“Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.” That quote from Sir John Templeton is older than any of us living today, but it’s as relevant in today’s market landscape as it’s ever been.

Another well-known quote is, “Trees don’t grow straight to the heavens.” It certainly feels like stocks can go straight to the moon, however, when the market cycle is in its euphoria phase. Folks who’ve been around long enough to remember the boom and bust phases of the 2000 internet bubble know how it feels to be on both sides of the cycle.

The problem is, financial traders have short attention spans and extreme recency bias. They expect stock market crashes to resemble 2020, when the downturn only lasted a couple of months and the recovery was sharp and immediate.

Gratification won’t always be immediate, though, and not every dip will be bought if the Federal Reserve isn’t hellbent on rescuing the stock market this time. Chairman Jerome Powell’s focus, this time around, is taming inflation at all costs so he doesn’t repeat the policy errors that led to hyperinflation in the 1970s.

Mega-cap stock traders are conveniently ignoring this, along with a host of other problems: a deeply inverted yield curve (which has consistently preceded recessions), five consecutive months of the Purchasing Managers Index (PMI) indicating that the U.S. manufacturing sector is in contraction, and job openings falling to a two-year low.

Yet, the stock market moves continuously upwards – or at least, that’s how it appears. Many stocks in the S&P 500 are actually flat or barely up in 2023 so far, but the index is heavily weighted in favor of a handful of tech stocks.

It’s astounding, when you think about it, that the top 10 stocks in the S&P 500 currently account for a 31% of the entire index – a record for the past 40 years. Just to compare, the top 10 stocks accounted for only 17% of the S&P 500 eight years ago.

That’s how it’s possible for a 500-stock index to rally even just because short-term traders and price chasers are crowding into a few tech names. They’ve even been given the title of the “Magnificent Seven,” which include Meta, Apple, NVIDIA, and other usual suspects.

With the tech-heavy NASDAQ up 37% year-to-date and the S&P 500 up 19%, one might assume that investors are rolling in profits now. In actuality, however, most people will lag the stock market’s moves; people tend to crowd into the long side of the trade only after the bull market has already been “confirmed” by a huge move to the upside.

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    Along with that, many stock traders have been conditioned to buy every dip since the post-pandemic rally – and really, since the Fed-backstopped recovery from the 2008-2009 financial crisis. After all, mega-caps are “too big to fail” and that means investors get a bailout every time.

    There’s no guarantee of a bailout the next time, though. The stock market has already priced in the end of inflation, no more interest rate hikes and the start of rate cuts in 2024, and terrific corporate earnings. If any of the legs of that table give way, the table itself will collapse.

    Keeping the inflation genie in the bottle will be awfully difficult when the oil price (shown above) is heading quickly toward short-term highs. It’s hard to imagine that stocks will continue to rally after five consecutive positive months – but again, most traders follow the most recent price moves instead of asking themselves, “What could possibly go wrong?”

    A lot can go wrong when people don’t know when to take profits. After such powerful gains during the first seven months of the year, investors can’t reasonably expect the remainder of 2023 to match that performance.

    But then, it’s unreasonable to expect people to be reasonable. Sir John Templeton was trying to warn us about the consequences of following crowds, but that’s human nature; only a few people like Warren Buffett and Charlie Munger actually resist the temptation to buy after everyone else has bought stocks.

    And, the results speak for themselves: Buffett and Munger are billionaires, while the market’s laggards and price chasers typically end up losing money. If there’s any silver lining here, it’s that a new bull market will be born the pessimism after the current one dies on euphoria – and that’s when you can buy the “Magnificent Seven” at magnificent prices.

    Prosperous Regards,
    Kenneth Ameduri
    Chief Editor, CrushTheStreet.com

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