digit decline is somewhat optimistic. The 2020 stock market decline was followed by a massive rally. That’s not unusual. Typically, the stock market will bottom a few months before the end of a recession and then rebuild its price. During the second year of the economic expansion, investors start to price in slower growth rates. That transition can be tricky. So far, the handoff has resulted in two-and-a-half months of sideways action. However, according to Ned Davis Research (NDR), it’s usually worse. For the last 60 years, these handoffs have turned into what NDR refers to as “echo bears.” Echo bears cause the S&P 500 to experience a median decline of 18.0% over 6.8 months.

There you have it. One hundred twenty-five years of history says the odds favor the stock market being up the rest of the year. But suppose those months are part of the second year of an economic expansion. In that case, it isn’t implausible to expect an 18.0% decline. I remain invested in the stock market, but you can see why I’m nervous about it.

However, you shouldn’t be nervous about a single-digit sell-off. According to Cornerstone Macro, since the March 2020 COVID-19 low, there have been six 5%+ sell-offs with an average decline of 7.8%. My prediction feels lazy, but it doesn’t mean it isn’t a high probability. It’s a garden-variety sell-off and should be expected.

When will it start? I think there’s a good chance it already has. On Friday, June 18, 2021, the percentage of stocks trading above their 50-day moving average (DMA) dropped to 44.0%, from 68.1% two weeks prior. Measuring how stocks are doing within an index is called tracking its “breadth.” Not all stocks go up or down at the same time. An index can keep going up as fewer and fewer stocks in that index participate in the rally. However, at some point, enough individual stocks turn down to bring the entire index lower. This could be the beginning of a 7.8%-ish drop we’ll all forget by the end of the year. After all, how many of us remembered there were six 5%+ drops throughout the last fifteen months? I’m not confident about the exact timing of a decline, but I am convinced that it’s not enough to motivate me to try and sidestep.

I am looking for reasons to get out, but I can’t. A 7.8% drop is ordinary. The timing of it is impossible to know for sure. And there is still a possibility it could go up from here. I just don’t find enough evidence to pull that sell trigger. Yet. But if we get an upside resolution, that could warrant some defensive moves in anticipation of a more significant drop.

What could cause a more considerable drop? The Fed could decide to shift to a more hawkish stance just as economic growth is peaking. It is common for the stock market to react negatively as the Fed transitions from a loose monetary policy to a tight one — making interest rates a headwind instead of a tailwind. That would increase the odds of matching that median decline of 18.0% over 6.8 months. The market is so richly valued that a drop of that significance could take a longer-than-usual time to recover. But for now, the problem for the market is that asset prices are overextended and not a severe fundamental issue. My base-case is that whatever drop is next isn’t the “big one,” but I’ve got my finger on the trigger to sell if information changes rapidly.

Allen Harris is the owner of Berkshire Money Management in Dalton, Mass., managing investments of more than $500 million. Unless specifically identified as original research or data-gathering, some or all of the data cited is attributable to third-party sources. Unless stated otherwise, any mention of specific securities or investments is for illustrative purposes only. Adviser’s clients may or may not hold the securities discussed in their portfolios. Adviser makes no representations that any of the securities discussed have been or will be profitable. Full disclosures. Direct inquiries: aharris@berkshiremm.com.Is the meltdown in Bitcoin warning us to get out of the stock market?

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CAPITAL IDEAS: The market will likely rise in the second half of 2021 - theberkshireedge.com
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