Are We Still Waiting For A Market Correction?

Many people have been asking, “when are we going to see this 10% market correction that the talking heads on CNBC and Fox Business have been discussing so often in recent weeks?”

The answer is: we’ve already seen a lot of the necessary pullbacks in over-inflated parts of the market. Many investors were concerned about the overly euphoric amount of leveraged buying (primarily driven by a new wave of retail traders/investors) in unprofitable/newly profitable tech stocks, SPACs, and cryptocurrencies.

I think it is fair to say that investors and traders have deflated some of the most stretched corners of the market in the past 3 months. Investors and traders are playing this market more rationally than some give them credit for. We’ve seen a rotation out of growth and into value over the past 6 months, deleveraging (such as the Archegos implosion), and tremendous Q1 earnings that have justified a lot of the S&P 500’s 14-month ripping rally.

The Deflation We Needed

High-growth equities had a huge run from their pandemic lows. Record low-interest rates, innovative stay-at-home technologies, along with overzealous retail traders drove these high-growth names to the moon, but these stocks have fallen back to Earth since mid-February as the economy reopens and treasury yields move higher. This growth narrative is best exemplified with Cathie Wood’s Ark Innovation ETF (ARKK), which rallied 385% from its pandemic lows to its high on February 16th but has since experienced an over 30% decline.

The SPAC mania that we saw at the end of 2020 in the first 3 months of 2021 has almost entirely evaporated as the risks associated with investing in these blank check enterprises quickly revealed themselves. 451 companies have had an IPO this year and 72% of them were SPACs. There are still 422 of these vague investment vehicles looking for a private company to take public. The problem is that there just aren’t enough private companies willing to go public via SPAC to meet the unprecedented volume of blank check companies listed. Investors and traders have rapidly lost interest in this nascent asset class, and you can see this in CNBC’s SPAC 50 index, which has lost 20% of its value since mid-February.

The “Great Unwinding” in the crypto market over the past couple of weeks seems to have been the final deleveraging compression that the market needed to get back to some level of parity. Some crypto trades were able to obtain 100 to 1 leverage on their positions, which is absolute lunacy. This leveraged trading drove both the massive upside in the past 6 months and its rapid capitulation in the past 2 weeks, forcing traders to cover margin calls and exit crypto positions in hordes.

Take Away

These 3 precarious corners of the market embodied the euphoria that I had been most concerned about regarding short-term risks. The blind buying frenzies we saw earlier in the year have largely dissipated, and these overextended segments have come down to much more moderate levels. Still, the S&P 500 is only 1% off its all-time highs and holds a roughly 75% annualized rate of return since the pandemic lows. The cyclical value rally since the beginning of November is keeping the drive alive.

I expect to see consolidation and some chop in the months to come, which should provide us with some short-duration opportunities. 

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ARK Innovation ETF (ARKK): ETF Research Reports
 
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