Don’t Be Fooled by the Current Stock Rally

Don’t Be Fooled by the Current Stock Rally

Dear Reader,

Companies worldwide are struggling to navigate these strange and unprecedented times, yet the stock market is rallying. Even companies on the brink of bankruptcy have seen surges in their share prices recently.

The question is: Is the mania over yet?

Well, to borrow a famous phrase from 1920s entertainer Al Jolson — which Jim Rickards artfully builds on below — you ain’t seen nothing yet.

Read on for more.

Until next time,

Shae Russell Signature

Shae Russell,
Editor, The Daily Reckoning Australia

You Ain’t Seen Nothing yet

The most famous singer in the world in the 1920s and 1930s was Al Jolson. At one point, he had the No. 1 movie, the No. 1 Broadway show, and the No. 1 record — all at the same time. When Jolson would finish a song to rapturous applause, he would thank the audience by stepping up to the microphone and saying ‘You ain’t seen nothing yet!’ before launching into an even more popular song.

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Well, bankruptcy lawyers are saying the same thing to investors, and that’s not a good thing.

In this new depression, we’ve already seen major bankruptcy filings by JCPenney, J Crew, Neiman Marcus, Hertz, Pier 1 Imports, Frontier Communications, and other household names. That would normally be a full plate of major bankruptcies for an economic recession, but, according to this article, the legal filings have just started.

Bankruptcies galore

May 2020 had the largest number of major bankruptcies (defined as companies with at least $50 million in debts) of any month since the global financial crisis of 2007–09. But this new depression is just beginning.

Bankruptcy lawyers say privately that they’re working on a number of huge new filings right now, but of course they can’t reveal their clients’ names. You can expect that at least one large US airline will be in that mix. Sometimes, creditors of distressed companies actually prefer bankruptcy because their debt is converted into equity in the reorganised company, which emerges with a clean balance sheet and a chance to return to the markets.

It’s different for equity holders; in bankruptcy they are usually wiped out. Investors cheering on equities in the current rally should exercise some caution. The new stock market rally is thinly traded, mostly by robots. Among the ‘winners’ may be some losers heading for bankruptcy soon. That equity will soon be worth nothing. Don’t bother asking the robots for your money back.

Don’t be fooled by the current stock rally

Stocks staged an impressive rally from late March to early June, regaining over half the ground that was lost in the crash from late February to late March. This was also trumpeted by the Wall Street crowd as a sign that the worst was over, the economy was reopening quickly, and a solid ‘V’-shaped recovery (down fast, up fast) was right around the corner.

This article describes a global stock market rally feeding off the US rally. It’s as if the whole pandemic never happened. Is it all good again? History tells a different tale.

During the Great Depression, the Dow Jones Industrial Average fell 89.2% from 1929–32. However, the Dow staged some impressive rallies along the way. Stocks rose 28.6% from 17 November 1929 to 20 April 1930. They rose 13.2% from 22 June to 7 September 1930. Stocks rallied again by 17.5% from 18 January to 22 February 1931. And finally, stocks rallied 22.2% between 31 May and 28 June 1931.

These double-digit rallies occurred in the midst of the greatest decline in history. The tape tells the tale. The 1929 rally started at Dow 228. The 1930 rally started at Dow 215.

The January 1931 rally started at Dow 163. The May 1931 rally started at Dow 128.

These rallies took place during a slow, relentless fall in the Dow from 380 to 42 by the time of the bottom in July 1932.

Rallies tell you nothing about the long-term trend

It’s not that rallies don’t happen. It’s not that some investors don’t make money. It is the case that rallies tell you nothing about the long-term trend, which is driven by larger forces than momentum and wishful thinking.

So, if you’re in the stock market right now, enjoy the ride. But be prepared for more drawdowns and further crashes before the economy and the markets find their footing.

The pandemic is not over. The new depression is not over. Social unrest is getting worse. And the stock market has much further to fall despite these bear market rallies.

All the best,

 Jim Rickards Signature

Jim Rickards,
Strategist, The Daily Reckoning Australia

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