Prepare for a repeat of 2002 - only the pivot is missing

Bear markets are created by excessive optimism and unjustified high valuations. When excesses in the stock market are to be rolled back at the same time as the Fed cannot or does not want to stop an incipient recession, the conditions exist for a healthy return to reasonably valued or even cheap stocks. The road there is longer than many realize. After 15 years of stimulus and soaring stock markets, most people are conditioned to buy the dips way too early.

It took e.g. three years for the extreme technology optimism of the late 1990s to normalize. Then the craziness was compared to the Nifty Fifty of the 60s (that you could only buy and keep the best stocks regardless of valuation) and the 1929 madness slogan that stock valuations had reached a "permanently high plateau". Never again could the market be tricked into something like this, people thought at the time. But just 5 years later, an even bigger housing bubble burst, and right after it, a new gigantic technology balloon began to be inflated again. It wouldn't even be possible to make an AI-directed flat Netflix movie on the same theme. The scenario is too unlikely.

Between the 14 months of March 2000 and May 2001, the S&P fell by 15%, just as much as the last 14 months from January 2022 to February 2023. In both cases, the index was first much deeper down, but in a few months it rebounded by just over 20%. The similarities are striking, both in magnitude and the fact that it is extremely highly valued technology stocks that lead the index both in the race and in the rush. Of course, we don't know what the future holds for us, but in the comparison example, the S&P fell a further 42% from May 2001 to the two bottoms in July and October 2002, respectively. It was therefore just as far left in time for the decline, but from a starting point 15% during all time high it was over 40% downside. I think it would count as a so-called "pain trade" for most people. Amazon e.g. fell by 95% from top to bottom. It took less than two years, but for Microsoft the suffering lasted for 9 full years and ended up 75% below the peak.

If the parallel rhymes, there is 40% downside left for just over a year left for the S&P500. It's also pretty close to what would lower the stock market valuation to just slightly above the long historical average (measured as market capitalization relative to GDP or corporate earnings).

The examples dance to the beat so far regarding tech stocks, valuations, initial decline and bounce, and an approaching recession. The only thing missing is for the Fed to pivot and start lowering interest rates. It was when the central bank seriously said that we must alleviate the recession by cutting interest rates that the stock market seriously crashed. The same pattern with dovish pivot => stock crash was also seen in 2008-2009 after the housing bubble.

We have just left the 2022 reporting period behind us. It was not as dangerous as some feared. I and many people with me (it can be seen in the 13F statistics for last autumn) expected that this would happen and may have bought META, Spotify and everything possible before the winter rally.

But now I think that means that it is over. To be clear, the long slump is not over. No, it's just about to enter its brutal second half. The only question is what to own and what not to own for the next 12 months. In 2002, both banks and insurance companies were hit by foreclosures and credit losses. In 2008 it got even worse and the entire financial system could only be saved with a law change that said “We look the other way while you rebuild your capital; in the meantime, you don't need to market the junk you own."

That means one of the few things that won't happen again this time is a banking crisis. This time the banks have a buffer. This means that you can easily buy retail banks in the Nordics. On the other hand, there will be much less money left in the consumer sector after mortgage costs and higher electricity bills. This means that all consumer goods, especially of the type white goods, renovation, fashion clothes, unnecessary gadgets will have it all the more difficult. The central banks are tied for the time being, so count on stocks for everything that is nice-to-have over need-to-have, where banks and oil are absolutely necessary - and still ridiculously cheap. Many so-called technology shares are really not needed, but have mainly lived on the fact that the customers, both small and institutional, had faith in the future and money to spare.

Above all, they are not cheap – Scott McNeely of Sun Microsystems laughed after the crash “How could someone pay 10 times sales for my company? Of course it would crash!”. Well, every other technology company costs 10x sales again after the winter's price doubling. The Nasdaq index thus has an extra large downside. Shopify, Tesla, Lululemon, Monster, DoorDash, Snowflake, Netflix, Docusign - the list is long of companies that may have unsustainable valuation, and in many cases questionable raison d’etres.

Incidentally, as recently as the day before yesterday, a friend’s Tesla S100 had a so-called "whompy wheel", i.e. the wheel axle suddenly broke off when he was going to park. It's a well-known flaw among Tesla analysts. Yesterday, Tesla also finally admitted that 362,000 Teslas have dangerous driver assistance software that needs to be fixed. A car company like that should not deserve 8 times sales in valuation when the norm is max 1 and the competition has increased significantly during the 2020s.

Before the rest of 2023 and into 2024, it could therefore be a good idea to avoid the tech sector, park the money in banks and oil, as well as well-chosen boring and cheap shares or acquisitions. When the relative movements become large, the buyouts usually come in a hailstorm. Regardless of whether or not the deals come through, the climate is good for medium-sized companies with focused business models. I like e.g. Elekta, SSAB, Austevoll and Kindred on the Nordic market. Further afield maybe Capri (Versace).

You might still want to ride the climb just a little bit more. By all means do it in well-chosen stocks, but hedge the downside with various index products and be prepared to hit the sell button when the dreaded pivot arrives, i.e. interest rate cuts that confirm the severity of the economic downturn.