We’re in the midst of the next stock market panic and no one is paying attention.
Worst of all, it will be the type of panic that will take more folks by surprise and, in the end, will turn out to be more costly to most investors than last fall’s market sell-off.
It’s the most dangerous kind of panic of them all.
But you don’t have to get sucked into it. All you have to do is look at past panics to see the one right in front of us. Best of all though, as you’ll see in a moment, there is one simple way you can guarantee you won’t lose big in this panic and still profit from it all.
The Latest Stock Market Panic
I’m talking about “panic buying.”
We talked about panic buying back in early April. Panic buying is when most investors start buying stocks because they think they’ll never be able to get in this low again. It’s the “buy now or you’ll never be able to buy this low again” mentality which has signaled the top of every bubble.
Right now, it’s happening in stocks.
Just take a look at what’s going on around us. Clearly, a lot of folks are getting nervous they’ll never be able to get in this low again.
The S&P 500 is up 50% from the March lows. This tremendous rally has brought “the herd” back into the markets.
Most panics start when everyone has gone “all in.” For instance, when it comes to stocks, panics happen when everyone is all in and there is no one left to buy stocks. That’s why stock prices fall so quickly. Panic buying is a bit different in that the panic buying is what gets everyone to go all in.
That’s the part of the cycle we’re at right now – getting everyone in.
The signs are all there.
One of the most obvious warning signs comes from the Washington Times. Today, a headline declared “A New Bull Market” has begun.
The economic euphoria has gotten so strong, two of the President’s key “money men,” Larry Summers and Tim Geithner, even brought up the possibility of tax increases to offset government deficit spending. This kind of talk would be unthinkable a few months ago.
Finally, the big money is starting to move in. The State Street Investor Confidence Index, which tracks the buying and selling decisions of institutional investors like pension and mutual fund managers, has been soaring. The index recorded a very positive reading of 119.4 last month. This is a huge upswing from last fall’s market sell-off when the index fell to 82.1.
That’s everyone – the mainstream media, the government, and the big money.
Clearly, the herd is still getting in on this rally. And each day the market rises, which seems like every day lately, we get closer and closer to the point of maximum optimism.
Bears Beware: the Secret is in the Sidelines
It’s easy to see another case of great expectations is building. As we like to say in the Prosperity Dispatch is that great expectations usually lead to even greater disappointments.
But the big question is when will it all end? When’s the next great disappointment?
To determine that we just have to step back and take a look at the single most important factor practically no one is paying attention to – the sidelines.
Despite the recent run-up in stocks, there is still a lot of money on the sidelines. The Investment Company Institute currently pegs the total cash sitting in U.S. money market funds at $3.592 trillion.
That’s a lot of cash which has so many ways of working its way into the economy. Money market funds can be used to bid up stocks, to pay for vacations or new TVs, or all kinds of other activities which would help keep GDP on the rise – either directly or indirectly.
The biggest positive impact the cash could have on the economy is through the wealth effect. The wealth effect is when a portfolio which is climbing impacts the spending decisions of the individual. As we’ve discussed before, 70% of all Americans have some exposure to the stock market. So the stock market simply going up goes a long way to impacting GDP.
They have already started going a long way to ending the vicious cycle of downturns and renewing a virtuous cycle. And virtuous cycles tend to go much longer than most people expect.
The Trend is Your Friend, But…
There’s no denying the current recovery will come to an end. There are very few reasons, aside from greater government intervention, to keep housing prices propped up. It’s simply a situation of supply and demand.
Also, as we looked at on Friday, the current government fixes for the economy are simply borrowing from future demand to help out selected industries in the short-term.
Most importantly, the government solutions to recessions since WWII have grown larger and larger. The most recent one, with $24 trillion in bailouts, guarantees and freshly printed dollars going to “prevent” further economic pain and push off the necessary healing.
That’s why all signs point to us being stuck in the middle. Sure, there are plenty of catalysts for the economy to show growth in the near-term, but the long-run future is not very bright.
Worst of all, there’s no telling when most investors will realize it. We’re in the early stages of panic buying, but it could get a lot more heated in the weeks and months ahead. Or the big stock buyers could pause for a multi-month break (like we had in May and June) before beginning again.
All this is why I continue to strongly recommend trailing stop losses. These orders, which prevent you from taking big losses while allowing you to still enjoy the upside opportunity, are perfectly built for times like these.
They allow you to jump in with the herd and make the trend your friend. But the trend is only your friend for a while. At the major turning points, running with the herd is very costly.
It’s likely this “recovery” will last more than most investors expect. Also, there’s no telling when panic buying will come to an end. But once you consider the heights expectations will eventually grow to, and what will happen as the amount of money on the sidelines shrinks, it’s easy to see it all could end very quickly and it’s never too early to take out an insurance policy. And trailing stops, which if used correctly have no cost, are one of the cheapest forms of “crash insurance” you’ll ever find.
By Andrew Mickey