- Following the quick, sharp market correction, there are three possible paths the market could go (a V bottom, retest, or a meltdown)
- We look at historical examples of each—and write about why one is the odds-on favorite
- Most encouraging is the gaggle of growth stocks that have bounced back strongly (often after earnings); many look to be in pole position if and when the buyers retake control.
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We’ll let others get into the supposed reasons why, but the fact is the stock market finally had a “real” correction recently, lowlighted by the sharp slip at the very beginning of August. From top to bottom (including last Monday’s panic open), the Nasdaq fell 16%, the S&P 500 fell 10% and formerly leading areas (like chips) collapsed, falling as much as 27%—all in less than four weeks.
Of course, the question now is—was that the low? Are we headed up from here? Or was that wipeout the start of something worse? As you might guess, I have a few thoughts: Today we’re going to look at three different scenarios and what the evidence tells us is most (and least) likely.
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3 Scenarios for the Market Going Forward
#1: Start of a Larger Decline or Bear Phase
The first scenario is the one none of us want to see, with the recent market decline being just the first leg of a bigger decline, possibly even a bear market, similar to how things played out in late 2021 and early 2022.
To be fair, there were some signs that point to this possibility—namely the divergence in June and July, something that’s often seen near tops. Even so, the preponderance of longer-term evidence (trend, tons of studies that point to higher prices, modest big-picture sentiment) is still positive, even among the hardest hit areas (like chips). Nothing’s impossible, but this is the least likely scenario in my opinion—maybe a 10% chance.
#2: V Bottom
The second scenario is the opposite of the first: The market’s 18-day air pocket was enough to reset things, and the major indexes simply march higher from here, similar to what was seen during the mini-bear phase of late 2018.
So far, that’s exactly what they’ve done, in fact—so far, for instance, the S&P 500 and Nasdaq have recovered 7.2% and 9% (respectively), with the S&P 500 pushing above its 50-day line and the Nasdaq testing its own key average. We’d also note that the Monday, August 5 wipeout did bring many panic readings, such as the VIX lifting over 60.
Probably the biggest factor in favor of the V bottom is the preponderance of growth stocks that either took the selling in stride or did get hit but have bounced right back (so-called tennis balls) in the past two weeks … not usually what you see if the market was about to keel over again. Honestly, I’m seeing more tempting names among growth titles now than I did a month ago, despite the action of the Nasdaq. Three of many examples are Monday.com (MNDY), the Israeli software provider that nosedived during the correction but has come all the way back to new highs after earnings; SharkNinja (SN), a fast-growing consumer products firm that also exploded higher after earnings; and Argenx (ARGX), an emerging blue chip in the drug space that’s actually risen 12 weeks in a row (!) and has shown huge buying power of late.
A week and a half ago, I’d say the chance of a V bottom was very low, but the push higher in the indexes and buoyant action of growth stocks has me thinking it’s a good chance—call it 35% to 40%.
#3: Bottoms Are a Process—Partial or Full Retest
This is the scenario I still think is most likely, though as you can tell by the prior percentages, it’s by no means a sure thing. A lot of the retest scenario comes down to a student-of-the-market-ism that big, sudden drops take time to “heal,” which is a cute way of saying big investors don’t have a chance to sell all the stock they want to during the first leg down, and thus need more time to sell (on the next bounce) and reposition their portfolios. There are countless examples of this, but the short, sharp 1998 bear phase was classic.
As we wrote at the outset, the ferocity of the recent slide was very sharp and quick—16% in the Nasdaq in just 18 days—and saw many leaders give way; in most cases, that initial wave of selling leads to some future reverberations, again as investors reposition their portfolios. Moreover, while the rally has been impressive, many of the formerly leading areas still appear to be “normal” retracements of the prior decline.
Another factor here is corrections usually have three “legs,” with the first being ignored by most (great buying opportunity! nothing to worry about!); this would correspond to the second half of July. The second leg gets worse, and at that time people realize there are issues (yen carry trades, economy weakening, etc.); that would correlate to what we saw during the recent meltdown.
And the third leg, which often involves some sort of retest of the prior low, brings panic—the indexes might not be any lower (net-net) than the second leg, but the news is much worse. When many throw in the towel, the market bottoms and begins its new advance.
All told, I’d say this rebuilding process (maybe with a retest) has something like a 50% to 55% chance of happening, slightly greater than the V scenario.
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To be fair, the real key during the next few weeks is to remain flexible. If the nascent growth stock strength accelerates, more breakouts emerge and all key major indexes reclaim and hold above their 50-day lines, I can’t ignore it—and, conversely, if the market suffers another air pocket like two weeks ago, you can never rule out a much deeper correction.
Still, as it stands now, the intermediate-term trend of most indexes, sectors and stocks is either down or, at best, sideways. That’s why I’m still playing things cautiously—nibbling a bit here and there but still holding lots of cash and seeing if the rally can confirm itself on the upside.
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