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DDIntel - Beware The Reaper Rally

DDIntel - Beware The Reaper Rally
By DataDrivenInvestor • Issue #38 • View online

Last week, the market broke a 2 month losing streak, making many wonder if stocks had marked a bottom and the bear market was over. Some pundits have even been calling for a June “ripper” rally. A so called ripper rally is a strong rally resulting in upward pressure on prices often accompanied by a short squeeze.
Sometimes, if it’s particularly pronounced, it’s known as a “face ripping” rally, as Fundstrat’s Tom Lee correctly named in April of last year. On April 5th, 2021, when the S&P 500 sat at 4077, Lee predicted 4200 by the end of the month. The S&P closed 20 points off his target. Unfortunately, fast forward 13 months, and the S&P 500 is down for the year, sitting around 4100.
What’s a face ripping rally, you ask? Well, when CNBC interviewed Tom Lee, there was no “technical term” for a “face ripper” rally. But after Lee’s continued accuracy, Urban Dictionary has enshrined the phrase into internet diction for eternity:
This is an extremely painful event. It typically occurs in the stock market, when you just finished getting so leveraged up on full margin with short positions.
The stock market then viciously turns and “heads” up the other direction all while ripping your face physically off. It happens so quickly it is typically only noticed when you look up from your keyboard to ask your trading partner what happened, and he only see’s a pair of lips and what used to resemble a face talking to him.
However, it’s important to distinguish between a garden variety ripper rally and what might be called a “Reaper Rally”. A reaper rally is essentially a bear market rally, a dead cat bounce, a bull trap. But calling it a reaper rally brings out what’s at stake: the financial reaper.
The main operational theory for how the stock market works according to economists is the efficient market hypothesis. It is impossible to beat the market, in short. An alternative theory is that the stock market is akin to a casino, where institutions are the house and retail investors are the players.
It’s possible to beat the house. But unlikely.
This theory has a number of implications. Perhaps most importantly, the “goal” of the stock market is to squeeze as much money from as many people as possible, on both the way up and the way down.
The stock market often moves counterintuitively for just this reason. For example, suppose that most people are bearish. The self fulfilling nature of stock trading implies that this bearishness will be reflected in declining prices.
However, it is possible for “smart” money to go long when everyone is bearish, pushing prices up temporarily, allowing the smart money to begin to short at a better price. This is why just when the market is forming a highly predictable pattern, that’s when the pattern breaks down.
In this context, a reaper rally is a bear market rally, whose goal is to allow a more attractive entry point for smart money shorts. It’s important to understand that when prices shift sharply, known as pivot points, there are literal bankruptcies happening. Another one meets the financial reaper.
Even a dead cat will bounce dropped from a great enough height, bulls will be trapped, suckers will be pulled in, and shorts will be squeezed. Now you can add another phrase to your lexicon: the reaper rally.
Of course, correlation is not causation. We’re not claiming that last week’s rally was The Reaper Rally, although the rally failed to continue this week, which suggests it might just have been exactly the market fake out described here. We’re also not calling that a reaper rally in the coming weeks.
But unlike Blue Oyster Cult, we recommend fearing the financial reaper.
Don’t lever up maximally in any direction, don’t become completely bearish or bullish, and don’t try to time the market. Instead invest for the long run by dollar cost averaging into companies you believe in.
Nevertheless, often times pundits’ analysis is no deeper than the aforementioned. Notice how often financial news coverage puts 2 events back to back as if they are related.
“Stocks declined, despite strong consumer sentiment.”
“Stocks climbed, on the backs of strong earnings.”
“The market went up despite bad news”.
But, these are just narratives. Sometimes, the reality is the market went up because of bad news.
In other words, in a bear market, a reaper rally sucks the shorts dry, all the while fooling a new crowd of investors into going long, slaying investors on the way up and down.
Stock market valuations are ultimately a combination of 2 major factors: expected earnings and market multiples. Expected earnings are how much profit a business expects to make (historically, around 7–8% annually), and market multiples are the average multiple of a company’s market cap compared to their earnings (historically, around 15x).
Therefore, the market may hypothetically rally on bad news, if that means that central bank policy may move in a less hawkish direction, effectively increasing market multiples or boosting expected earnings.
But bad news is still bad news. Until we know more about whether inflation is transitory, whether we are in or near a recession, by how much the Federal Reserve will have to raise rates by, and so on, sentiment remains unclear and the vigilant trader must beware the reaper rally.
Thanks for tuning in to this week’s DDIntel. We’ve broken up 10 top articles from the week into 5 different sections. Whether you are an entrepreneur, trader, crypto enthusiast, or just a financial wizard, we’ve got something for you.
Be sure to subscribeforward this to others who might like it, and check out our previous issues. You may also want to learn about how to work with DDI here.
Entrepreneurship
Is Rocket Ship Growth Really the Correct Path for Your Company? | by Marc Patterson | May, 2022 | DataDrivenInvestor
If you’re familiar with Silicon Valley, you’ve probably heard the mantra growth at all costs. Managing Director at Bennu Partners, Marc Patterson, points out that growing too fast may actually backfire, and the vast majority of small businesses don’t need Silicon Valley level growth to thrive.
AstroForge Raises $13m To Mine Asteroids | by slashdotted | May, 2022 | DataDrivenInvestor
The commercial space race is entering a new phase! Y Combinator startup AstroForge recently raised $13 million in hopes of mining asteroids in the near future. Their goal is to demonstrate in space material refinement by the end of next year, and they aim to become one of the first deep space companies.
Trading
Stock Trading Indicators — The Stochastic Oscillator | by Joseph Liebreich | May, 2022 | DataDrivenInvestor
For those budding traders out there, it’s time to learn some indicators! In this article, author Joseph Liebreich covers the stochastic oscillator, an indicator similar to the Relative Strength Index (RSI) that indicates if a stock is possibly oversold or overbought.
The 4 Possible Scenarios For The S&P 500 Today | DataDrivenInvestor
If you are curious, not only whether the market is overvalued today, but how to actually calculate the market valuation yourself, check out this article by Thomas Herold. Herold outlines 4 possible trajectories and highlights whether now is the time to buy. Or not!
Macro
4 Major stock market crashes in U.S. history | DataDrivenInvestor
We had to highlight this deep dive into some of history’s worst financial collapses. Author Arslan Mirza looks at the Great Depression, Black Monday, The Great Recession, and the 2011 Sovereign Debt Crisis. Mirza emphasizes how governments and investors reacted and lessons to be drawn.
GDP Growth: Why Are We So Obsessed with It? | by Deep Dive by Lina | May, 2022 | DataDrivenInvestor
Have you ever simultaneously wondered how to calculate GDP and why economists focus on it to the detriment of other indicators? Then this Deep Dive by Lina is for you! Covering alternatives to GDP measures, such as the Gross Happiness Index, this article is a great introduction to macroeconomics for anyone interested.
Emerging Markets
Is Now the Time to Buy Japan?. and avoid Europe? | by Armchair Banker | May, 2022 | DataDrivenInvestor
Japan’s economy may just be better positioned than many foreign markets during this period of high uncertainty and inflation. Armchair Banker walks us through Japan’s debt issues, its relative standing to Europe, currency strength and weakness, and more. Did you know that Warren Buffet and Jeremy Grantham both have major investments in Japan?
10 Unexpected Jobs and Business Concepts That Will Grow Through the Growth of Electromobility | by Mats Larsson | May, 2022 | DataDrivenInvestor
How is electromobility going to affect emerging markets? Swedish consultant Mats Larsson details how the world is going to change in the coming decades as vehicles switch from oil based to electric. From Infrastructure Strategist to Digitalization Specialist, our electric future has just begun!
Crypto
The Crypto Mayhem: Terra Luna Investors Burning Their Worthless Coins | by Napoleon | May, 2022 | DataDrivenInvestor
If you have been following crypto markets, then you probably heard about the recent Terra “stable coin” collapse. If not, do you live under a rock? Terra is rightfully roasted in this article, so check it out if you want to learn more about crypto, stable coins, and Terra, all the while enjoying a bit of humor.
And now, what to do with the stablecoins? After reading up on Terra, this should be your first question. And Carlos Pascual has an answer. Stable coins are an important element of stability in the crypto markets; it will be crucial to see what happens to algorithmic stable coins in the wake of Terra’s failure.
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