Here is Why REXIT + FEXIT Means 20-40% LOWER Stock Prices From Here!

Why the Combined REXIT (DeRussification of the Western World) and the FEXIT (Draining $6 Trillion of Liquidity From the Capital Markets + Raising Fed Funds Rate to 4%+ from ZIRP) = QQQ Bear Market Down Up to 50%+ & SP 500 Down 35%+ in 2022 through the first half of 2023

Hey Subscriber,

The message I hope you have taken from the last updates and NLs since March is that "REXIT + FEXIT = Means EVERY Financial Asset Valuation Gets a Valuation Reset!"

Right on cue, the down 20%+ bear market we started forecasting in March is officially here--SP 500 down 21% and QQQ down 33%.

The bad news is from both a valuation and historical basis, the overall stock market (as measured by the SP 500) and the Big Tech Nasdaq 100 index as valued by the CAPE Shiller stock valuation index have a lot farther to go down in value (for a number of critical reasons I will address in a moment--here is my brainy friend Lynn Alden to explain Cape Shiller Index ). 

Actions to Take Right Now: 
1) Lowering REXIT Buy Unders on Ultra Income+ Growth to 100-day SMA
2) PROFIT PROTECTION Tightening Ultra Income + Growth Sell Stops to 8% UNDER today's closing prices and $XOP to 8% under closing prices
3) SELL $EURN, $PFFL $HCDIP
4) SELL/Clean Out Any Remaining Ultra Growth Positions You Still Hold
5) SELL Call options on the HUGE dividend UI+Growth Positions we Bought in April/May/June 2020 (if you want to learn how we do this, click here to join us in the All-Access trading room and we will show you how!

But FIRST--what I REALLY think you should do right now is take 20 minutes and reread our 3 TR Special Reports from the last 45 days. The reason is that when the Fed raises the Fed Funds rate 75 basis points (3/4%) on Wednesday, you will understand the reasons why they HAVE TO as we have meticulously addressed and explained in these special reports.  

BUT--if they wuss out and only raise 50bps, and the market TANKS, then you REALLY need to read the special reports to understand how delusional the market now sees JayPow and the Gang of 115 PhD Economists Who Failed Economics 101 and Calculus (specifically the second derivative aka "the rate of the rate of change.")

Here are the links to click again:

1) TR's 2023 Recession Base Case: Why The Fed's "Immaculate Monetary Tightening" aka Soft Landing Narrative Is Mathematically Impossible 

2) TR's 2022 $SP 500 DOWN 35%-40%/Nasdaq100 DOWN 50%+ Bear Market Case: Why The 2002-2023 Bear Market for > 16+ P/E Stocks Is a 100% Certainty 

3) I wrote in our June 3 update that "BEAR MARKET prudence has us HOLDING on adding more REXIT sectors and stocks UNTIL we get the highly predictable 10-20% pullback in prices since REXIT stocks were quite literally the ONLY stocks making big juicy 50%+ profits this year and will sell-off from profit survival selling as the bear market starts to really hurt. 

Here is the list of REXIT stocks on the "bench" waiting for that 10-20% PROFIT TAKING pull back that comes 100% of the time in SP 500/QQQ bear markets as institutional investors--especially algorithm black box positive price momentum factor hedge funds who ONLY buy stocks that are outperforming and then SELL them when the break 20 day moving averages-- 

Then read (or reread for some of you) the great value investor Howard Marks of Oak Tree Capital on why the only certainty in the stock market is the hard-wired human investing psychology: greed/fear of missing out on easy profits and fear of losing money. 

Bear Markets end with a major bout of infectious investor selling--commonly called the "Puke Point" and the complete emotional reverse of YOLO FOMO mania. The puke point is where MILLIONS of investors call their broker (or get into their online accounts") and sells EVERYTHING regardless of price or sector.

At our shop, this reflexive "GMTFO NOW" moment has not recently occurred since we went to cash in Feb 2020 and have now taken $millions in profits in 2022 and sit 75%-85% ish in cash at present.  

Make sure to click this link here for Howard's critically important knowledge of bull and bear market investor psychology that I send to EVERY managed account client and discuss deeply. 

Look--WHY the Fed overstayed its welcome at ZIRP/QE is still a mystery to me--they see the same data that we do. As we forecast, the realization of very entrenched very "sticky" 7%+ cost of living inflation (Fuel oil up 75% YoY, Gasoline 49% YoY, Household energy up 19.5% YoY, New and Used Vehicles 15.2%, Groceries 11.9%, and the biggie Shelter up 5.9% YOY that makes up 40% of the CPI) was compounded by  Michigan Consumer Survey that shows consumer expectations for the cost of living inflation rose to the highest levels ever since the survey was started in the 1970's.

The fancy economist's phrase for these higher for longer consumer inflation expectations is "inflation expectations have become anchored at dangerously high levels." The reason they are dangerous is say I buy my favorite Gin (Bombay Saphire btw) at the same price for many years and then suddenly the price rises 10%+ (like in Feb 1991--those were dark days :).

In that case, I will buy two or three bottles being a thrifty Scotsman (for some reason, alcohol prices were the LOWEST rising product in the survey at 4%--whew!). 

Now multiply that behavior over everything--when high inflation expectations become anchored, people buy ahead to save money. Yet the actual definition and mechanism of price inflation is more demand than supply! Talk about a dangerous price inflation feedback loop!   

Here is a quick preview of the investor psychology from the Wisdom of Marks (my comments are in parentheses). 

Excesses and Corrections 

My second book is Mastering the Market Cycle: Getting the Odds on Your Side.  It’s well known that I’m a student of cycles and a believer in cycles.  I’ve lived through (and been schooled by) several significant cycles during my years as an investor.  I believe understanding where we stand in the market cycle can give us a hint regarding what’s coming next.  And yet, when I was about two-thirds of the way through writing that book, a question dawned on me that I hadn’t considered before: Why do we have cycles?

For example, if the S&P 500 has returned just over 10% a year on average over the 65 years since it assumed its present form in 1957, why doesn’t it just return 10% every year?  And updating a question I asked in my memo The Happy Medium (July 2004--a must-read!), why has its annual return been between 8% and 12% just six times during this period?  Why is it so far from the mean 90% of the time?

After pondering this question for a while, I landed on what I consider the explanation: excesses and corrections.  If the stock market was a machine, it might be reasonable to expect it to perform consistently over time.  Instead, I think the substantial influence of psychology on investors’ decision-making largely explains the market’s gyrations.

When investors turn highly bullish, they tend to conclude that (a) everything’s going to go up forever and (b) regardless of what they pay for an asset, someone else will come along to buy it from them for more (the “greater fool theory”).  Because of the high level of optimism:

  • Stock prices rise faster than company profits, soaring well above fair value (excess to the upside like 2020-2022).  

  • Eventually, conditions in the investment environment disappoint, and/or the folly of the elevated prices becomes clear, and they fall back toward fair value (negative correction) and then through it.  

  • The price declines generate further pessimism (negative feedback loop), and this process eventually causes prices to far understate the value of stocks (excess to the downside).  

  • Resultant buying on the part of bargain-hunters causes depressed prices to recover toward fair value (positive correction).  


The excess to the upside makes for a period of above-average returns, and the swing toward excess on the downside makes for a period of below-average returns.  There can be many other factors at work, of course, but in my view, “excesses and corrections” covers most of the ground.  We saw a number of excesses to the upside in 2020-21, and now we’re seeing corrections thereof.  

Bull Market Psychology

In a bull market, favorable developments lead to price rises and lift investor psychology (aka suspension of natural skepticism and disbelief).  Positive psychology induces aggressive behavior.  Aggressive behavior leads to higher prices.  Rising prices encourage rosier psychology and further risk-taking (extrapolation of previous gains to continue). 

This upward spiral (positive feedback loop enhanced by market-cap-weighted index investors) is the essence of a bull market.  When it’s underway, it feels unstoppable.

We saw a classic collapse of asset prices in the early days of the pandemic.  For example, the S&P 500 reached a then-all-time high of 3,386 on February 19, 2020, before falling by 33 percent in just 34 days to a low of 2,237 on March 23.  After that, a number of forces combined to produce massive price gains:

  • The Federal Reserve cut the fed funds rate to roughly zero, and the Fed was joined by the Treasury in announcing massive stimulative measures.

  • These actions convinced investors that these institutions would do whatever it took to stabilize the economy.

  • The interest rate cut significantly reduced the prospective returns required to make investments look attractive in relative terms.

  • The combination of these factors forced investors to bear risks they had been running from just a short time earlier.

  • (Federal and State "Stimmy Checks" caused 45 million NEW brokerage accounts to be opened and the most new money injected into the stock market in 24 years).

  • Asset prices rose: by late August, the S&P 500 had retraced its decline and surpassed its February high.

  • The FAAMGs (Facebook, Amazon, Apple, Microsoft and Google), software stocks, and other tech stocks rose dramatically (think Cathie Woods $ARKK), pushing the market higher.

  • Eventually, investors concluded – as they often do when things are going well – that they could expect more of the same. 


The most important thing about bull market psychology is that, as cited in the final bullet point above, most people take rising stock prices as a positive sign of things to come.  Many are converted to optimism.  Relatively few suspect that the gains to date might have been excessive and borrowed from future returns and that they presage reversal, not a continuation.

That reminds me of another of my favorite adages – one of the first ones I learned, roughly 50 years ago – “the three stages of a bull market”:

  • first, when a few forward-looking people begin to believe things will get better (us in April 2020!),

  • the second, when most investors realize improvement is actually underway, and

  • the third, when everyone concludes that things will get better forever.

Optimistic Rationales, Super Stocks, and the New, New Thing

Raging bull markets are examples of mass hysteria.  At the extreme, thinking and thus behavior becomes unmoored from reality.  In order for this to occur, however, there has to be some factor that activates investors’ imagination and discourages prudence.  Thus, special attention should be paid to an element that almost always characterizes bull markets: a new development, invention, or justification for the rising stock prices.  

Bull markets are, by definition, characterized by exuberance, confidence, credulousness, and a willingness to pay high prices for assets – all at levels that are shown in retrospect to have been excessive.  History has generally shown the importance of keeping these things in moderation.  For that reason, the intellectual or emotional rationale for a bull market is often based on something new that history can’t be used to discount (eyeballs in the DotCom mania, Work from Home SaaS and ex-urban homes in the Fed's $6 trillion Everything Bubble). 

Those last six words are very important.  History amply demonstrates that when (a) markets exhibit bullish behavior, (b) valuations become excessive, and (c) the latest thing is accepted without hesitation, the consequences are often very painful.  Everyone knows – or should know – that parabolic stock market advances are generally followed by declines of 20-50%.  Yet those advances occur and recur, abetted by what I learned in high school English class to call “the willing suspension of disbelief.”  Here’s another of my very favorite quotes:

Contributing to . . . euphoria is two further factors little noted in our time or in past times.  The first is the extreme brevity of the financial memory.  As a consequence, financial disaster is quickly forgotten.  In further consequence, when the same or closely similar circumstances occur again, sometimes in only a few years, they are hailed by a new, often youthful, and always supremely self-confident generation as a brilliantly innovative discovery in the financial and larger economic world.  There can be few fields of human endeavor in which history counts for so little as in the world of finance.  Past experience, to the extent that it is part of memory at all, is dismissed as the primitive refuge of those who do not have the insight to appreciate the incredible wonders of the (new rapturous mania) present.  (John Kenneth Galbraith, A Short History of Financial Euphoria, 1990 – emphasis added)

I’ve shared that quote with readers many times over the last 30 years – since I think it so beautifully sums up a number of important points – but I haven’t previously shared my explanation for the behavior it describes.  I don’t think investors are actually forgetful.  Rather, knowledge of history and the appropriateness of prudence sit on one side of the balance, and the dream of getting rich (quickly) sits on the other.  The latter always wins.  Memory, prudence, realism, and risk aversion would only get in the way of that dream.  For this reason, reasonable concerns are regularly dismissed when bull markets get going.  

What appears in their place is often intellectual justifications for valuations that exceed historical norms.  On October 11, 1987, Anise Wallace described this phenomenon in an article in The New York Times titled “Why This Market Cycle Isn’t Different.”  Optimistic thinking was being embraced at the time to justify unusually high stock prices, but Wallace said it wouldn’t hold:

The four most dangerous words in investing are “this time it’s different,” according to John Templeton, the 74-year-old mutual fund manager.  At stock market tops and bottoms, investors invariably use this rationale to justify their emotion-driven decisions.  

Over the next year, many investors are likely to repeat those four words as they defend higher stock prices.  But they should treat them with the same consideration they give “the check’s in the mail.”  No matter what brokers or money managers say, bull markets do not last forever.

It didn’t take a year.  Just eight days later, the world experienced “Black Monday,” when the Dow Jones Industrial Average dropped by 22.6% in a single day.  

Another justification for bull markets is often found in the belief that certain businesses are guaranteed to enjoy a terrific future.  This applies to the Nifty-Fifty growth companies in the late 1960s; disc drive manufacturers in the ’80s; and telecom, Internet, and e-commerce companies in the late ’90s.  Each of these developments was believed to be capable of changing the world, such that the past realities of business need not constrain investors’ imaginations and willingness to pay up.  And they did change the world.  Nevertheless, the highly elevated asset valuations they were thought to justify didn’t hold.

In many bull markets, one or more groups are anointed as what I call “super stocks.”  Their rapid rise makes investors increasingly optimistic.  In the circular process that often characterizes the markets, this rising optimism takes the stocks to still-higher prices (boosted by their inclusion in $trilions of market-cap-weighted SP 500 and QQQ Index funds).  And some of this positivity and appreciation reflects favorably on other groups of securities – or all securities – through relative-value comparisons and/or because of the general improvement in investors’ mood. "   Get going on your homework...it is critically important you understand and control your emotions as this bear market shit show gathers steam. 

Toby

PS--IF you want to TRADE this insane volatility in the REXIT Screw You Russia Energy and Fertilizer and metals and steel/aluminum etc, click here, scroll down to the bottom of the registration page and join us in the All Access trading room for some historic profit opportunities.  

We are updating ALL Portfolio Buy Unders to 100-day price moving averages in the morning https://transformityresearch.com/ultra-income-portfolio

Tobin Smith